Module 2: Receivables

2.1 Nature, recognition, and presentation of Receivables

Receivables are financial assets that represent a contractual right to receive cash or another financial asset
from another entity.
Examples of which are:

1. Trade receivables - These are claims arising from the sale of merchandiser or services in the ordinary
course of business.

It includes accounts receivable and notes receivable.

Accounts receivable are supported by sales invoices (debit to AR and credit to Sales Revenue) while Notes
receivable are supported by a promissory note.

2. Nontrade receivables - These are claims arising from sources other than the sale of merchandise or
services in the ordinary course of business.

It includes the following:

 Advances to Officers / Shareholders / Employees

 Advances to business affiliates (normally treated as long-term investments)
 Subscriptions receivable

If collected within a year, then, it can be reported as a Current asset. (12 months)
If not collected within a year, then, it is reported as a deduction from subscribed share capital in the
shareholders' equity.

 Accrued income such as rent receivable and interest receivable.

 Claims receivable such as claims against common carriers for losses or damages are normally
classified as current.
 Supplier's debit balances - arises from overpayments made by the entity to the supplier or creditor.

Note: Customers' credit balances - We understand that the normal balance of receivables is debit, hence, a
credit balance in the customer's account is not normal but could happen such as overpayments, returns
and allowances, and advance payments. If that would happen, customers' credit balances are not offset in
the receivable account but should be reported as current liabilities.
Recognition:
PFRS 9, paragraph 5.1.1, provides that a financial asset shall be recognized at fair value plus transaction
costs that are directly attributable to the acquisition.
It means the transaction price or the fair value of the consideration given.
Presentation:
Trade and nontrade receivables which are currently collectible shall be presented as a separate one line
item entitled "Trade and nontrade receivables" at the face of the Statement of financial position.
Details are disclosed in the Notes to financial statements.

2.2 Accounts Receivables

Accounts receivable - These are claims by the company to the customers. Its normal balance is Debit and
is generally for trading purposes. (current asset)
Initial measurement: Accounts receivable shall be measured initially at face amount or original invoice
amount. (Net realizable value), cash (face value)
It is not discounted because normally the effect of discounting is immaterial.
Subsequent measurement: Accounts receivable shall be measure at amortized cost.
Amortized cost is the net realizable value (NRV) of Accounts receivable.
Net realizable value is Gross accounts receivable less allowance for bad debts.
To properly measure Accounts receivable, we also need to account for freight charges, discounts, and bad
debts.
Accounting for Freight charges: FOB (“free on board” or “freight on board”)
Freights charges - these are the delivery fees in the purchase of goods. Who will shoulder the freight
charge depends on the terms of the shipping arrangement.
Shipping arrangements can be FOB shipping point or FOB destination.
FOB destination - The title of the goods passes on the destination or upon receipt of the goods by the
buyer. This means that freight should be paid by the seller.
FOB shipping point - The title of the goods passes on the shipping point or upon shipment of the goods.
This means that freight should be paid by the buyer.
Freight collect - Freight charge is paid by the buyer
Freight prepaid - Freight charge is paid in advance by the seller.
Regardless if it is freight collect or freight prepaid, the ultimate consideration of who should shoulder the
freight is the FOB term. If FOB destination, then, it is the seller. If FOB shipping point, then, it is the
buyer.
The seller record the freight as a debit to the "Freight out" account which is reported as part of the entity's
selling expenses.

