DE LA SALLE UNIVERSITY MANILA

RVR – COB DEPARTMENT OF ACCOUNTANCY

ACCCOB2 1st Term AY 20 - 21

ACCCOB2 Lecture 2 Prof. Francis H. Villamin

RECEIVABLES

Definition

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

For retailers or manufacturers, receivables are classified into trade receivables and nontrade
receivables.

Trade and nontrade receivables

Trade receivables refer to claims arising from sale of merchandise or services in the ordinary
course of business.

Trade receivables include accounts receivable and notes receivable.

Accounts receivable are open accounts arising from the sale of goods and services in the
ordinary course of business and not supported by promissory notes.

Other names of accounts receivable are customers’ accounts, trade debtors, and trade
accounts receivable.

Notes receivable are those supported by formal promises to pay in the form of notes.

Nontrade receivables represent claims arising from sources other than the sale of merchandise
or services in the ordinary course of business.

Loans Receivable

For banks and other financial institutions, receivables result primarily from loans to customers.

The loans are made to heterogeneous customers and the repayment periods are frequently
longer or over several years.

Classification

Trade receivables which are expected to be realized in cash within the normal operating cycle
or one year, whichever is longer are classified as current assets.

If collectible beyond one year, nontrade receivables are classified as noncurrent assets.
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Presentation

Trade receivables and nontrade receivables which are currently collectible shall be presented
on the face of the statement of financial position as one-line item called trade and other
receivables.

However, the details of the total trade and other receivables shall be disclosed in the notes to
financial statements.

Examples of nontrade receivables

a. Advances to or receivables from shareholders, directors, officers or employees. If

collectible in one year, such advances or receivables should be classified as current assets.

Otherwise, such advances or receivables are classified as noncurrent assets.

b. Advances to affiliates are usually treated as long-term investments.

c. Advances to supplier for the acquisition of merchandise are current assets.

d. Subscriptions receivables are current assets if collectible within one year. Otherwise,
subscriptions receivable should be shown preferably as a deduction from subscribed share
capital.

e. Creditors’ accounts may have debit allowances as a result of overpayment or returns and
allowances. These are classified as current assets.

If the debit balances are not material, an offset may be made against the creditors’
accounts with credit balances and only the net accounts payable may be presented.

f. Special deposits on contract bids normally are classified as noncurrent assets because
such deposits are likely to remain outstanding for a considerable long period of time.

However, the deposits that are collectible currently should be classified as current assets.

g. Accrued income such as dividend receivable, accrued rent receivable, accrued royalties
receivable and accrued interest receivable on bond investment are usually classified as
current assets.

h. Claims receivable such as claims against common carriers for losses or damages, claims
for rebates and tax refunds, claim from insurance entity, are normally classified as current
assets.

Customers’ credit balances

Customers’ credit balances are credit balances in accounts receivable resulting from
overpayments, returns and allowances, and advance payments from customers.

These credit balances are classified as current liabilities and are not offset against the debit
balances in other customers’ accounts, except when the same is not material in which case only
the net accounts receivable may be presented.

Initial Measurement of Accounts Receivable

PFRS 9 provides that a financial asset shall be recognized initially at fair value plus
transaction costs that are directly attributable to the acquisition.

The fair value of a financial asset is usually the transaction price, meaning, the fair value of
the consideration given.
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For short-term receivables, the fair value is equal to the face amount or original invoice
amount.

Cash flows relating to short-term receivables are not discounted because the effect of
discounting is usually immaterial.

Accordingly, accounts receivable shall be measured initially at face amount or original invoice
amount.

Subsequent Measurement

In accordance with PFRS 9, after initial recognition, accounts receivable shall be measured at
amortized cost.

The amortized cost is actually the net realizable value of accounts receivable.

The term amortized cost has more relevance in long-term note receivable.

Thus, the term net realizable value is preferably used in relation to accounts receivable.

The net realizable value of accounts receivable is the amount of cash expected to be collected
or the estimated recoverable amount.

