THEORIES IN IA MIDTERMS EXAM

THEORY 1 - All about classification of current assets - trade receivables

In a properly classified statement of financial position, trade receivables are generally

classified as current assets because they are collectible within entity’s normal
operating cycle.

Where the normal operating cycle of the business extends beyond 12 months because
of long credit terms, as in the case of certain installment receivables (e.g., installment
sales for household appliances), in which such accounts are integral part of working
capital, it is appropriate to classify the receivables as current assets; however, the
amount or estimate thereof not collectible within 12 months should be disclosed.

Non-trade receivables that are expected to be collected within 12 months from the
end of the reporting period are also classified as current assets, regardless of the
length of the entity’s normal operating cycle.

Receivables

Did they arise from sale of goods

and services in the normal
course of business?

Are they collectible within 12

months from the end of the
reporting period?

YES NO

Report as
current assets Report as non-
current assets

THEORY 2 - Examples of trade receivables

Trade receivables should include only charges for actual sales completed (when
there has already been actual or constructive delivery of goods or performance of
services) on or before the end of the reporting period. Such as:

Trade account receivable

Trade receivable - assigned
Trade receivable - unassigned
Notes receivable - trade
Credit card sale

THEORY 3&4 - Formula in computing accrued interest receivable on notes

receivable

Accrued interest = Principal amount x interest rate x time

Divide by 12 if per month hinahanap

Divide by 365 if per day

Example:

Frame Company has an 8% note receivable dated June 30, 2021, in the original
amount of 1,500,000

Payments of P500,000 in principal plus accrued interest are due annually on July 1,
2022, 2023, and 2024.

On June 30, 2023, what amount should be reported as accrued interest on the
note receivable?

Since sa June 30, 2023 yung hinahanap na amount sa accrued interest, 500k lang
muna babawasan natin sa principal amount na 1,500,000 pero if nag-due yan ng July
1, 2023, then 1,000,000 ang ibabawas sa kanya.

Computation:

1,000,000 x 8% = 80,000 ang sagot.

THEORY 5 - All about discounting of notes receivable

Discounting of notes receivable is another form of receivable financing whereby the

holder endorses a note to a bank in exchange for the maturity value less a discount. At
maturity date, the bank collects from the maker of the note. Notes may be discounted
on a without a recourse or with a recourse basis.

Without recourse With recourse

 The entity is not liable in case the  The entity is liable in case the maker
maker fails to pay. fails to pay
 The note is solid outright and  The note is not derecognized and the
therefore derecognized. discounting is accounted for as
either:
a. Conditional sale - a contingent
liability equal to the face amount of
the note is only disclosed in the notes
to financial statements
 b. Secured borrowing - a liability
equal to the face amount of the note
is recognized.

Net proceeds = Maturity Value - Discount

Maturity Value = Principal + Interest for the full term of the note
Discount = MV x Discount period x Discount rate

Discount period - is the remaining period to maturity date of the note as of date of
discounting. The discount period is also the unexpired term of the note and can be
computed as the “full term of the note less the expired term”

Discount rate - is the rate at which the note is discounted with a back.

Interest income - is the accrued interest as of the date of discounting.

THEORY 6 - Examples on non-trade receivables

Receivables that arise from sources other than from sale of goods or services in the
normal course of business are considered non-trade receivables. Specific examples
of non trade receivables include:

a. Loans to officers and employees

b. Advances to affiliates
c. Accrued interest and dividends
d. Deposits to guarantee performance or payment or to cover possible damages or
losses
e. Subscriptions for the entity's equity securities (if collectible within 12 months)
f. Deposit with creditors
g. Claims for losses and damages
h. Claims for tax refund or rebates
i. Claim against common carriers for damaged or lost goods

THEORY 7 - Reasons selling accounts receivable

The advantages of selling accounts receivable include: quick access to working

capital without creating debt, streamlined business operations, improved cash flow
issues, no more late payments, and easier to qualify for than traditional bank funding.

