Chapter 3

RECEIVABLES

LEARNING OBJECTIVES

After studying this chapter, the student should be able to:

 Understand the nature of receivables as a financial asset.
 Enumerate and describe the specific accounts that are classified under receivables.
 Know the requirements for the initial recognition, subsequent recognition, and derecognition
of short-term and long-term receivables.
 Measure the net realizable value of receivables.
 Understand the basic disclosures needed for trade and other receivables.
 Compute for the present value of notes receivable.
 Prepare an amortization table for notes receivable.

WHAT IS A RECEIVABLE?

Since its innovation and successful introduction to the public many years back, plastic
money or credit card has become an indispensable business companion of both customers and
creditors. Banks continue to liberalize their credit card policies in order to capture wider public
patronage, even going to the extent of offering call-for-cash credits. In the same way, business
entities are spending more time, effort, and significant amount of money in advertisements,
giving of discounts and loyalty points, and improving selling strategies to get a significant chunk
of the market as well. The captivating pull of “on sale” strategy of business entities continue to
lure customers to part with their hard-earned money for items which may turn out to be not
necessary after all. Credit transactions have now become permanently entrenched in our culture.

Cash sales compete neck to neck with credit sales, with the latter gaining more ground as
customers try to hold on to their cash for a longer period and use their credit cards instead. The
slogan that says credit is good but we need cash seems to be a thing of the past. Business
establishments that still continue to sell purely on cash basis may find themselves lagging behind
in the race to get public patronage. Noticeably, merchandising business during the last decade
has indeed flourished at an unprecedented level as the volume of credit buying and selling
continue to rise.

Credit sales have contributed a significant percentage to the total income of

merchandisers and service providers. More liberal credit terms are now offered by way of giving
significant trade and cash discount to encourage customers not only to pay their accounts at the
earliest possible time but also to make large volume purchases. With the significant amount of
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credit sales being transacted every day, merchandisers and service providers need to focus on
one of their significant financial assets, receivables. Obviously, once receivables have been
recorded, business firms should monitor these customer accounts by anticipating the probability
of their collection or non-collection, and finally reassessing existing credit policies based on past
experience.

Cash sales immediately increase the entity’s booked revenues in line with the accounting
principle of revenue realization. However, recording of revenues from cash transactions is not
solely the source of revenues. Accounting allows business entities to recognize income when
goods are sold or when services have been rendered, not necessarily when cash is received.
This is the main reason why business firms sell on credit. Given that, accrual assumption
mandates firms to recognize from credit transactions an asset that represents claim from another
party. That asset is what we call receivable.

Financial accounting defines receivable as a financial asset that represents a contractual

right to receive cash or other financial asset from another entity.

TYPES OF RECEIVABLES

Receivables are presented at the current assets section of the statement of financial
position under the heading Trade and Other Receivables. Trade receivables are comprised by
Accounts Receivable and Notes Receivable. These are the usual receivables that arise from the
ordinary course of business operation. However, receivables may not only arise from sale of
goods or rendering of services but may also come from other sources, as listed below:

1. Claims receivable represents amount expected to receive from an insurance company for
any claims in one’s insurance policy.

2. Interest receivable represents the amount of interest already earned but not yet received
as of the end of the year. Interest receivable represents the interest accrued as of yearend.

3. Advances to affiliates such as employees and suppliers represent amounts given in

advance to such parties, which are expected to be received in the near future.

The list given is not exhaustive since there are other receivables an entity might recognize
and record on its financial statements in the course of its daily operations.

Accounts Receivable
These are essentially short-term receivables that arise from the ordinary course of
business operations. When a merchandiser sells goods on credit, he recognizes an account
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receivable in his books. The credit term or agreement is considered an open account which
means that no formal written promise to pay, or promissory note, is required of the customer-
debtor. Term such as 3/10 n/30 normally covers a credit sale, the purpose of which is to
encourage the buyer to pay his account in full within 10 days after purchase date and be granted
a 3% cash discount.

Initial recognition

The general guidelines in paragraph 5.1.1 of the Philippine Financial Reporting

Standard No. 9 (PFRS 9) Financial Instruments state that financial assets such as receivables
are recognized at fair value plus transaction costs that are directly attributable to the acquisition.
Measuring the fair value of a receivable is quite straightforward because accounts receivable are
initially recorded at cost. This means that in a credit sale transaction, the seller or the supplier
records the invoice price as the amount of the receivable on initial recognition.

Short-term receivables, which include accounts receivable, are expected to be collected

within a year; thus, they are initially recorded at face value. An account receivable arises from
the sale on account of the entity’s goods or merchandise and presented as part of current assets
on the statement of financial position. Normally, it is also the amount of revenue, or Sales,
recognized and presented by the entity on the profit or loss statement.

