Learning Material 2, Receivables Lesson 1, Accounts Receivable

Learning Material 2:
Receivables

Lesson 1

ACCOUNTS RECEIVABLE

Learning Outcomes:

At the end of this lesson, the students shall be able to:

a. Explain the following concepts:
∙ Classification and presentation of receivables;
∙ initial and subsequent measurement of accounts receivable;
∙ adjustments necessary in determining the net realizable value of accounts
receivable;
∙ gross method and net method of recording credit sales; and
∙ accounting for doubtful accounts, worthless accounts written off and recoveries of
accounts written off.
b. Demonstrate understanding of the concepts by applying them in solving related
problems;
c. Analyze crucial situations besetting the rigor in solving related problems; and d.
Check on the accuracy of solutions through the concepts and principles applicable to
accounts receivable.

Activity 1
Discussion of Accounting Principles

Nature of Receivables

1. 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 as trade receivables and

nontrade receivables.

2. Trade receivables are claims arising from sale of merchandise or services in the ordinary
course of business. Included are 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
are customers’ accounts, trade debtors, and trade accounts receivable.

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

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

4. Loans receivable – for banks and other financial institutions, receivables result primarily
from loans to customers.

5. Classification of trade and nontrade receivables

 Learning Materials in Accounting 3 – Intermediate Accounting 1 42
Learning Material 2, Receivables Lesson 1, Accounts Receivable

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

∙ Nontrade receivables which are expected to be realized in cash within one year, the
length of operating cycle notwithstanding, are classified as current assets.

∙ If collectible beyond one year, nontrade receivables are classified as noncurrent

assets.

∙ The classifications are in accordance with PAS 1, Presentation of Financial

Statements, paragraph 66, which reads as follows:

“An entity shall classify an asset as current when the entity expects to realize the
asset or intends to sell or consume it in the entity’s normal operating cycle, or when
the entity expects to realize the asset within twelve months after the reporting
period”.

6. 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 suppliers for the acquisition of merchandise are current assets. d.

Subscriptions receivable 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 balances 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.

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,
claim for rebates and tax refunds, claim from insurance entity, are normally classified
as current assets.

7. 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 customers’ accounts, except when the same is not material in which
case only the net accounts receivable may be presented.

Learning Materials in Accounting 3 – Intermediate Accounting 1 43

Learning Material 2, Receivables Lesson 1, Accounts Receivable

Measurement of Accounts Receivable

1. A financial asset shall be recognized initially at fair value plus transaction costs that are
directly attributable to the acquisition (PFRS 9, paragraph 5.1.1).

2. The fair value of a financial asset is usually the transaction price which means the fair
value of the consideration given.

3. Short-term receivables – the fair value is equal to the face amount or original invoice
amount.

4. Accounts receivable shall be measured initially at face amount or original invoice

amount. 5. After initial recognition, accounts receivable shall be measured at amortized

cost. 6. The amortized cost is actually the net realizable value of accounts receivable. 7.

The term amortized cost has more relevance in long-term note receivable. 8. Thus, the

term net realization value is preferably used in relation to accounts receivable.

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

Net Realizable Value

1. 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.

2. This is based on the established basic principle that assets shall not be carried at above
their recoverable amount.

3. In estimating the net realizable value of trade accounts receivable, the following
deductions are made:
a. Allowance for freight charge
b. Allowance for sales return
c. Allowance for sales discount
d. Allowance for doubtful accounts

Terms Related to Freight Charge

1. In order to give proper accounting recognition to freight charge in relation top accounts
receivable, the following terms should be understood – FOB destination, FOB shipping
point, freight collect, and freight prepaid.

2. FOB destination means that ownership of the goods purchased is vested in the buyer
upon receipt thereof. Hence, the seller shall be responsible for the freight charge up to
 the point of destination.

3. FOB shipping point means that ownmership of the transportation charge from the point
of shipment to the point of destination. Therefore, it is incumbent upon the buyer to pay
for the transportation charge from the point of shipment to the point of destination.

Learning Materials in Accounting 3 – Intermediate Accounting 1 44

Learning Material 2, Receivables Lesson 1, Accounts Receivable

4. Freight collect means that freight charge on the goods shipped is not yet paid. The
common carrier shall collect the same from the buyer. In this case, the freight charge is
actually paid by the buyer.

