Audit of receivables part 1

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.

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

If collectible beyond one year , non trade receivables are classified as non
current assets.

Accounts receivable shall be measured initially at face amount or original

invoice amount .

However , subsequently the accounts receivable shall be measured at net

realizable value , meaning the amount of cash expected to be collected or
the estimated recoverable amount.

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

The two methods of accounting for bad debts are the allowance method
and direct write off method.

The allowance method requires recognition of bad debt loss if the accounts
are doubtful of collection.

The doubtful accounts are recorded by debiting doubtful accounts expense

and crediting allowance for doubtful accounts
Generally accepted accounting principles require the use of the allowance
method because it conforms with the matching principle.

Moreover , accounts receivable will be properly measured at net

realizable.

The direct write off method requires recognition of a bad debts loss only
when the accounts are worthless or uncollectible

Worthless accounts are recorded by debiting bad debts and crediting

accounts receivable.

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.

Customers credit balances are credit balances in accounts receivable

resulting from overpayments, returns and allowances and advance
payments from customers.

Customers credit balances are classified as current liabilities , and shall not
be offset against the debit balances in other customers accounts.

However , when the amount is not material, only the net accounts
receivable may be presented in the statement of financial position.

Doubtful accounts expense in the income statement are classified as

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 costs.

2. Administrative costs

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

Ross Company provided the following information for the current year

Accounts receivable on January 1 1,300,000

Credit sales 3,400,000

Collections from customers excluding recovery 4,750,000

Accounts written off 125,000

Collection of accounts written off in prior years

(customer credit was not reestablished ) 25,000

Estimated uncollectible receivables per aging of

Receivables at December 31 165,000

What is 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

Solution

Accounts receivable Jan. 1 1,300,000

Add; credit sales 5,400,000

Total 6,700,000

Less ; collections from customers 4,750,000

Accounts written off 125,000 4,875,000

Accounts receivable Dec. 31 1,825,000 a

The recovery of accounts written off does not affect the balance of
accounts receivable because the effect is offsetting .

2.MAAN COMPANY reported the following information at year end.

Total accounts receivable 930,000

Allowance for uncollectible accounts ( 20,000)

Claim receivable 30,000

Selling price of unsold goods sent by MAAN

On consignment at 130% of cost and not

Included in MAAN’s ending inventory 260,000

Security deposit on lease of warehouse used

For storing some inventories 300,000

Total 1,500,000

What total amount should be reported as trade and other receivables

under current assets at year end ?

a. 940,000
b. 1,200,000
c. 1,240,000
d. 1,500,000

Solution

Trade accounts receivable 930,000

Allowance for uncollectible accounts ( 20,000 )

Claim receivable 30,000

Total trade and other receivables 940,000 a

The selling price of goods on consignment is excluded from accounts

receivable because the goods are still unsold .

The cost of the goods consigned of 200,000 (260,000/130% ) should be

included in inventory.

The security deposit is a non current receivable .

3 .ONE Company prepared an aging of accounts receivable on December

31 and determined that the net realizable value of the accounts
receivable was 2,500,000

What amount should be recognized as doubtful accounts expense for the

current year ?

a. 230,000
b. 200,000
c. 150,000
d. 100,000

Solution;

Allowance for doubtful January 1 280,000 * given

Recovery of accounts written off 50,000 * given

Doubtful accounts expense (squeeze) 100,000 d.

Total 430,000 *given

Accounts written off ( 230,000)

Allowance for doubtful accounts December 31 200,000

Since the December 31 accounts receivable balance is 2,700,000and the
net realizable value is 2,500,000 , the December 31allowance for doubtful
accounts should be 200,000 .

The doubtful accounts expense is squeezed by working back from the

December 31 allowance for doubtful accounts of 200,000.