Subsequent recognition

At the end of the reporting period, accounts receivable is reported at its net realizable
value. This means that they are no longer carried at their initial face value but at an amount
expected to be collected from them through an adjustment recognizing probable loss. This is a
logical and generally accepted practice because the entity cannot always expect to recover the
entire amount of the receivables that were initially recognized. Some customers would not be
able to pay the amount due because of certain reasons such as business downturn or bankruptcy.
The accounting process of anticipating probable loss on receivables is supported by the principle
of prudence.

Derecognition

According to paragraph 3.2.3 of PFRS 9, a financial asset such as account receivable is

derecognized, or removed from the books, when either of the two occurs:

1. The contractual rights to the cash flow expire.

2. The entity transfers the receivable and the transfer qualifies for derecognition.

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 The first situation occurs upon the collection of the account receivable, or upon its write-off.
The second situation occurs in a factoring transaction, where the entity sells its accounts
receivable. The carrying amount of the accounts receivable is derecognized thereafter.

Net realizable value

As mentioned earlier, short-term receivables should be reported at net realizable value.

At the end of each year, the entity assesses or estimates the amount that could be eventually
collected from its customers’ accounts.

This estimated amount is the receivables’ net realizable value (NRV). The NRV is
deducted from the gross or outstanding balances of accounts receivable at year end and the
resulting difference is recognized as Allowance for Doubtful Accounts. This is a contra-
account (deduction from) of accounts receivable.

METHODS OF ESTIMATING LOSS ON ACCOUNTS RECEIVABLE

(Recording of Doubtful Accounts Expense)

A. The Allowance for Doubtful Accounts is updated by a certain percentage of

Accounts Receivable

To comply with the generally accepted accounting principle of conservatism (or

prudence), business firms use the allowance method in estimating at year end a portion of their
accounts receivable that may not be collected in the next accounting period. Under this method,
the amount of doubtful accounts expense is estimated through the allowance account under the
following situations:

1. The Allowance for Doubtful Accounts is estimated at a certain percentage of Accounts

Receivable.
2. The Allowance for Doubtful Accounts is increased to a certain percentage of Accounts
Receivable.
3. The Allowance for Doubtful Accounts is increased by a certain percentage of Accounts
Receivable.

The general formula to compute doubtful accounts expense under the allowance method
is set forth below.

Accounts Receivable, end ₱xxx

Multiplied by estimated loss rate 0.xx
Required allowance ₱xxx
Allowance for Doubtful Accounts, before adjustment (xxx)
Doubtful Accounts Expense ₱xxx

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Illustration:

New Millennium Trading shows the following balances in its books as of December 31, 2020:

Accounts Receivable ₱ 500,000

Allowance for Doubtful Accounts (before adjustment) 30,000

Determine the amount of doubtful accounts expense to be recorded by the entity in 2019 under
the following situations:

1. The Allowance for Doubtful Accounts is estimated at 10% of Accounts Receivable.

2. The Allowance for Doubtful Accounts is increased to 15% of Accounts Receivable.
3. The Allowance for Doubtful Accounts is increased by 5% of Accounts Receivable.

Computations to determine the amount of doubtful accounts expense for 2020 are
presented below.

1. The Allowance for Doubtful Accounts is estimated at 10% of Accounts Receivable:

Accounts Receivable, end ₱500,000
Multiplied by estimated loss rate 0.10
Required allowance ₱50,000
Allowance for Doubtful Accounts, before adjustment (30,000)
Doubtful Accounts Expense ₱ 20,000

2. The Allowance for Doubtful Accounts is increased to15% of Accounts Receivable:

Accounts Receivable, end ₱500,000
Multiplied by estimated loss rate 0.15
Required allowance ₱75,000
Allowance for Doubtful Accounts, before adjustment (30,000)
Doubtful Accounts Expense ₱ 45,000

3. The Allowance for Doubtful Accounts is increased by 5% of Accounts Receivable:

Accounts Receivable, end ₱500,000
Multiplied by estimated loss rate 0.05
Doubtful Accounts Expense ₱ 25,000

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 For situations 1 and 2, the updated amount of the Allowance for Doubtful Accounts to be
presented as deduction from gross Accounts Receivable on the Statement of Financial Position is
equal to the computed required allowance of ₱50,000 and ₱75,000, respectively.

Situation 3 does not need a “required” amount for the allowance. The updated amount of
Allowance for Doubtful Accounts for financial statement purposes is obtained by adding the
computed amount of doubtful accounts expense to the unadjusted or previous balance of the
allowance. With this, the amount of the allowance account for financial statement purposes is
₱55,000 (₱30,000+₱25,000).

The effects of the above computations on the balances of accounts receivable, allowance
for doubtful accounts, and net realizable value after posting the adjustment are summarized
below.