1. Account for Sales discounts:

Sales discounts - These are cash discounts given by the seller to the buyer, on the latter's prompt payment.
It is a contra sales account and has a normal balance of debit. This can be expressed as 5/10 or n/30
which means 5% discount if paid within 10 days and no discount if paid in 30 days.
Method for recording credit sales and sales discount:
Gross method - The accounts receivable and sales are recorded at gross invoice amount. A sales discount
is debited upon payment of the buyer at the discount period.
Net method -The accounts receivable and sales are recorded at the "net" invoice amount. A sales discount
forfeited is credited upon payment of buyer beyond discount period.
Let us have the side by side Pro-forma journal entry:

b. Account for bad debts:

Bad debts or Doubtful accounts - These are the credit risk of nonpayment by the customers.
The Two methods of recognizing doubtful accounts are:

1. Allowance method - It requires the recognition of "Allowance for bad debts" or Allowance for Doubtful
accounts" every accounting period. The Allowance account is a contra Accounts receivable and has a
normal "credit" balance. This method conforms to the Matching principle (of revenue and expense) and
measured Accounts receivable at NRV.

2. Direct write off method - It requires recognition of bad debts when the account is already proven as
uncollectible or worthless. This method violates the Matching principle and is not allowed under PFRS but
is the only method allowed by the BIR for Income tax purposes.

Let us also have the side by side journal entry under the two methods:
Notice that setting up an expense and allowance account is only made under Allowance method. Direct
write off method will only record the expense upon actual discovery of worthless account but no Allowance
account is recorded.

The methods of estimating bad debts (Doubtful accounts) are:

1. Percent of sales - Bad debts are based on a certain percentage of sales (Income statement approach).
The amount computed is the Bad debt expense for the period.
2. Percent of Accounts receivable - Bad debts are based on a percentage of accounts receivable (Balance
sheet approach). The amount computed is the ending balance Allowance for Bad debt expense.
3. Based on the Aging report – Bad debts would be based on the aging of accounts receivables such as 1-
30 days, 31-60 days, 61-90 days, 91-180 days.

The T-account shows the ending balances of Accounts receivable and Allowance for bad debts are
P781,000 and P74,000 respectively.

2.2.1 Illustrative problem - Gross and net method

To apply the concepts, let us solve the illustrative problem:
On January 15, 2021, Marian Company shipped 100 cellphone units to Angel.
The related data:
The list price per unit P6,200
Trade discount per unit 200
Total freight charges 3,500 FOB shipping point
Tem of payments 2/10, n/30
The invoice price is 150% based on cost.

At month-end, Angel returned 5 units of the damaged cellphone.

The entity uses the perpetual inventory system.

Requirements:
What are the related journal entries if gross and net method?
Notes:

1. Sales is computed as (6,200-200)*100 = P600,000 per gross method.

2. If a Net method, you need to deduct cash discount to arrive at P588,000.
3. Cost of sales is computed as P600,000/125% = P400,000 since the invoice price is based on cost.
4. If the invoice price is based on sales, the cost of sales will just be a percentage of the sale (i.e.
600,000*75% = P450,000).

2.3 Allowance for bad debts

Not all receivables by the entity are collected, inevitably, a certain portion is past due or uncollected but
worst will be written-off (removed from accounts receivable). This leads us to account for bad debt.
Bad debts or Doubtful accounts - These are the credit risk of nonpayment by the customers.
The Two methods of recognizing doubtful accounts are:

1. Allowance method - It requires the recognition of "Allowance for bad debts" or Allowance for Doubtful
accounts" every accounting period. The Allowance account is a contra Accounts receivable and has a
normal "credit" balance. This method conforms to the Matching principle (of revenue and expense) and
measured Accounts receivable at NRV.

Accounts receivable, gross Pxxxx

Less: Allowance for bad debts xxxx
Net realizable value xxxx

2. Direct write off method - It requires recognition of bad debts when the account is already proven as
uncollectible or worthless. This method violates the Matching principle and is not allowed under PFRS
but is the only method allowed by the BIR for Income tax purposes.