Net realizable value

The initial amount recognized for accounts receivable shall be reduced by adjustments which in
the ordinary course of business will reduce the amount recoverable from the customer.

This is based on the established basic principle that assets shall be carried at above their
recoverable amount.

Accordingly, in estimating the net realizable value of trade accounts receivable, the allowance
for doubtful accounts is deducted.

Accounting for bad debts

Business entities sell on credit rather than only for cash to increase total sales and thereby
increase income.

However, an entity that sells on credit assumes the risk that some customers will not pay their
accounts.

When an account becomes uncollectible, the entity has sustained a bad debt loss. This loss is
simply one of the costs of doing business on credit.

Two methods are followed in accounting for this bad debt loss, namely:
1. Allowance method
2. Direct write off method

Allowance method

The allowance method requires recognition of a bad debt loss if the accounts are doubtful of
collection. The journal entry to recognize the doubtful account is:

Doubtful accounts xxx

Allowance for doubtful accounts xxx
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The “allowance for doubtful accounts” is deduction from accounts receivable.

If the doubtful accounts are subsequently found to be worthless or uncollectible, the accounts
are written-off as follows:

Allowance for doubtful accounts xxx

Accounts receivable xxx

Generally accepted accounting principles require the use of the allowance method because it
conforms with the matching principle.

Moreover, accounts receivable would be properly measured at net realizable value.

Recoveries of accounts written off

If a collection is made on account previously written off as uncollectible, the customary

procedure is first to recharge the customer’s account with the amount collected and possibly
with the entire amount previously charged off if it is now expected that collection will be
received in full.

The collection is then recorded normally by debiting cash and crediting accounts receivable.

The recharging of the customer’s account is usually followed because it is an evidence of the
attempt of the customer to reestablish his credit with the entity.

What account should be credited when the customer’s account is recharged?

The generally accepted approach is to simply reverse the original entry of write off regardless
of whether the recovery is during the year of write off or subsequent thereto.

Direct write off method

The direct write off method requires recognition of a bad debt loss only when the accounts
proved to be worthless or uncollectible.

Worthless accounts are recorded by debiting bad debts and crediting accounts receivable. If
the accounts are only doubtful of collection, no adjustment is necessary.

This approach is often used by small businesses because it is simple to apply.

As a matter of fact, the Bureau of Internal Revenue recognizes only this method for income
tax purposes.

However, the direct write off method violates the matching principle because the bad debt loss
is often recognized in later accounting period than the period in which the sales revenue was
recognized.

Doubtful accounts in the income statement

1. Distribution cost

If the granting of credit and collection of accounts are under the charge of the sales
manager, doubtful accounts shall be considered as distribution cost.

2. Administration expense

If the granting of credit and collection of accounts are under the charge of an officer other than
sales manager, doubtful accounts shall be considered as administrative expense.
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In the absence of any contrary statement, doubtful accounts shall be classified as
administrative expense.

ESTIMATION OF DOUBTFUL ACCOUNTS

Methods of estimating doubtful accounts

There are three methods of estimating doubtful accounts, namely:

1. Aging the accounts receivable or “statement of financial position approach”

2. Percent of accounts receivable or also statement of financial position approach

3. Percent of sales or “income statement approach”

Aging of accounts receivable

The aging of accounts receivable involves an analysis where the accounts are classified into
not due or past due.

a. Not due e. 91 to 120 days past due

b. 1 to 30 days past due f. 121 to 180 days past due
c. 31 to 60 days past due g. 181 to 365 days past due
d. 61 to 90 days past due h. More than 1 year past due

The allowance is then determined by multiplying the total of each classification by the rate of
percent of loss experienced by the entity for each category.

The major argument for the use of this method is the more accurate and scientific computation
of the allowance for doubtful accounts.

This method has the advantage of presenting fairly the accounts receivable in the statement of
financial position at net realizable value.

The objection to the aging method is that it violates the matching process.

Moreover, this method could become prohibitively time consuming if a large number of
accounts are involved.