Accounts Allowance for Net Realizable

Method Receivable Doubtful Accounts Value
1 ₱ 500,000 ₱ 50,000 ₱ 450,000
2 500,000 75,000 425,000
3 500,000 55,000 445,000

B. Aging of Accounts Receivable

According to PFRS 9, estimating bad debts may also be accomplished by creating

categories or groups that show the number of days the accounts are already past due. An account
is past due if it is not fully paid after expiration of the credit period. For every credit sale, the
seller designates a credit term—for example 2/10 n/30. Any account receivable that is not fully
paid after the 30th day from the date of sale is already past due. If the sale under the said credit
term was transacted on October 1 and the account has not been fully paid as of December 31, the
account is past due for 61 days (from November 1 to December 31) because the 30-day credit
period for the sale ended on October 31.

The rationale behind the use of the aging method is to analyze in more detail the
probability of collection or non-collection of a particular customer account based on the credit
terms. Thus, an account that has been past due for a longer period is assigned a higher estimated
loss rate. If the entity has many customer accounts, aging of the accounts manually would be
very tedious for the bookkeeper. Computers definitely should be used for the process if the
entity wants timely and accurate output.

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Illustration:

The following accounts were gathered from the records of Hannigan Company:

Accounts Receivable, December 31, 2020 ₱ 8,000,000

Allowance for Doubtful Accounts, January 1, 2020 150,000

Hannigan categorizes its outstanding accounts for financial reporting purposes, as follows:

Days Past Due Amount % Uncollectible

Current ₱ 4,000,000 2
1 to 30 1,600,000 4
31 to 90 800,000 6
91 to 120 640,000 10
121 to 180 480,000 20
181 to 360 320,000 30
Over 360 160,000 50

Discussion:

The receivables’ required allowance for doubtful accounts for financial statement
purposes is computed as follows:

Category Amount Rate Required Allowance

(a) (b) (a x b)
Current ₱4,000,000 2% ₱ 80,000
1-30 1,600,000 4% 64,000
31-90 800,000 6% 48,000
91-120 640,000 10% 64,000
121-180 480,000 20% 96,000
181-360 320,000 30% 96,000
Over 360 160,000 50% 80,000
Total ₱ 8,000,000 ₱ 528,000

The required balance of the Allowance for Doubtful Accounts at the end of the period to
be deducted from the face value of the outstanding accounts receivable should be ₱528,000. It is
necessary to bring the amount of the beginning balance of the allowance from ₱150,000 to
₱528,000. Increasing the amount of the allowance by ₱378,000 requires recognition of Doubtful
Accounts Expense for ₱378,000.

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 At the end of the reporting period, Hannigan Corporation’s Accounts Receivable should
be reported at net realizable value of ₱7,472,000 under the current assets section of its statement
of financial position:
Accounts Receivable ₱8,000,000
Allowance for Doubtful Accounts (528,000)
Net realizable value ₱ 7,472,000

The table above can be seen in the disclosures. This basically means that of the
₱8,000,000 receivables that are yet to be collected by Hannigan, an estimated amount worth
₱528,000 is anticipated to be uncollectible in the next accounting period.

Other notes
When an account receivable is deemed worthless, it has to be written off or removed
from the company’s records. For example, this could happen when the customer has absconded
and cannot be contacted anymore or has declared bankruptcy. In this case, the entity has no way
of collecting the account anymore so that the account receivable from the client, as well as its
corresponding allowance for doubtful accounts, is written off from the company’s records. The
simultaneous removal of the customer’s account receivable and its related allowance for doubtful
accounts will not affect the net realizable value of the firm’s total customers’ accounts.

In the event that the previously written off account is recovered and subsequently
collected by the company, the entity should recognize the cash received as other income.

Notes Receivable

Note receivable is also a trade receivable similar to account receivable but a more formal
claim against another party. In other words, a note is a written promise to pay a certain sum of
money at a specific future date.

How does a note differ from a typical account receivable? Firstly, notes are supported by
a document. Accounts receivable may be oral in nature, although in practice, such an instance is
almost nonexistent because all transactions that enter the books are supported by some sort of
document in compliance with the principle of objectivity. Secondly, notes can be either short-
term or long-term while account receivable is typically a short-term claim and normally
classified as current asset. Lastly, a note normally is interest bearing. An account receivable is an
open account and does not earn interest.

Initial Recognition

The requirements to recognize a short-term interest-bearing note receivable are the same
as those for accounts receivable. On the other hand, a long-term note is initially recognized at
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its present value. In this case, the entity has to know the effective interest rate of the note. The
reason why these notes are recorded at their present value is that the nominal amount (face
amount) of cash that would be received in the future would in fact have less value or purchasing
power than the nominal amount of the same receivable had it been recognized this period. We
take into account the effect of future value vis-a-vis present value because of a number of
factors, one of which is inflation.

The effective interest rate or market rate is the rate used to determine the present value of
a note or any other long-term negotiable instrument. The effective interest rate is quite different
from the note’s nominal or coupon rate. The coupon rate determines the cash that the payee will
receive regularly from the note while the effective rate determines the interest income to be
recorded by the payee. The two rates may or may not be equal. The nominal rate may also be
zero, which means that the note is a noninterest-bearing one.