THEORY 8 - All about notes receivable

A note receivable is a claim supported by a formal promise to pay certain sum of

money at a specific future date usually in the form of a promissory note. A note can
be negotiable instrument that a maker signs in favor of a designated payee who may
legally and readily sell or otherwise trander the note to others. It is considered fairly
liquid, even if long-term, because entities may easily convert them to cash, although a
fee might be paid to do so.

Entities classify notes as either:

Interest bearing note
has a stated interest rate (nominal rate, coupon rate, face rate)

Non interest-bearing note

does not have a stated interest rate but included as part of the face amount present
value computation is needed to separate interest from the principal amount

THEORY 9, 11 & 12 - All about inventories - when do we classify items as

inventories

Assets held for sale in the ordinary course of business (finished goods)

In the process of production for sale ( work in process)

In the form of materials or supplies to be consumed in the production process

Examples of inventories:

a. Merchandise purchased by a trading entity and held for resale.

b. Land and other property held for sale in the ordinary course of business
c. Finished good, goods undergoing production, and raw materials and supplies
awaiting use in the production process by a manufacturing entity.

Recognized when:
a. they meet the definition of inventory
b. the entity obtains control over them
c. legally enforceable rights ( ownership or legal title)

THEORY 10 - All about consignment

 Consignor delivers the goods to Consignee

 Consignee sells the goods in behalf of the consignor

 Consignor retains the control over the consigned goods until they are sold to the
customers.

 Until they are sold, the consigned goods remain in the consignor’s inventory

 Freight and other incidental costs of transferring goods to the consignor –

included in the cost of the consigned goods.

 Repair cost for damages during shipment and storage costs are charged as
expense

 Commissions paid to the consignee are recorded as expense by the consignor

and income by the consignee.

THEORY 13 - 14 All about FIFO, LIFO, Weighted average

 FIFO - assumed
that inventories that were purchased or produced first are sold first, and therefore
unsold inventories at the end of the period are those most recently purchased or
produced

WAM - cost of sales and ending inventory are determined based on weighted average
cost of beginning inventory and all inventories purchased or produced during the
period. The average may be calculated on a periodic basis or as each additional
purchase is made, depending upon the circumstances of the entity.

LIFO - Last in, first out (LIFO) is a method used to account for business inventory
that records the most recently produced items in a series as the ones that are sold first.

THEORY 15 - Effect of inflation in inventory costing

If inflation is rapid enough, shortages of goods as consumers begin hoarding out of

concern that prices will increase in the future. Therefore, high inflation encourages
companies to keep a high level of inventories.

THEORY 16 - Accounting treatment for AR assigned

NOTIFICATION BASIS NON-NOTIFICATION BASIS

Assignor/borrower notifies the debtor Assignor/borrower does not notify the
whose receivables have been assigned debtors

Debtor will remit payments on the Debtors will continue to remit payments
receivables directly to the to the assignor/borrower
assignee/lender
On March 1, 20x1, ABC Co. assigned P4,000,000 accounts receivable to Piggy Bank
in exchange for a 2-month, 12% loan equal to 75% of the assigned receivables. ABC
Co. received the loan proceeds after a 2% deduction for service fee based on the
assigned accounts. During March P2,500,000 were collected from the receivables.
Sales returns and discounts amounted to P50,000.

THEORY 17 & 20 - All about allowance for doubtful accounts

Basic accounting concept: assets should not be recognized at more than their
recoverable amount.

Recognized to adjust the receivables to their recoverable amount

It is treated as a contra-asset(deduction) to accounts receivables when determining

Net Realizable Value (NRV)
Similar terms include "Allowance for Bad Debts," "Allowance for Uncollectible
Accounts," "Allowance for Probable Losses on Receivables," and "Loss Allowance."