5. Freight prepaid means that freight charge on the goods shipped is already paid by the
seller.

Accounting for Freight Charge

1. There are times when goods are sold FOB destination but shipped freight collect with
the understanding that the buyer will pay for the freight charge and deduct the same
when remittance is made by him/her.

2. On the part of the seller, the freighht charge is recorded by debiting freight out and
crediting allowance for freight charge.

3. For example, the entity has a P50,000 account receivable at the end of accounting
period.

4. The term are 2/10, n/30, FOB destination and freight collect. The customer paid freight
charge of P2,000.

1. To record the sale:

Accounts receivable 50,000
Freight out 2,000
Sales 50,000 Allowance for freight charge 2,000

2. To record the collection within the discount period:

Cash 47,000
Sales discount (50,000 x 2%) 1,000
Allowance for freight charge 2,000
Accounts receivable 50,000 Allowance for Sales Returns

1. The measurement of accounts receivable shall also recognize the probability that some
customers will return goods that are unsatisfactory or will make other claims requiring
reduction in the amount due as in the case of shipment shortages and defects.

2. For example, an amount of P20,000 of the total accounts receivable at year-end

represents selling price of goods that will probably be returned. The journal entry to
recognize the probable return is:

Sales return 20,000

Allowance for sales return 20,000 Sales Discount

1. Entities usually offer cash discounts to credit customers. A cash discount is a reduction
 from an invoice price by reason of prompt payment.

2. A cash discount is known as sales discount on the part of the seller and purchase
discount on the part of the buyer.

3. A cash discount may be expressed as 5/10, n/30. This means that the customers is
entitled to a 5% discount if payment is made in 10 days from the invoice date.

Learning Materials in Accounting 3 – Intermediate Accounting 1 45

Learning Material 2, Receivables Lesson 1, Accounts Receivable

4. If the customer fails to pay within the 10-day discount period, the gross amount of the
invoice price must be paid within 30 days from the invoice date.

Methods of Recording Credit Sales

a. Gross method – Accounts receivable and sales are recorded at gross amount of the
invoice. This is the common and widely used method because it is simple to apply.

b. Net method – Accounts receivable and sales are recorded at net amount of the invoice,
meaning the invoice price minus the cash discount.

Illustration – Gross method

1. Sales of merchandise for P100,000, terms 5/10, n/30.
Accounts receivable 100,000
Sales 100,000

2. Assume collection is made within the discount period.

Cash 95,000
Sales discount 5,000
Accounts receivable 100,000

3. Assume collection is made beyond the discount period.

Cash 100,000
Accounts receivable 100,000

Illustration – Net method

1. Sale of merchandise for P100,000, terms 5/10, n/30.
Accounts receivable 95,000
Sales 95,000

2. Assume collection is made within the discount period.

Cash 95,000
Accounts receivable 95,000

3. Assume collection is made beyond the discount period.

Cash 100,000
Accounts receivable 95,000 Sales discount forfeited 5,000

The sales discount forfeited account is classified as other income.

Allowance for Sales Discount

1. If customers are granted cash discounts for prompt payment, it follows that estimates of
cash discounts on open accounts at the end of the period based on past experience
shall be made.

2. For example, of the accounts receivable of P1,000,000 at the end of the period, it is
 reliably estimated that discounts to be taken will amount to P50,000.

3. The adjustment to record the expected sale discount is:

Sales discount 50,000

Allowance for sales discount 50,000

4. The adjustment may be reversed at the beginning of the next period in order that
discounts can then be charged normally to sales discount account.

Learning Materials in Accounting 3 – Intermediate Accounting 1 46

Learning Material 2, Receivables Lesson 1, Accounts Receivable

Accounting for Bad Debts

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

2. An entity that sells on credit assumes the risk that some customers will not pay their
accounts.

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

4. Two methods are followed in accounting for this bad debt loss, namely:
a. Allowance method
b. Direct writeoff method

Allowance Method

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

Doubtful accounts xx
Allowance for doubtful accounts xx 2. The “allowance for doubtful

accounts” is deduction from accounts receivable.