To determine the present value of a note, apart from the fact that one has to be familiar
with the present value formulas, it is necessary to understand the cash flows by the specific
conditions stated in the note. The agreement would dictate the present value formula or formulas
to be used.

ILLUSTRATION:
A. Note Receivable ‒ recorded at a discount:
Assume that on January 1, 2020, Bridges Co. received a 10%, five-year note, having a
face value of ₱1,000,000. The note pays interest every December 31. On the date of the receipt
of the note, the effective interest rate was 11%.

Since the effective rate of interest is higher than the nominate rate, the note is recorded at
a discount and the present value of the note is lower than its face amount.

Initial Recognition

The present value of the note mentioned above is determined with the use of present
value formulas: (1)one formula to compute the present value of a single sum for the principal of
P1,000,000, and (2) another formula to compute the present value of an ordinary annuity of 1 for
the nominal interest of ₱100,000 (P1M x 10%). The present value formula of a single sum is
shown below:

PV = FV(1 + 𝑖)

PV represents the present value of the principal. FV is the future value of the principal
which is also the face value of the principal itself. The symbol i stands for the effective interest
rate, and t stands for the term of the note.

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 The present value of the interest is determined by applying the formula for the present
value of an ordinary annuity of 1, as shown below:

( )
𝑃𝑉𝑂𝐴 = P[ ]

In the second formula, P stands for periodic payment, or the cash receipt from interest.
This is simply taken by multiplying the nominal or stated rate to the principal of the note.

Given the above formulas, the present value of the note and the discount would be as
follows:
Present value of principal ₱ 593,451.33
Present value of interest 369,589.70
Total present value ₱ 963,041.03
Face amount of the note 1,000,000.00
Discount on Notes Receivable ₱ 36,958.97

The note should be initially recorded at ₱963,041.43, its total present value as shown
above. The difference of ₱36,958.97 between the face amount of the note and its initial present
value is called Discount on Note Receivable, a contra-account of Notes Receivable. For financial
statement purposes, the discount is deducted from the face amount.

Subsequent Recognition

At the end of the reporting period, the initial present value of the note would increase to
₱968,975.54 because of the addition of ₱5,934.51 representing amortization of interest (see table
below). This new present value, or carrying amount, represents the subsequent recognition of
note. At the end of every period thereafter, the carrying amount of the note continues to increase
until it equals the face amount (future value) of the note at maturity. The amortization process is
facilitated by preparing a table of amortization similar to the one shown below:

(a) (b) (c) (d)

Date Interest Earned Cash Received Amortization Carrying Amount
(CA x 11%) (P1M x 10%) (a-b) (Prev. CA + c)
01-01-2020 963,041.03
12-31-2020 105,934.51 100,000.00 5,934.51 968,975.54
12-31-2021 106,587.31 100,000.00 6,587.31 975,562.85
12-31-2022 107,311.91 100,000.00 7,311.91 982,874.76
12-31-2023 108,116.22 100,000.00 8,116.22 990,990.98
12-31-2024 109,009.02 100,000.00 9,009.02 1,000,000.00
01-01-2025 Full collection 0

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Notes:
1. Interest earned (a) is obtained by multiplying column (d) by the effective rate of 11%.
2. Cash received (b) is obtained by multiplying ₱1,000,000 (face amount) by the nominal
rate of 10%
3. Amount of amortization (c) is the result of deducting column (b) from column (a)
4. Carrying amount (d) at year end is the result of adding column (c) to the previous
carrying amount.

From the amortization table above, the carrying amount of the note at the end of 2020 is
₱968,975.54, to be disclosed as follows:

Face amount of note receivable ₱1,000,000.00

Discount on Note Receivable * (31,024.46)
Carrying amount, December 31, 2020 ₱ 968,975.54

* The note received by Bridges Co. for ₱1,000,000 was initially recognized at
₱963,041.03, giving rise to a discount of ₱36,958.97. This initial amount of
discount decreased to ₱31,024.46 at the end of 2020 because of the amortization
of interest for ₱5,934.51. Every end of the period, the balance of the discount
decreases while the carrying amount of the note increases.

Derecognition

If the note is held by Bridges Co. until its maturity date, the note will simply be collected
at its face amount of ₱1,000,000 on January 1, 2025, a day after it matures on December 31,
2024.

B. Note Receivable ‒ recorded at a premium:

Note receivable received at a premium involves the same procedures used for a discount
situation to record its initial recognition, subsequent recognition, and derecognition.

Assume the same data for the note received by Bridges Company on January 1, 2020.
This time, the nominal rate is 13% instead of 10%. The note’s present value is still computed the
same way; but in this case, the nominal rate is now 13%.