Illustration:

The following data are summarized in aging the accounts receivable at the end of the period:

Balance Experience rate Required allowance

Not due 500,000 1% 5,000

1-30 days past due 300,000 2% 6,000
31-60 days past due 200,000 4% 8,000
61-90 days past due 100,000 7% 7,000
91-180 days past due 50,000 10% 5,000
181-365 days past due 30,000 30% 9,000
More than one year 20,000 50% 10,000
1,200,000 50,000

The amount computed by aging of accounts receivable represents the required allowance for
doubtful accounts at the end of the period.

Thus, if the allowance for doubtful accounts has a credit balance of P10,000 before adjustment,
the doubtful accounts expense is determined as follows:
ACCCOB2 Receivables Page 6
Required allowance 50,000
Less: Allowance balance before adjustment 10,000
Doubtful accounts expense 40,000

The journal entry to record the doubtful accounts expense is:

Doubtful accounts expense 40,000

Allowance for doubtful accounts 40,000

Percent of accounts receivable

A certain rate is multiplied by the open accounts at the end of the period in order to get the
required allowance balance.

The rate is usually determined from past experience of the entity.

This procedure has the advantage of presenting the accounts receivable at estimated net
realizable value. The approach is also simple to apply.

However, the application of this approach violates the principle of matching bad debt loss
against the sales revenue.

Moreover, the loss experience rate may be difficult to obtain and may not be reliable.

Illustration

The balance of accounts receivable is P2,000,000 and the credit balance in the allowance for
doubtful accounts is P10,000. Doubtful accounts are estimated at 3% of accounts receivable.

Journal entry

Doubtful accounts 50,000

Allowance for doubtful accounts 50,000

Required allowance (3% x 2,000,000) 60,000

Less: Credit balance in allowance 10,000

Doubtful accounts expense 50,000

Percent of sales

The amount of sales for the year is multiplied by a certain rate to get the doubtful accounts
expense. The rate may be applied on credit sales or total sales.

Theoretically, the rate to be used is computed by dividing the bad debt losses in prior years by
the charge sales of prior years.

The rate thus obtained is multiplied by the current year’s charge sales to arrive at the doubtful
accounts expense.

Practically, however, there is no substantial difference if in the computation of the rate, the
basis is total sales of the prior periods.

In such a case, the rate thus obtained is multiplied by the current year’s total sales to get the
doubtful accounts expense.

This procedure of determining the rate has the advantage of eliminating the extra work of
making a record of cash sales and credit sales.
ACCCOB2 Receivables Page 7
However, this approach may prove unsatisfactory when there is a considerable fluctuation in
the proportion of cash and credit sales periodically.

Argument for percent of sales method

When the “percent of sales” method is used in computing doubtful accounts, proper matching
of cost against revenue is achieved.

This is because the bad debt loss is directly related to sales and reported in the year of sale.

Thus, this method is an income statement approach because it favors the income statement.

Argument against percent of sales method

The main argument against this method is that the accounts receivable may not be shown at
estimated realizable value because the allowance for doubtful accounts may prove excessive or
inadequate.

Thus, it becomes necessary that from time to time the accounts should be “aged” to ascertain
the probable loss.

As a consequence, the rate applied on sales should be revised accordingly:

Illustration:

The following accounts are gathered from the ledger:

Accounts receivable 1,000,000

Sales 5,050,000
Sales return 50,000
Allowance for doubtful accounts 20,000

If doubtful accounts are estimated at 1% of net sales, the doubtful accounts expense is
P50,000 (1% x P5,000,000) and recorded as follows:

Doubtful accounts 50,000

Allowance for doubtful accounts 50,000

If this method is used, the resulting amount of the computation is already the amount of the
doubtful accounts expense and not the required allowance, in contradistinction with the aging
method and the percent of accounts receivable method.

The allowance balance before adjustment is ignored in determining the doubtful accounts
expense to be recorded.