3. If the doubtful accounts are subsequently found to be worthless or uncollectible, the

accounts are written off as follows:

Allowance for doubtful accounts xx

Accounts recivable xx

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

5. In this instance, accounts receivable would be properly measured at net realizable

value. Recoveries of Accounts Written Off

1. If a collection is made on account previously written of as collectible, the customary

procedure is first to rechargethe customer’s account with the amount collected and
possibly with the entire amount previously charged off it is now expected that collection
will be received in full.
2. The collection is then recorded normally by debiting cash and crediting accounts
recivable.

3. 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?

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

Learning Materials in Accounting 3 – Intermediate Accounting 1 47

Learning Material 2, Receivables Lesson 1, Accounts Receivable

Illustration – Allowance method

1. Accounts of P30,000 are considered doubtful accounts of collection.

Doubtful accounts 30,000
Allowance for doubtful accounts 30,000

2. The accounts are subsequently discoverd to be worthless or uncollectible.

Allowance for doubtful accounts 30,000
Accounts receivable 30,000

3. The same accounts that are previously written off are unexpectedly recovered
or collected.
Accounts receivable 30,000
Allowance for doubtful accounts 30,000
Cash 30,000
Accounts receivable 30,000 Direct Writeoff Method

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

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

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

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

5. However, the direct writeoff 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.

6. The direct writeoff method is not permitted under IFRS.

Illustration – Direct Writeoff Method

1. Accounts of P30,000 are considered doubtful of collection.

No entry
 2. The accounts proved to be worthless.
Bad debts 30,000
Accounts receivable 30,000

3. The same accounts that are previously written off as worthless are recoverd
or collected.
Accounts receivable 30,000
Bad debts 30,000

Cash 30,000
Accounts receivable 30,000

Learning Materials in Accounting 3 – Intermediate Accounting 1 48

Learning Material 2, Receivables Lesson 1, Accounts Receivable

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. Administrative expense

If the granting of credit and collection of accounts are under the cahrge of an officer
other than sales manager, doubtful accounts shall be considered as administrative
expense.

In the absence of any contrary statement, doubtful accounts shall be classified as

administrative expense.

Activity 2
Application Exercises

You are provided with exercises that will demonstrate the application of accounting
principles discussed for cash, cash equivalents, and petty cash. Appropriate accounting
analysis was used to solve the exercises correctly and accurately.

Four exercises are provided in this lesson.

Exercise 1

JERICHO Company reported the “Receivables” account with a debit balance of Ᵽ2,000,000
at year-end.

The allowance for doubtful accounts had a credit balance of Ᵽ50,000 on the same
date. Subsidiary details revealed the following:

Trade accounts receivable 775,000 Trade notes receivable 100,000 Instalments

receivable , normally due 1 year to two years 300,000 Customers’ accounts
reporting credit balance arising from sales return ( 30,000) Advance payments for
 purchase of merchandise 150,000 Customers’ accounts reporting credit balances
arising from advance
payments (20,000) Cash advance to subsidiary 400,000 Claim from insurance
entity 15,000 Subscription receivable due in 60 days 300,000 Accrued interest
receivable 10,000 2,000,000

Required:
a. Prepare one compound entry to reclassify the receivables account. b.
Compute the amount to be presented as “trade and other receivables” under
current assets.
c. Indicate the classification and presentation of the other items excluded from “trade
and other receivable”.

Learning Materials in Accounting 3 – Intermediate Accounting 1 49

Learning Material 2, Receivables Lesson 1, Accounts Receivable

Solution to Exercise 1

a. Compound Entry to reclassify the receivables account.

Accounts receivable 775,000
Notes receivable 100,000
Installment receivable 300,000
Advance to suppliers 150,000
Advance to subsidiary 400,000
Claim receivable 15,000
Subscription receivable 300,000
Accrued internet receivable 10,000
Customers credit balances 30,000 Advances from customers 20,000 Receivable
2,000,000

b. Amount to be presented as “trade and other receivables” under current assets

Accounts receivable 775,000
Less: Allowance for doubtful accounts 50,000 725,000 Notes receivable 100,000
Installments receivable 300,000 Advance to suppliers 150,000 Subscription receivable
300,000 Claim receivable 15,000 Accrued internet receivable 10,000 Total trade and
other receivable 1,600,000

c. Classification and pre4sentation of other items excluded from “trade and other
receivables”
Advance to subsidiary – Noncurrent asset ----- presented as long-term investment
Customers credit balances - Classified as current liabilities
Advances from customers - Part of trade and other payables