This is a premium situation because the effective rate is lower than the nominal rate.
This time, the present value of the note is higher than its face amount, giving rise to a Premium
on Notes Receivable account. The note is initially recorded at ₱1,073,917.94 and the initial
amount of premium is ₱73,917.94, determined as follows:

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 Present value of principal ₱ 593,451.33
Present value of interest 480,466.61
Total present value ₱ 1,073,917.94
Face amount of note 1,000,000.00
Premium on Notes Receivable ₱ 73,917.94

The amortization table is prepared as follows:

(a) (b) (c) (d)

Date Interest Earned Cash Received Amortization Carrying Amount
(CA x 11%) (P1M x 13%) (a-b) (Prev. CA + c)
01-01-2020 1,073,917.94
12-31-2020 118,130.97 130,000.00 (11,869.03) 1,062,048.91
12-31-2021 116,825.38 130,000.00 (13,174.62) 1,048,874.29
12-31-2022 115,376.17 130,000.00 (14,623.83) 1,034,250.47
12-31-2023 113,767.55 130,000.00 (16,232.45) 1,018,018.02
12-31-2024 111,981.98 130,000.00 (18,018.02) 1,000,000.00
01-01-2025 Full collection 0

The premium is presented as an addition to the note receivable. On its December 31,
2020 statement of financial position, Bridges Co. will subsequently record the note it received on
January 1, 2020, as follows:

Face value of notes receivable ₱1,000,000.00

Premium on Notes Receivable 62,048.91
Carrying amount ₱1,062,048.91

The initial amount of premium decreased from ₱73,917.94 to ₱62,048.91 because of the
amortization of interest for ₱11,869.03. Every end of the period, the premium balance decreases
as the amortization of interest increases, resulting in a decreasing balance of the note’s carrying
amount. Finally on December 31, 2024, the premium is reduced to zero, and the carrying
amount of the note equals its face amount of ₱1,000,000, which is the amount to be collected by
the entity.

PRESENT VALUE COMPUTATION USING ORDINARY CALCULATOR

(“Short-cut” method)

There is another way of computing the present value of financial instruments which
include notes receivable. This is done with the use of an ordinary calculator.

Assume the same note received by Bridges Co. on January 1, 2020 and recorded at a
discount.

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Step 1: Determine the present value factor (PVF) of the principal and interest. Using
ordinary calculator, follow the instructions below to obtain the PVFs for both principal
and interest:

Turn on calculator and press the clear all key (CA)

1. Enter “1.11” (The .11 is the 11% effective rate of interest given in the problem.)
2. Press “divide” key once
3. Press “equal” key five times (the five times corresponds to 5 years given in the problem)
4. The result is the PVF of the principal (you should get 0.59345133)
5. Press “M+” key five times
6. Press the “GT” key once
7. The result is the PVF of the interest (you should get 3.6958970)

Step 2: Multiply the principal amount by its PVF to get the present value of the principal.
Likewise, multiply the annual interest (use the nominal rate) by its PVF to get the present
value of the interest, as follows:

₱1,000,000 x 0.59345133 ₱ 593,451.33

₱1,000,000 x 10% x 3.6958970 369,589.70
Present value of note – 01/01/2019 ₱963,041.03

The resulting figures under the “short-cut method” using ordinary calculator are exactly
the same as the figures that were obtained using the traditional present value formulas for both
principal and interest using either the present value tables or the scientific calculator.

Derecognition of All Receivables under PFRS 9

According to paragraph 3.2.3 of PFRS 9, financial assets such as receivables are

derecognized when and only when:

a. The contractual rights to the cash flows from the financial asset expire, or
b. It transfers the financial asset and the transfer qualifies for derecognition.

The first situation occurs when the receivable is collected or is written off in the records
of the company. Should the receivable be derecognized because of a write-off, the face value of
the account and an accompanying equal amount of allowance for doubtful accounts should be
removed from the entity’s records.

FINANCIAL STATEMENT PRESENTATION

Below is a portion of PLDT’s current assets section of its statement of financial position
as of December 31, 2017 (unaudited), with 2016 comparative figures (The 2017 figures are in
bold font).

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 As required by accounting standards, the statement of financial position should present
the results of the firm’s operation for the latest two-year period at the minimum. The reason for
this is to allow users of financial statements to compute on their own financial ratios that
normally require two-year data and be able to analyze the financial position and performance of
the entity.

2017 2016
(Unaudited) (Audited)
Current Assets
Cash and cash equivalents (Note 16) 32,905 38,722
Short-term investments (Note 28) 1,074 2,738
Trade and other receivables (Note 17) 33,761 24,436
Inventories and supplies (Note 18) 3,933 3,744
Current portion of derivative financial assets (Note 28) 171 242
Current portion of investment in debt securities and other long-term investments (Note 12) 100 326
Current portion of prepayments (Note 19) 10,673 7,505
Current portion of advances and other noncurrent assets (Notes 20 and 28) 8,087 8,251
Total Current Assets 90,704 85,964
TOTAL ASSETS 459,262 475.119

Presented below are the accompanying notes for the items contained in PLDT’s statement
of financial position. Each line item of trade and other receivables may not be familiar to many
students, particularly to those who are only exposed to the very basic financial statements of a
merchandising business, rather than that of service concern corporations like the PLDT.

