Accounting for Receivables (Part 2 - Impairment)

An accounts receivable is considered impaired if a loss event indicates a negative effect on the
estimated cash flows to be received from the customer. Notes receivable is a formal claim
against another that is evidenced by a written promise, called promissory note, or a written
order to pay at a later time, called time draft. Notes receivable shall be measured initially at
present value. Present value is the sum of all future cash flows discounted using the prevailing
market rate of interest for similar notes. The prevailing market rate if interest is actually the
effective interest rate. Based on IAS 39, loans and receivables shall be measured in the
statement of financial position at amortized cost using the effective interest method. The
amortized cost is the ledger balance of Notes receivable plus any remaining balance of
Premium on Notes Receivable or minus remaining balance of Discount on Notes Receivable.

At the end of this module, you will be able to:

1. Learn the accounting for receivables (impairment)
2. Define notes receivable
3. Explain the accounting for receivables
The common application of the lessons that are under this module consists of being able to
determine if there are indications that receivables are impaired and understand the nature of
notes receivable.

Accounting for receivables (impairment)

IMPAIRMENT
-An accounts receivable is considered impaired if a loss event indicates a negative effect on the
estimated cash flows to be received from the customer.

PAS 39, paragraph 64, provides that the following detailed guideline in assessing whether
accounts receivable should be considered impaired:
-Individually significant accounts receivable should be considered for impairment separately and
if impaired, the impairment loss is recognized.
-Accounts receivable not individually significant should be collectively assessed for impairment.
-Accounts receivable not considered impaired should be included with other accounts
receivable with similar credit-risk characteristics and collectively assessed for impairment.

Example: An entity had the following accounts receivable at year-end

Customer A 1,000,000
Customer B 1,500,000
Customer C 2,500,000
Customer D 3,000,000
Customer E 2,000,000
Other customer accounts 4,000,000
Total 14,000,000
All of the account receivables are individually significant, except the other customers' accounts
receivable

Customer A not impaired 0

Customer B not impaired 0
Customer C partially impaired 1,500,000
Customer D partially impaired 1,000,000
Customer E totally impaired 2,000,000
It is also reliably determined that a composite rate of 5% is appropriate to measure impairment
on all other accounts receivable.

The impairment loss is computed as follows:

Customer C 1,500,000
Customer D 1,000,000
Customer E 2,000,000
Other accounts receivable
5% x 6,500,000 325,000
Total impairment loss 4,825,000

Customer A 1,000,000
Customer B 1,500,000
Other customer accounts 4,000,000
Total other accounts receivable 6,500,000

The impairment loss is recorded as follows:

Doubtful Accounts Expense 4,825,000
Allowance for Doubtful Accounts 4,825,000

Accounting for notes/loans receivable (Definition, Initial and Subsequent Measurement

and Noninterest-bearing note)
Notes receivable is a formal claim against another that is evidenced by a written promise, called
promissory note, or a written order to pay at a later time, called time draft.

A promissory note is an unconditional written agreement to pay a certain sum of money on a

specific or determinable date to order of the payee or to bearer.

Initial Measurement
Notes receivable shall be measured initially at present value. Present value is the sum of all
future cash flows discounted using the prevailing market rate of interest for similar notes. The
prevailing market rate if interest is actually the effective interest rate.

Short Term - at face value

Long Term
Interest bearing - measured at face value.
Non interest-bearing - measured at present value which is the discounted value of future cash
flows using the effective interest rate.

Rate Note is at
Stated = Effective Rate Face value
Stated > Effective Rate Premium
Stated < Effective Rate Discount

Subsequent Measurement
Based on IAS 39, loans and receivables shall be measured in the statement of financial position
at amortized cost using the effective interest method. The amortized cost is the ledger balance
of Notes receivable plus any remaining balance of Premium on Notes Receivable or minus
remaining balance of Discount on Notes Receivable.

Example 1: Non Interest-Bearing Note

On January 1, 2017, Allan Manufacturing sells an equipment costing P800,000 with
accumulated depreciation of P450,000. The company receives as consideration P100,000 and
a non interest- bearing note for P400,000 due on Dec. 31, 2017. The prevailing interest rate for
a note of this type is 15%.

2017
Jan. 1 Cash 100,000
Notes receivable 400,000
Accumulated Dep.- Equipment 450,000
Equipment 800,000
Discount on Notes 137,000
Gain on Sale of Equipment 13,000

Face Value of the Note 400,000

Present Value of the Note (0.6575 x 400.000) 263,000
Discounts 137,000

Cash Received 100,000

PV of Note 263,000
Sales Price 363,000
Carrying Value 350,000
Gain on Sale 13,000

Amortization Table
Date Interest Revenue Amortized Cost
Jan. 1, 2017 263,000
Dec. 31, 2017 39,450 302,450
Dec. 31, 2018 45,368 347,818
Dec. 31, 2019 52,182 400,000

The following are the entries relating to the note:

2017
Dec. 31 Discount on Notes 39,450
Interest Revenue 39,450

2018
Dec. 31 Discount on Notes 45,368
Interest Revenue 45,368

2019
Dec. 31 Cash 400,000
Discount on Notes 52,182
Notes Receivable 400,000
Interest Revenue 52,182

Glossary
Discount on Notes Payable: Contra-asset account that arises when effective rate is greater than
stated rate.
Impairment Loss: the decline in value of an asset due to a loss event that indicates a negative
effect on the estimated cash flows to be received from the customer.
Premium on Notes Payable: account that arises when effective rate is less than stated rate