THEORY 18, 26 & 32 - All about factoring of AR

Sale of receivables to a financial institution (factor)

Without recourse
factor assumes the risk of uncollectability
transferor not liable if debtor fails to pay
receivable is derecognized entirely
With recourse
transferor guarantees payment to the factor
transferor pays the factor in case debtor defaults

FACTORS HOLDBACK
transferor is responsible for any sales returns and discounts
factor retention is recorded as “ “Factor’s holdback” or “Receivable from factor”

Casual basis
charges are recorded as loss if factoring is an isolated event

Regular
charges are recorded as commission expense or interest expense if factoring is done
on a regular basis

THEORY 19 & 28 - All about adjustments to bad debts expense

page 167 onwards sa book wahahah ang dami (if gusto niyo lagyan pa-share please)

THEORY 21 - All about pledging of AR

Under a pledge transaction, receivables are used as collateral security for a loan. A
pledge is treated as secured borrowing because the pledgor/borrower retains control
over the pledged receivables. Accordingly, the pledged receivables are not
derecognized, and are also not specifically identified from other receivables. No entry
is made for the pledged receivables; only a note disclosure is necessary. Only the loan
transaction is needed.

THEORY 22 - All about gross method, net method

Either of the two are used when accounting for cash discounts under Traditional
GAAP
Gross Method - Accounts Receivables and Sales are initially recorded at amounts
gross of cash discounts. Cash discounts are recorded only when they are taken by the
buyer.

Net Method - AR and Sales are initially recorded at amounts net of cash discounts.
Cash discounts not taken by the buyer are credited to the "Sales Discount Forfeited"
account and included as part of "other income" or "finance income." Cash discounts
taken by the buyer are not accounted for.

Ex: An entity sells inventory with a list price of P10,000 on account under credit
terms of 20%, 10%, 2/10, n/30.
Gross Method Net Method
1. Sale on account
Accts Receivable* 7,200 Accts Receivable** 7,056
Sales 7,200 Sales 7,056

*(10K x 80% x 90%) **(10K x 80% x 90% x 98%)

Trade discounts are deducted from the list Trade and cash discounts are deducted from
price to determine the invoice price gross of the list price to determine the invoice price
cash discounts. net of cash discounts.
2. Assume collection is made within the discount period
Cash 7,056 Cash 7,056
Sales Discounts (7,200x2%) 144 Accounts Receivable 7,056
Accounts Receivable 7,200
3. Assume collection is made beyond the discount period
Cash 7,200 Cash 7,056
Accounts Receivable 7,200 Sales Discounts Forfeited 144
Accounts Receivable 7,056

THEORY 23 - All about purchase discount lost

Purchase Discount Lost - an account used when accounting for cash discounts under
Net Method when cash cash discounts are not taken.

Ex: An entity purchases inventory with a list price of P10,000 on account under credit
terms of 20%, 10%, 2/10, n/30.
Gross Method Net Method
1. Purchase of inventory
Purchases 7,200* Purchases 7,056**
Accounts Payable 7,200 Accounts Payable 7,056

*(10K x 80% x 90%) **(10K x 80% x 90% x 98%)

4. Assume payment is made within the discount period
Accounts Payable 7,056 Accounts Payable 7,056
Purch Discounts (7,200x2%) 144 Cash 7,056
Cash 7,200
5. Assume payment is made beyond the discount period
Accounts Payable 7,200 Accounts Payable 7,056
Cash 7,200 Purchase Discounts Lost 144
Cash 7,200

THEORY 24 - All about perpetual inventory system

 “Inventory account” is updated each time a purchase or sale is made

 shows a running balance of the goods on hand
 stock cards and stock ledger cards are maintained
 physical count is performed only as an internal control to determine the accuracy
of the balance per records
 Purchases, freight in, purchase returns, purchase discounts, cost of goods sold are
recorded in the “Inventory “ account

THEORY 25 - All about non interest bearing note - recording

Fair value plus transactions costs.

Fair value is equal to the present value of future cash flows from the receivables.