However, the allowance for doubtful accounts should have an adjusted balance of P70,000, the
beginning allowance of P20,000 plus the adjustment of P50,000.

NOTES RECEIVABLE

Definition

Notes Receivable are claims supported by formal promises to pay usually in the form of notes.
ACCCOB2 Receivables Page 8
A negotiable promissory note is an unconditional promise in writing made by one person to
another, signed by the maker, engaging to pay on demand or at a fixed determinable future
time a sum certain in money to order or to bearer.

Simply stated, a promissory note is a written contract in which one person, known as the maker,
promises to pay another person, known as the payee, a definite sum of money.

The note may be payable on demand or at a definite future date.

Standing alone, the term notes receivable represents only claims arising from sale of
merchandise or service in the ordinary course of business.

Thus, notes received from officers, employees, shareholders and affiliates shall be designated
separately.

Dishonored notes

When a promissory note matures and is not paid, it is said to be dishonored.

Theoretically, dishonored notes receivable should be removed from the notes receivable
account and transferred to accounts receivable.

The amount debited to accounts receivable should include the face amount, interest and other
charges.

Such approach is defended on the ground that the overdue note has lost part of its status as a
negotiable instrument and really represents only an ordinary claim against the maker.

Initial measurement of notes receivable

Conceptually, notes receivable shall be measured initially at present value.

The 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 of interest is actually the effective interest rate.

However, short-term notes receivable shall be measured at face value.

Cash flows relating to short-term notes receivable are not discounted because the effect of
discounting is usually not material.

Interest-bearing notes receivable

The initial measurement of long-term notes will depend on whether the notes are interest-
bearing or non-interest bearing.

Interest-bearing long-term notes are measured at face value which is actually the present value
upon issuance.

Non-interest bearing notes receivable

Non-interest bearing long term notes are measured at present value which is the discounted
value of the future cash flows using the effective interest rate.
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Actually, the term “noninterest-bearing” is a misnomer because all notes implicitly contain
interest.

It is simply a case of the “interest being included in the face amount” rather than being stated as
a separate rate.

Subsequent measurement

Subsequent to initial recognition, long-term notes receivable shall be measured at amortized

cost using the effective interest method.

Meaning of amortized cost

The amortized cost is the amount at which the notes receivable is measured initially:

a. Minus principal repayment

b. Plus or minus cumulative amortization of any difference between the initial carrying amount
and the principal maturity amount
c. Minus reduction for impairment or uncollectibility

For long-term noninterest-bearing notes receivable, the amortized cost is the present value
plus amortization of the discount, or the face value minus the unamortized unearned
interest income.

Accordingly, only long-term notes receivable will be discussed in conjunction with the present
value concept under the following situations:

a. Interest bearing note

b. Noninterest bearing note

TIME VALUE OF MONEY

An understanding of the concept of time value of money is essential in study of accounting as

well as in the application of the PFRSs. It plays a very important role in accounting
measurements and most of the topics in financial reporting require its use.

Time value of money involves interest calculations. It connotes a relationship between the time
value of money and time. The concept of time value of money provides that contractual
agreements to receive cash (or to pay cash) in the future will earn (or incur) interests due to
passage of time regardless of whether interests have been agreed upon or not. This is
because of the opportunity to invest today’s peso and receive interest on that investment.

One topic that will be used in conjunction with time value of money pertaining to notes
receivable is the present value.

Present Value of a future amount (PV of P1)

The present value of P1 answers the question: “How much do I have to deposit today to
receive P1 (one peso) in the future?” .

The present value of P1 factor may be determined by referring to the present value table, by
using financial calculator, or by using other tools, or simply using the formula below on a
scientific or basic calculator.

-n
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PV of P1 = (1+i)

Note that “n” is a negative amount expressed in periods.

Note that ‘’í” is the interest rate.