Let us also have the side by side journal entry under the two methods:
Notice that setting up an expense and allowance account is only made under the Allowance method. The
direct write-off method will only record the expense upon actual discovery of a worthless account but no
Allowance account is recorded.
The methods of estimating bad debts (Doubtful accounts) are:

1. Percent of sales - Bad debts are based on a certain percentage of sales (Income statement approach).
The amount computed is the Bad debt expense for the period.
2. Percent of Accounts receivable - Bad debts are based on a percentage of accounts receivable (Balance
sheet approach). The amount computed is the ending balance Allowance for Bad debt expense.
3. Based on the Aging report – Bad debts would be based on the aging of accounts receivables such as
1-30 days, 31-60 days, 61-90 days, 91-180 days.

The T-account shows the ending balances of Accounts receivable and Allowance for bad debts are
P781,000 and P74,000 respectively.
2.3.1 Illustrative problem - Allowance for bad debts
Three methods of estimating bad debts (Doubtful accounts):
Percent of Accounts receivable - Bad debts are based on a percentage of accounts receivable (Balance
sheet approach).
Illustrative problem:
Accounts receivable, January 1, 2020 P120,000
Allowance for bad debts, January 1, 2020 10,500
Sales for the period 5,000,000
Collection for the period 3,890,000
% of Bad debts 2%
All sales are on account.
Requirements:

1. How much are the bad debts expense, December 31, 2020?
2. How much are the Accounts receivable, December 31, 2020?
3. What are the related journal entries?
Note: In percent of receivable, the amount computed is the Required Allowance for bad debts. It means
that it is the ending balance of Allowance for Bad debts.

Percent of sales - Bad debts are based on a certain percentage of sales (Income statement
approach).
Illustrative problem:
Accounts receivable, January 1, 2021 P500,000
Allowance for bad debts, January 1, 2021 28,500
Sales during the year 6,250,000
% of Bad debts 3%
Accounts written-off during the year 35,000
Accounts recovered from prior year write-offs 12,700
All sales are on account.
Requirements:

1. Prepare the related journal entries

2. How much is the net realizable value of the Accounts receivable on December 31, 2021?

Aging of accounts receivable - Under this method, the entity uses the aging of accounts receivable to
identify the past due accounts.
2.4 Note Receivables
Note receivable - These are claims to customers supported by a promissory note.
The difference of note receivable to accounts receivable is the latter is not evidence by a promissory note.
(a promise to pay)
Note receivable is initially measured at present value, however, short-term note receivable are generally
measured at face value.
Subsequently, note receivable shall be measured at amortized cost using the effective interest method.
Amortized cost pertains to the present value of the note less or plus amortized portion of the
principal.

There are 2 kinds of a note receivable namely:

1. Interest bearing note

2. Noninterest-bearing note

2.4.1 Interest bearing note

Interest bearing note - It has a stated interest rate on the face of the note. Consequently, it is measured at
face value less any principal collection received. (There is a interest rate)
For example, the principal amount of a P5 Million interest-bearing note is measured P5 Million. It means
the collection is equaled to the Principal Interest.

Illustrative problem:
On January 1, the entity sold land with a cash sales price of P1,200,000 receiving a two-year promissory
note with a stated interest rate of 12% and payable at the end of the 2nd year. The carrying amount of the
land is P900,000.
What are the related journal entries?

2.4.2 Noninterest bearing note

Noninterest-bearing note It does not have a stated interest rate on the face of the note. (Included na yung
rate sa face of the note)
However, a prevailing rate of similar borrowing exists. We call that prevailing rate as Effective rate (or
Market / Yield rate).
The interest is included in the face of the note.
For example, we assume, a P5 Million noninterest-bearing note contains a P400,000 interest on it. Hence,
the principal amount of the note is P4.6 million which is the present value of the note. The P5 Million is the
future value of the note.

Notes:

1. The cash Sales price is the present value of the consideration.

2. If the cash sales price is not given, you need to compute the present value of the noninterest-bearing
note. It can be an installment or lump sum.
3. For installment - the present value of the note equals to Annual payment multiplied by the PV of an
ordinary annuity for a certain period.