246 onwards po sa book hehe (palagay if sinipag kau uwu)

THEORY 27 - Which method of AR financing when AR is considered sold

Sale on trial - the good remains in the seller’s inventory during the trial period
if the good is not returned after the trial period has lapsed, the good is considered
sold.

Page 372 sa book

THEORY 29 - Occurrence of debit balance in Allowance for DA

Page 153 (?)

THEORY 30 - All about bad debts expense - effect in aR

Page 167 (?)

THEORY 31 - All about financing of AR

PRODUCT FINANCING AGREEMENT

seller sells goods to the buyer but assumes obligation to repurchase it at a later date.

Does not result to transfer of control, thus, seller retains ownership over the inventory

PLEDGE OF INVENTORY
borrower uses its inventory as collateral security for a loan

does not result to a transfer of control over the asset, thus, borrower retains the
ownership over the inventory
Warehouse financing – a third party (e.g. public warehouse) holds the inventory and
act as the creditor’s agent. The public warehouse furnishes the creditor the
warehouse receipts evidencing the rights to the inventory

LOAN OF INVENTORY
entity borrows inventory from another entity to be replaced with the same kind of
inventory

results to transfer of control over the assets, thus, the borrower includes the loaned
goods in its inventory
SALE WITH UNUSUAL RIGHT OF RETURN
buyer intends to return the goods to the seller within the time limit allowed under the
sale agreement

Thus, buyer does not recognize this as inventory

SALE ON TRIAL
seller allows a prospective customer to use a good for a given period of time

the good remains in the seller’s inventory during the trial period

if the good is not returned after the trial period has lapsed, the good is considered
sold.

LAY AWAY SALE

goods are delivered only when the buyer makes the final payment in an installment
sales

goods are included in the seller’s inventory until the goods are delivered to the buyer
when he makes the final payment

goods can be included in the buyer’s inventory if:

 significant payments have already been made and
 delivery is probable.

INSTALLMENT SALES
possession of the goods is transferred to the buyer but the seller retains the legal title
solely to protect the collectability of the amount due

considered as regular sales

thus, excluded from the seller’s inventory and included in the buyer’s inventory.

BILL AND HOLD ARRANGEMENT

a contract of sale where a seller bills a customer but retains physical possession of the
goods until it is transferred to the customer at a future date

goods are excluded from the seller’s inventory and included in the buyer’s inventory
upon billing provided
 it is substantive (the customer has requested for the arrangement
 identified separately as belonging to the customer
 available for immediate transfer to the customer
 seller cannot use the goods or sell them to another customer

THEORY 33 - Bad debts which focuses on credit sales

Accounting for Bad Debts - Two methods: a) Allowance Method b) Direct write-off
method
Allowance Method - recognized for bad debts expense when the collectability of
acounts becomes doubtful or questionalbe. Whenit comes certain that accounts are
uncollectible or worthless, the accounts are written off.
Direct Method - bad debts expense is directly written off from the balance of AR only
when the accounts are deemed worthless. No entries are made for accounts that are
merely doubtful of collection.

THEORY 35 - All about trade discounts

Trade dicounts are given to encourage orders in large quantities or to avoid frequent
changes in catalogs, to alter prices for different quantities purchased, or to hide the
true invoice price from competitors. Trade discounts are deducted from the list price
when determining the invoice price. Trade discounts are not recorded (i.e., not
accounted for seperately) by either the buyer or the seller.

THEORY 36 - All about abnormal wastages in inventory - treatment

Abnormal amounts of wasted materials, labor, or other production are excluded from
the cost of inventories and are expensed in the period in which they are incurred.

THEORY 37 - All about inclusion of costs in inventory - costs to be included

Purchase cost
purchase price, net of trade discounts and rebates
import duties
non-refundable purchase taxes
transport, handling and other costs attributable to the acquisition of the inventory

it excludes refundable or recoverable taxes.

Conversion costs – costs necessary in converting raw materials to finished goods

direct labor
production overhead
Other costs - costs necessary in bringing the inventories to their present location and
condition