Note 17 – Trade and other Receivables

As at December 31, 2017 and 2016, this account consists of receivables from:

2017 2016
(Unaudited) (Audited)
(In million pesos)
Real subscribers (Note 28) 17,961 20,290
Corporate subscribers (Notes 25 and 28) 9,641 9,333
Foreign administrations (Note 28) 6,517 5,819
Domestic carriers (Notes 25 and 28) 457 354
Dealers, agents and others (Notes 25 and 28) 13,686 7,428
48,262 43,224
Less: Allowance for doubtful accounts (Notes 5 and 28) 14,501 18,788
33,761 24,436

Receivables from foreign administrations and domestic carriers represent receivables based on interconnection agreements with
other telecommunications carriers. The aforementioned amounts of receivables are shown net of related payables to the same
telecommunications carriers where a legal right of offset exists and settlement is facilitated on a net basis.

Receivables from dealers, agents and others consist mainly of receivables from credit card companies, dealers and distributors
having collection arrangements with the PLDT Group, dividend receivables and advances from affiliates.

Trade receivables are noninterest-bearing and are generally with settlement term of 30 to 180 days.

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Analysis of Accounts Receivable

One can evaluate an entity’s financial performance and financial condition with regard to
its accounts and notes receivable by using financial ratios. Financial ratios take into account the
relationship between elements in the financial statements and offer users valuable insights
regarding the two key performance measures mentioned above – performance and condition.

To be more specific, a financial statement user can make use of accounts receivable
turnover and average collection period in evaluating an entity’s performance.

Accounts receivable turnover

Accounts receivable turnover is used to quantify a company’s effectiveness in collecting

its receivables. It shows how well an entity uses and manages the credit it extends to its
customers. The formula for accounts receivable turnover is as follows:

𝐍𝐞𝐭 𝐜𝐫𝐞𝐝𝐢𝐭 𝐬𝐚𝐥𝐞𝐬

𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐫𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞 𝐭𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐚𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐫𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞

Average accounts receivable is the average of the beginning and ending balances of the
customers’ accounts. For example, if the computed accounts receivable turnover is 12, it means
that the entity is able to collect the credit extended to its customers 12 times during the year.
Generally speaking, higher turnover is more favorable because this means that the entity is more
efficient in collecting its customers’ accounts.

Average collection period

Average collection period refers to the number of days that an entity is able to collect
from its credit customers. The formula for this ratio is as follows:

𝟑𝟔𝟓
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐜𝐨𝐥𝐥𝐞𝐜𝐭𝐢𝐨𝐧 𝐩𝐞𝐫𝐢𝐨𝐝 =
𝐍𝐞𝐭 𝐜𝐫𝐞𝐝𝐢𝐭 𝐬𝐚𝐥𝐞𝐬
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐚𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐫𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞𝐬

or

𝟑𝟔𝟓
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐜𝐨𝐥𝐥𝐞𝐜𝐭𝐢𝐨𝐧 𝐩𝐞𝐫𝐢𝐨𝐝 =
𝐚𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐫𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞 𝐭𝐮𝐫𝐧𝐨𝐯𝐞𝐫
Just like accounts receivable turnover, there is no absolute rule in interpreting the
significance of the figure computed for the average collection period. However, it is more
efficient for an entity to have a shorter collection period compared to its normal credit terms. For
example, if the normal credit term of an entity is 30 days, the entity is better off if it has an
average collection period of less than 30 days. This would ensure that accounts receivable
actually materializes into cash at the earliest possible time.

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RECEIVABLE FINANCING

There are instances when business entities would be in a tight cash position for various
reasons. One reason could be a loose or very liberal credit policy coupled with poor cash
collection system. This situation becomes an immediate problem when payables are due for
payment and there is no available cash to pay off those debts. More often than not, firms look to
their accounts receivable that are in current status as probable source of cash. Thus, cash-
strapped firms may resort to receivable financing.

Receivable financing is a technique undertaken by entities to expedite cash flows from

their accounts receivable, which would involve selling, pledging, assigning, and factoring of
customer accounts. Additionally, cash can also be obtained through discounting of notes
receivable.

Pledging

Pledging of accounts receivable is offering of accounts receivable as collateral against an

existing loan. Just like in any other pledging arrangements, the ownership does not transfer to the
creditor yet, nor are the collections used to pay off the debt. The ownership and control over the
receivables would only transfer to the creditor if the debtor defaults on his debt and when this
happens, the entire amount of receivables pledged will be used as payment of the existing loan.

For financial reporting purposes, accounts receivable that have been pledged will not be
removed despite the pledging agreement.