Present Value of an annuity of P1

The present value of an annuity of P1 answers the question: “How much do I have to deposit
today to be able to make several equal payments of P1 each over equal periods in the future?”
-n
[1 – (1+i) ]
PVOA of P1 = ___________
i

EFFECTIVE INTEREST METHOD

The “effective interest method” or simply “interest method” recognizes two kinds of interest rate
– nominal rate and effective rate.

The nominal rate is the rate appearing on the face of the notes while the effective rate is the
actual interest incurred on the bond issue.

The nominal rate is also known as the coupon rate or stated rate.

The effective rate is the rate that exactly discounts estimated cash future payments through
the expected life of the notes or when appropriate a shorter period to the net carrying amount of
the notes.

The effective rate is also known as yield or market rate.

If the notes are issued at face amount, the nominal rate and effective rate are the same.

If the notes are issued at a discount, the effective rate is higher than nominal rate.

If the notes are issued at a premium, the effective rate is lower than nominal rate.

The annual amortization of premium or discount is the difference between the effective interest
expense and nominal interest expense.

The effective interest expense is computed by multiplying the carrying amount of the notes at
the beginning of the year by the effective rate.

The nominal interest expense is computed by multiplying the face amount of the notes by the
nominal rate.

The effective interest method provides for an increasing amount of discount amortization
and increasing amount of interest expense.

The effective interest method provides for an increasing amount of premium but a
decreasing amount of interest expense

Illustration:
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On January 1, 2019, James Co, received a 10%, five year note from a customer. Interest is
paid every December 31. The note has a face value of P12,000,000. The effective rate on the
date of the receipt of the note was 12%.

Required:

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 2019 to 2023.
3. Compute for the interest income recognized by James during each period from 2019 to
2023.

-5
Present value of principal (P12M x [1.12] P 6,809,122.27
-5
( 1 - [1.12] )
Present value of interest (P1.2M x .12 ) 4,325,731.44
____________
Total present value P11,134.853.71
============

Face Value P12,000,000.00

Total Present Value 11,134,853.71
Discount P 865,146.29
============

A B C D

Discount
2 Date
Date Interest income Cash receipt Amortization Carrying
amount
Jan. 1, 2019 11,134,853.71
Dec. 31, 2019 1,336,182.45 1,200,000.00 136,182.45 11,271,036.16
Dec. 31, 2020 1,352,524.34 1,200,000.00 152,524.34 11,423,560.50
Dec. 31, 2021 1,370,827.26 1,200,000.00 170,827.26 11,594,387.76
Dec. 31, 2022 1,391,326.53 1,200,000.00 191,326.53 11,785,714.29
Dec. 31, 2023 1,414,285.71 1,200,000.00 214,285.71 12,000,000.00

D= D+C
A= D x EIR (Carrying Amount x Effective Interest Rate)
B = FV x NIR (Face Value x Nominal Interest Rate)
C= A–B

RECEIVABLE FINANCING
Pledge, assignment and factoring

Concept of receivable financing

Receivable financing is the financing flexibility or capability of an entity to raise money out of its
receivables.

During a general business decline, an entity may find itself in tight cash position because sales
decrease and customers are not paying their accounts on time.

But the entity’s current accounts and notes payable must continue to be paid if its credit
standing not to suffer.
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The entity then would be in a financial distress as collections of receivables are delayed but
cash payments for obligations must be maintained.

Under these circumstances, if the situation becomes very critical, the entity may be forced to
look for cash by financing its receivables.

Forms of receivable financing

The common forms of receivable financing are:

a. Pledge of accounts receivable
b. Assignment of accounts receivable
c. Factoring of accounts receivable
d. Discounting of notes receivable

Pledge of accounts receivable

When loans are obtained from the bank or any lending institution, the accounts receivable may
be pledged as collateral security for the payment of the loan.

Normally, the borrowing entity makes the collections of the pledged accounts but may be
required to turn over the collections to the bank in satisfaction for the loan.

No complex problems are involved in this form of financing except the accounting for the loan.

The loan is recorded by debiting cash and discount on note payable if loan is discounted, and
crediting notes payable.