Formula (paid in advance, the same date of the inception date):

Formula (annual payment at the end of the year):

4. For lump sum - the present value of the note equals to Face amount multiplied by PV of 1 of an annuity
due for a certain period.

Formula:

To apply the concepts, let us solve the illustrative problem:

On January 1, 2021, an entity sold equipment at a cost of P400,000 for P650,000.
The term includes a down payment amounting to P50,000 and for the balance, the buyer issued a
P600,000 noninterest-bearing promissory note in 3 equal annual installments every December 31.
The effective rate of the note is 10%.
The present value of an ordinary annuity of 1 for three periods at 10% is 2.4869.
Requirements:

1. What is the present value of the note receivable on January 1, 2021?

2. What is the present value of the note receivable on December 31, 2021?
3. What are related journal entries?
Note: The Total balance in the interest income is the Unearned interest income.
In effect, the note included an unearned interest.
Can you solve the following questions?
How much is the note receivable on December 31, 2021?
How much is the current portion of the note receivable on December 31, 2021?
How much is the noncurrent portion of the note receivable on December 31, 2021?

2.5 Loan Receivables and related impairment loss

Loan receivable - It is the financial asset arising from a bank or other financial institution loan to a
borrower.

Initial measurement: At Fair value plus transaction costs that are directly attributable to the acquisition of
the financial asset.

Subsequent measurement: Amortized cost using the effective interest method.

Transaction costs - These are direct origination costs not chargeable against the borrower.
It is recognized as "Direct origination cost" and amortized over the term of the loan. The amortization
decreases interest income.
Origination fees received -These are direct origination costs chargeable against the borrower.
It is recognized as Unearned interest income and amortized over the term of the loan.
Generally, direct origination costs are deducted from origination fees received.
Origination fees include compensation for Credit evaluation fees, processing fees of the documents, and
closing and approving fee of the loan.
Note: Indirect organization costs should be treated as an outright expense.
To apply the concepts, let us solve the illustrative problem:
Impairment of loan:
PFRS 9, paragraph 5.5.1, provide than an entity shall recognize a loss allowance for expected credit losses
on financial asset measured at amortized cost.
Paragraph 5.5.3 provides that an entity shall measure the loss allowance for a financial instrument at an
amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has
increased significantly since initial recognition.
Credit losses are the present value of all cash shortfalls.

Note that the P3,000,000 loan receivable is impaired due to the financial difficulty of the client. In this case,
an allowance for impairment loss is recognized at an amount of P592,100.
The carrying amount of the loan receivable is now P2,407,900.

2.6 Receivable financing

When an entity needs cash, one way to raise it is through Receivable financing. The different forms are as
follows:

1. Pledge of Accounts receivable - Under this form, the entity pledges its Accounts receivable as collateral
on the loan the entity borrowed from the bank. There is no journal entry, a disclosure to the Notes to
Financial statements will suffice to indicate that the bank loan is secured by the Accounts
receivable.

2. Assignment of accounts receivable - Under this form, the entity assigns its rights to the lender.

The owner/borrower is called the Assignor and the lender is called the Assignee.
It can be on a non-notification basis, wherein the entity continues to collect the Accounts receivable -
assigned to the specific customer.
On a notification basis, the bank/lender, notify the customers who are included in the Accounts receivable -
assigned.
The lender will outright deduct the collection as payment to the loan.

3. Factoring of Accounts receivable - Under this form, the entity sells its Accounts receivable to a financial
institution called a Factor.

A gain or loss on factoring is recorded: NRV > than Cash proceeds = Loss on factoring
NRV < than Cash proceeds = Gain on factoring

4. Discounting of a note receivable - Under this form, the payee endorses the note receivable to a bank.

The payee becomes an endorser and the bank becomes the

endorsee.
It can be with recourse, even if the note becomes uncollected, the bank will still collect it to the payee.
If Without recourse, the bank will suffer the loss if the note becomes uncollected.