Assignment

Under this scheme, the entity who is called the assignor obtains a loan from a creditor
called assignee. The loan is to be repaid by the collection of the accounts receivable that
assigned to the creditor. When accounts receivable are assigned, the responsibility of collecting
the accounts may be given by the firm to the creditor. However, the ownership to the accounts is
still retained by the firm. Once the accounts are assigned to the creditor-assignee, a new account,
Accounts receivable – assigned, is set up by the entity in its books.

Assignment of accounts receivable may be done on a non-notification or notification

basis. When receivables are assigned on a non-notification basis, customers whose accounts are
assigned are not informed that their accounts have been assigned. Therefore, they would
continue to pay the entity, who will then forward the collections to the assignee to be applied to
his existing loan balance. If the accounts are assigned on a notification basis, the customers
already know that their accounts have been assigned, so they pay directly to the creditor-
assignee. The creditor-assignee regularly renders a report to the assignor-debtor regarding the
status of the assigned accounts and the existing balance of the debt. This arrangement is
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terminated when the loan balance is paid in full and final settlement is made by the entity with
the creditor-assignee.

Factoring

When accounts receivable are factored, the entity actually sells outright its accounts
receivable to a buyer called factor. The factor does not normally pay the seller the entire face
value of the receivables being factored because of the risk of non-collection of the accounts.
Normally, the factor would only pay the seller a portion of the face value of the receivables
factored.

Under pledging and assigning of accounts receivable, it is the entity who bears the loss in
case of non-collection of the accounts. However, when the receivables factored are deemed
worthless, the factor bears the loss from non-collection of the accounts.

Discounting of notes receivable

Discounting of note is undertaken when the entity wants to have its note turned into cash
prior to its maturity date. The entity endorses the unmatured note to a financial institution which
is usually a bank. The proceeds of the note will depend on the remaining term of the note, its
nominal interest rate, and its face value.

Notes may be discounted with or without recourse. If they are discounted with recourse,
the bank may go after the entity to collect the maturity value of the note plus protest fee if the
maker dishonors it. However, if the note is discounted without recourse, the bank can no longer
collect from the entity that discounted the note should the maker dishonor the note.

DISCUSSION QUESTIONS

1. Briefly define receivables.

2. Identify items that are included in the line item Trade and Other Receivables.
3. Define net realizable value. Why do entities have to recognize receivables at that amount?
4. What is a note receivable?
5. Explain the initial and subsequent recognition of interest-bearing long-term notes
receivable.
6. What types of notes are recorded at present value?
7. Briefly define effective interest rate. What is its importance in accounting for long-term
notes receivable?
8. Enumerate the four most common types of receivable financing.
9. What is discounting of notes receivable?
10. How does assignment of accounts receivable differ from factoring?

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MULTIPLE CHOICE
1. These represent open accounts with customers.
a. Trade receivables
b. Nontrade receivables
c. Accounts receivable
d. Notes receivables

2. Upon initial recognition, accounts receivable are measured at

a. Face value
b. Discounted value
c. Maturity value
d. Net realizable value

3. Trade receivables that are expected to be collected within 12 months after the reporting
period shall be presented in the statement of financial position at
a. Net realizable value
b. Maturity amounts
c. Face amounts
d. Discounted values

4. Receivables denominated in a foreign currency should be

a. Translated to local currency using the exchange rate at the time of recognition
b. Shown at face value of the foreign currency
c. Translated to local currency using the exchange rate at closing rate
d. Translated to local currency using the exchange rate when the financial statements are
authorized for issue
5. Which valuation allowance is a proper deduction from trade accounts receivable in arriving
at estimated realizable value?
a. Allowance for doubtful accounts
b. Allowance for trade discount
c. Allowance for cash discount
d. Allowance for freight charge

6. Trade receivables are classified as current assets when they are reasonably expected to be
collected
a. Within one year
b. Within the normal operating cycle
c. Within one year or within the normal operating cycle whichever is shorter
d. Within one year or within the normal operating cycle whichever is longer

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7. Nontrade receivables are classified as current assets only if they are reasonably expected to
be realized in cash
a. Within one year or normal operating cycle, whichever is shorter.
b. Within the normal operating cycle
c. Within one year or the normal operating cycle, whichever is longer
d. Within one year, the length of the operating cycle notwithstanding
8. Which is true concerning the balance sheet presentation of receivables?
a. Trade receivables and nontrade receivables are shown separately.
b. Nontrade receivables are presented as noncurrent assets.
c. Trade accounts receivable and trade notes should be presented separately.
d. Trade receivables and nontrade receivables, which are currently collectible, shall be
presented as one line item called “trade and other receivables”.