Exercise 2

ELIVIC Company provided the following T-account summarizing the transactions affecting
the account receivable for the current year:

Accounts Receivable
Jan. 1 balance 600,000 Collections from customers 5,300,000 Charge sales 6,000,000 Write off
35,000 Shareholders’ subscription 200,000 Merchandise returns 40,000 Deposit on Contract
120,000 Allowance to customer for shipping
damages 25,000
Claims against common Collections on carrier claims 40,000
carrier for damages 100,000

IOUs from employees 10,000 Collection on subscription 50,000 Cash advance to affiliates
100,000
 Advances to a supplier 50,000

Required:

a. Compute the correct amount of accounts receivable.

b. Prepare one compound entry to adjust the accounts receivable.
c. Compute the amount to be presented as “trade and other receivables” under
current assets.
d. Indicate the classification and presentation of the other items.

Learning Materials in Accounting 3 – Intermediate Accounting 1 50

Learning Material 2, Receivables Lesson 1, Accounts Receivable

Solution to Exercise 2

a. Accounts receivable – Jan. 1 600,000 Change sales 6,000,000 Total 6,600,000

Less: Collection from customers 5,300,000
Write off 35,000
Merchandise returns 40,000
Allowance to customers 25,000 5,400,000 Accounts receivable – Dec. 31
1,200,000

b. Subscription receivable (200,000-50,000) 150,000 Deposit on contract 120,000

Claim receivable (100,000-40,000) 60,000 Advances to employees 10,000 Advances to
affiliates 100,000 Advances to supplier 50,000 Accounts receivable 490,000

c. Accounts receivable 1,200,000 Claim receivable 60,000 Advances to employees

10,000 Advances to suppliers 50,000 Total trade and other receivables 1,320,000

d. The subscription receivable should be deducted from Subscribed Share Capital

Deposit on contract – noncurrent – presented as Other Noncurrent Asset
Advances to affiliates – noncurrent – presented as Long-term Investment

Exercise 3

ANGELO Company sold merchandise on account for Ᵽ500,000. The terms are 3/10, n/30.
The related freight charge amounted to Ᵽ10,000. The account was collected within the
discount period.

Required:
Prepare journal entries to record the transactions under the following freight
terms: 1. FOB destination and freight collect
2. FOB destination and freight prepaid
3. FOB shipping point and freight collect
4. FOB shipping point and freight prepaid

Solution to Exercise 3

1. FOB destination & freight collect

a. Accounts receivable 500,000 Freight out 10,000
Sales 500,000 Allowance for freight charge 10,000

b. Cash 475,000 Sales discount (500,000 x 3%) 15,000

Allowance for freight charge 10,000
 Accounts receivable 500,000

Learning Materials in Accounting 3 – Intermediate Accounting 1 51

Learning Material 2, Receivables Lesson 1, Accounts Receivable

2. FOB destination & freight prepaid

a. Accounts receivable 500,000
Freight out 10,000 Sales 500,000 Cash 10,000

b. Cash 485,000
Sales discount 15,000
Accounts receivable 500,000

3. FOB shipping point & Freight collect

a. Accounts receivable 500,000
Sales 500,000

b. Cash 485,000
Sales discount 15,000
Accounts receivable 500,000

4. FOB shipping point/ Freight prepaid

a. Accounts receivable 510,000
Sales 500,000 Cash 10,000

b. Cash 495,000
Sales discount 15,000
Accounts receivable 510,000

Exercise 4

LINCOLN Company records sales return during the year as a credit to accounts receivable.
However, at the end of the accounting period, the entity estimates the probable sales return
and records the same by means of an allowance account.

The following transaction occurred in summary form:

1. Sales on merchandise on account, 2/10, n/30 4,000,000 2. Collection within the

discount period 1,470,000 3. Collection beyond the discount period 1,000,000 4.
Sales return granted 100,000 5. Sales return estimated at the end of the year
20,000

Required:
Prepare journal entries to record the transaction.