The subsequent payment of the loan is recorded by debiting note payable and crediting cash.

With respect to the pledged accounts, no entry would be necessary. It is sufficient that
disclosure thereof is made in a note to financial statement.

Assignment of accounts receivable

Assignment of accounts receivable means that the borrower called the assignor transfers rights
in some accounts receivable to a lender called the assignee in consideration for a loan.

Actually, assignment is a more formal type of pledging of accounts receivable. Assignment is

secured borrowing evidenced by a financing agreement and a promissory note both of which
the assignor signs.

However, pledging is general because all accounts receivable serve as collateral security for
the loan.

On the other hand, assignment is specific because specific accounts receivable serve as
collateral security for the loan.

Assignment may be done either on a nonnotification or notification basis.

When accounts are assigned on a nonnotification basis, customers are not informed that their
accounts have been assigned.

As a result, the customers continue to make payments to the assignor, who in turn remits the
collections to the assignee.

When accounts are assigned on a notification basis, customers are notified to make their
payments directly to the assignee.
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The assignee usually lends only a certain percentage of the face value of the accounts
assigned because the assigned accounts may not be fully realized by reason of such factors as
sales discount, sales return and allowances and uncollectible accounts.

The percentage may be 70%, 80%, or 90% depending on the quality of the accounts.

The assignee usually charges interest for the loan that it makes and requires a service or
financing charge or commission for the assignment agreement.

Factoring

Factoring is a sales of accounts receivable on a without recourse, notification basis.

In a factoring arrangement, an entity sells accounts receivable to a bank or finance entity called
a factor.

Accordingly, a gain or loss is recognized for the difference between the proceeds received and
the net carrying amount of the receivables factored.

Factoring differs from an assignment in that an entity actually transfers ownership of the
accounts receivable to the factor.

Thus the factor assumes responsibility for uncollectible factored accounts.

In assignment, the assignor retains ownership of the accounts assigned.

Because of the nature of the transaction, the customers whose accounts are factored are
notified and required to pay directly to the factor.

The factor has then the responsibility of keeping the receivable records and collecting the
accounts.

RECEIVABLE FINANCING
Discounting of notes receivable

Concept of discounting

As a form of receivable financing, discounting specifically pertains to notes receivable.

In a promissory note, the original parties are the maker and payee.

The maker is the one liable and the payee is the one entitled to payment on the date of
maturity.

When a note is negotiable, the payee may obtain cash before maturity date by discounting the
note at a bank or other financing company.

To discount the note, the payee must endorse it.

Thus, legally the payee becomes an endorser and the bank becomes an endorsee.

Endorsement

Endorsement is the transfer of right to a negotiable instrument by simply signing at the back of
the instrument.
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Endorsement may be with recourse which means that the endorser shall pay the endorsee if
the maker dishonors the note.

In the legal parlance, this is the second liability of the endorser.

In the accounting parlance, this is the contingent liability of the endorser.

Endorsement may be without recourse which means that the endorser avoids future liability
even if the maker refuses to pay the endorsee on the date of the maturity.

In the absence of any evidence to the contrary, endorsement is assumed to be with recourse.

ANALYSIS OF ACCONTS RECEIVBLE

Accounts Receivable Turnover Ratio

Liquidity may also be measured by determining how frequently accounts receivable can be
converted into cash. The accounts receivable turnover ratio is the number of times, on the
average, accounts receivable are collected during the period. This is computed by dividing net
credit sales by the average net accounts receivable during the year. Since the amount of credit
sales is not disclosed in the financial statements, the amount of net sales is used instead. The
average accounts receivable, on the other hand, is usually the average of the beginning and
ending balance of accounts receivable.

The higher the turnover, the more rapid is a firm’s average collection period.

Average Collection Period

This represents the average time required to collect accounts receivable, obtained by dividing
the average accounts receivable by the average daily sales. Average daily sales is computed
by dividing the sales amount by 365 days. The same measurement can be obtained by dividing
the number of days in a year by the accounts receivable turnover.

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