9. A discount given to a customer for purchasing a large volume of merchandise is typically

referred to as
a. Quantity discount
b. Cash discount
c. Trade discount
d. Size discount

10. Which of the following is false in relation to cash and trade discounts?
a. Cash discounts are reductions in the invoice price allowed when payment is made
within the discount period while trade discounts are reduction from the list price or
catalog price in order to get the invoice price or amount actually charged to the buyer.
b. Cash discounts are recorded but trade discounts are not recorded.
c. The purpose of cash discounts is to encourage prompt payment while the purpose of
trade discounts is to encourage trading or promote sales.
d. Both purchases with trade and cash discounts should be recorded at net.

Exercise 3 – 1

An analysis of the accounts receivable of Grammar Inc. shows the following information:

Age Balance % Collectible

Current ₱3,500,000 99.5
1 to 30 days past due 2,000,000 98
31 to 60 days past due 1,200,000 95
61 to 90 days past due 1,000,000 92
91 to 120 days past due 800,000 85
121 to 180 days past due 400,000 70
181 to 360 days past due 200,000 50
More than 360 days past due 100,000 10

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 Before any adjustments were made, Grammar’s allowance for doubtful accounts had a
balance of ₱80,000.

1. Determine the required balance of Grammar’s doubtful accounts at the end of the reporting
period.
2. Determine the doubtful accounts expense Grammar should recognize during the period.
3. Determine the net realizable value of Grammar’s accounts receivable at the end of the
period.

Exercise 3 – 2
Coachella Co. prepared the following analysis of its accounts receivable on December 31,
2020:
Number of days past due Amount
0-30 ₱5,000,000
31-60 3,500,000
61-90 1,000,000
91-180 500,000
Over 180 100,000

Coachella’s experience on the uncollectibility of its accounts receivables for the last five
years are summarized below:

End of year % Uncollectible on days overdue

Year
balance 0-30 31-60 61-90 90-180 Over 180
2019 ₱ 9,700,000 3 8 18 48 79
2018 9,300,000 2 9 19 52 72
2017 8,800,000 4 10 21 46 85
2016 8,200,000 4 7 17 54 81
2015 7,500,000 2 6 15 50 78

Before any adjustments were made, the balance of the allowance for doubtful accounts
was ₱175,000. Coachella determines the balance of the allowance for doubtful accounts at the
average percentage of the losses for the last five years. The entity writes off receivables if they
are determined to be totally worthless.

1. Compute for the adjusted balance of Coachella’s allowance for doubtful accounts on
December 31, 2020.
2. Compute for the doubtful accounts expense that Coachella should recognize in 2020.
3. Determine the net realizable value of Coachella’s accounts receivable on December 31,
2020.

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Exercise 3 – 3
The adjusted trial balance of Thomas Company as of December 31, 2019 shows the
following:

Debit Credit
Accounts Receivable ₱ 1,000,000
Allowance for Doubtful Accounts ₱ 40,000

Additional information:

a. Cash sales of the company represent 10% of gross sales. Total sales amounted to
₱12,000,000.
b. Ninety percent of the credit sales customers did not take advantage of the 2/10, n/30 terms.
Total face value of accounts receivable collected during the year was ₱8,360,000.
c. Sales returns in 2020 amounted to ₱400,000. All returns were from charge sales.
d. During 2020, accounts totaling ₱40,000 were written off as uncollectible; bad debt recoveries
during the year amounted to ₱3,000.
e. The allowance for doubtful accounts is measured as follows:
Percentage of ending balance Percent uncollectible
60 2
20 20
12 40
5 60
3 90

Based on the information given, answer the following:

1. Accounts Receivable balance as of December 31, 2020

2. Allowance for Doubtful Accounts, December 31, 2020
3. Net realizable value, December 31, 2020
4. Doubtful Accounts Expense for 2020.

Exercise 3 – 4

On January 1, 2020, James Co. received a 10%, five year note from a customer. Interest
is paid every December 31. The note has a face value of ₱12,000,000. The effective rate on the
date of the receipt of the note was 12%

1. Determine the initial amount of the note.

2. Prepare an amortization table to show the balance of the note at the end of each reporting
period from 2020 to 2024.
3. Compute for the interest income recognized by James during each period from 2020 to 2024.
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Exercise 3 – 5

On January 1, 2020, Frank Co. received a 14%, three-year note from a customer. The
interest on the note is paid every June 30 and December 31. The note has a face value of
₱1,000,000. The effective rate applicable on the note is 12%.

1. Determine the initial amount of the note.

2. Prepare an amortization table to show the balance of the note at the end of each reporting
period from 2020 to 2022.
3. Compute for the interest income recognized by Frank during each period from 2020 to 2022.

Exercise 3 – 6

Accounts receivable balance of Skinner Co. on December 31, 2019 was ₱1,200,000.
Pertinent information regarding the company’s credit sales and accounts receivable in 2020 and
2021 follows:

2020 2021
Accounts receivable, December 31 ₱ 1,300,000 ₱ 1,700,000
Credit sales 22,500,000 21,600,000

1. Compute for the accounts receivable turnover in 2020 and 2021.

2. Compute for the average collection period in 2020 and 2021.

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