Solution to Exercise 4

1. Accounts receivable 4,000,000 Sales 4,000,000

2. Cash 1,470,000 Sales discount 30,000 Accounts receivable (1,470,000/ .98) 1,500,000

3. Cash 1,000,000 Accounts receivable 1,000,000

4. Sales return 100,000

Learning Materials in Accounting 3 – Intermediate Accounting 1 52

Learning Material 2, Receivables Lesson 1, Accounts Receivable
 Accounts receivable 100,000

5. Sales return 20,000 Allowance for sales returns 20,000

Activity 3
Evaluation Exercises

General Instructions: You are required to provide solutions/answers to the following

exercises. Supporting computations which are presented in good form shall be part of all
solutions. Answers/solutions to these exercises are to be submitted to the Professor
through the Google Classroom created for this course. This evaluation exercise will be sent
also as assignment so you can post your answers.

A. Theoretical Exercises
(Individual Task)

Provide justifiable convincing account via applicable appropriate accounting principles

discussed in Activity 1 to the following questions.

1. Explain the following as how you understood these accounting concepts:

a) How are receivables classified and presented in the Financial Statements?

b) What is the initial and subsequent measurement of accounts receivable? c)
What is a net realizable value of accounts receivable?
d) What is your understanding of the following concepts:
1. gross method of recording credit sales
2. net method of recording credit sales
3. accounting for doubtful accounts
4. accounting for worthless accounts written off
5. accounting for recoveries of accounts written off

B. Practical Exercises
(Group Task)

Solve the following problem with supporting computations presented in good form:

1. On June 15, 2021, JOSHUA Company sold 100 air conditioning units. The sale price for
each unit is Ᵽ45,000.

All of the sales are subject to terms 2/10, n/30. The entity used the gross method of
accounting for accounts receivable.

Required:

1. Prepare journal entry to record the sale.

2. Prepare journal entry to record receipt of the payment assuming the correct amount
was received on June 25, 2021.
3. Prepare the journal entry to record receipt of the payment assuming the correct
amount was received on July 10, 2021.

Learning Materials in Accounting 3 – Intermediate Accounting 1 53

Learning Material 2, Receivables Lesson 1, Accounts Receivable

C. Practical Exercises
(Individual Task)

Solve the following problems with supporting computations presented in good form. Identify
the letter of the correct answer in your answer sheet.

A. CAMILLE Company reported the following analysis of current receivables at year-end:

Trade accounts receivable 2,000,000 Allowance for doubtful accounts ( 100,000)
Claim against shipper for goods lost transit in November 300,000 Selling price
unsold goods sent by Valiant on consignment at 150%
of cost and not included in ending inventory 600,000 Security deposit on lease of
warehouse 200,000
Total 3,000,000

Determine the total amount that should be reported as current trade and other
receivables.
a. 2,200,000 b. 2,400,000 c. 2,300,000 d. 3,000,000

B. GWEN Company had the following information for the current year relating to accounts
receivable:
Accounts receivable, January 1 1,300,000 Credit sales 5,400,000 Collections
from customers, excluding recovery 4,750,000 Accounts written off 125,000
Collection of accounts written off in prior re-established
year, customer credit was not 25,000

Estimated uncollectible receivable per aging at December 31 165,000

Determine the balance of accounts receivable before allowance for doubtful accounts,
on December 31.
a. 1,825,000 b. 1,850,000 c. 1,950,000 d. 1,990,000

C. At year-end, KYLA Company reported accounts receivable of Ᵽ8,200,000 with the

following analysis:

Accounts known to be worthless 100,000 Advance payment on purchase order

400,000 Advance to subsidiary 1,000,000 Customers’ accounts reporting credit
balance arising from
sales returns ( 600,000) Trade accounts receivable 3,500,000 Subscription
receivable due in 30 days 2,200,000 Trade instalments receivable due 1-18
months, including unearned
finance charge of Ᵽ50,000 850,000 Trade accounts receivable from officers, due
currently 150,000 Trade accounts on which postdated checks are held and no
entries
were made on receipt of checks 200,000

Determine the correct balance of trade accounts receivable.

a. 4,650,000 b. 4,700,000 c. 4,150,000 d. 4,050,000 *****

Learning Materials in Accounting 3 – Intermediate Accounting 1 54