AUDIT OF RECEIVABLES

AUDIT PROGRAM FOR RECEIVABLES

AUDIT OBJECTIVES :

To determine that

1. Receivables represent valid claims against customers and other

parties and have been properly recorded.
2. The related allowance for doubtful accounts , returns and allowances
and discounts are reasonably adequate
3. Receivables are properly described
4. Disclosures with respect to the accounts are safeguarded

AUDIT PROCEDURES

1. Obtain a list of aged accounts receivable balances from the

subsidiary ledger and
- Foot and cross foot the list
- Check if the list reconciles with the general ledger control account
- Trace individual balances to the subsidiary ledger
- Test the accuracy of the aging
- Adjust non trade accounts erroneously included in customers
accounts
- Investigate and reclassify significance credit balances

2. Test accuracy of balances appearing in the subsidiary ledger

3. Confirm accuracy of individual balances by direct communication

with customers
- Investigate exceptions reported by customers and discuss with
appropriate officer for proper disposal
- Send a second request for positive confirmation requests without any
replies from customers
- If the second requests does not produce a reply from the customer ,
perform extended procedures like
- Reviewing collections after year end
- Checking supporting documents
- Discussing the account with appropriate officer
- Discuss with appropriate officer , confirmation requests returned by
the post office and perform extended procedures
- Prepare a summary of confirmation results

4. Review correspondence with customers for possible adjustments

5. Test propriety of cutoff

a. Examine sales recorded and shipments made a week before and after
the end of the reporting period and ascertain whether the sales were
recorded in the proper period.
b. Investigate large amount of sales returned shortly after the end of
the reporting period

6. Perform analytical procedures like

a. Gross profit ratio
b. Accounts receivable turnover
c. Ratio of accounts written off to sales or balance of accounts
receivable
d. Compare with prior years and industry averages

7. Review individual balances and age of accounts with appropriate

officer and
- Determine accounts that should be written off
- Determine adequacy of allowance for doubtful accounts
8. Obtain analyses of significant other receivables
 9. Ascertain whether some receivables are pledged , factored ,
discounted or assigned

10. Determine propriety of financial statement presentation and

adequacy of disclosures

11. Obtain receivable representation from the client.

EXERCISES ;
On January 1, 2021 HELLO Company reported accounts receivable
2,000,000 and allowance for doubtful accounts 100,000. The entity
provided the following data

CREDIT SALES WRITEOFFS RECOVERIES

2018 11,000,000 250,000 20,000

2019 13,000,000 305,000 35,000

2020 14,000,000 300,000 40,000

2021 15,000,000 200,000 50,000

THE collections from customers during 2021 totaled 14,000,000 excluding

recoveries.

Doubtful accounts are provided for as a percentage of credit sales.

The entity calculated the percentage annually by using the experience of

the three years prior to the current year.

1. What amount should be reported as doubtful account expense for

2021?
a. 200,000
b. 300,000
c. 400,000
d. 250,000

2. What amount should be reported as allowance for doubtful accounts

on December 31, 2021 ?
a. 250,000
b. 400,000
c. 300,000
d. 450,000

3. What is the net realizable value of accounts receivable on December

31, 2021?
a. 2,550,000
b. 2,600,000
c. 2,750,000
 d. 2,800,000

receivables part 2

ASSIGNMENT AND FACTORING

MONTEREY Company assigned 3,000,000 of accounts receivable as

collateral for a 2,000,000 loan with a bank. The bank assessed a 4%
finance fee and charged 6% interest on the note at maturity.

What would be the journal entry to record the transaction ?

a. Debit cash 1,920,0o00 debit finance charge 80,000 and credit note
payable 2,000,000
b. Debit cash 1,920,000 debit finance charge 80,000 and credit
accounts receivable 2,000,000
c. Debit cash 1,920,000 debit finance charge 80,000 debit due from
bank 1,000,000 and credit accounts receivable 3,000,000
d. Debit cash 1,880,000 debit finance charge 120,000 and credit note
payable 2,000,000

Solution

Face amount of loan 2,000,000

Finance fee (4% x 2,000,000 ) 80,000

Cash received 1,920,000

Answer a

Cash 1,920,000

Finance charge 80,000

Note payable 2,000,000

No gain or loss is recognized on the transfer of accounts receivable
because assignment of accounts receivable is a secured

borrowing and not a sale.

2. On December 1, 2021 Rose Company assigned specific accounts

receivable totaling 4,000,000 as collateral on a 3,000,000 12% note from a
certain bank. The entity will continue to collect the assigned accounts
receivable.

In addition to the interest on the note, the bank also charged a 5 %

finance fee deducted in advance on the 3,000,000 value of the note.

The December collections of assigned accounts receivable amounted to

2,000,000 less cash discounts of 100,000. On December 31, 2021 , the
entity remitted the collections to the bank in payment for the interest
accrued on December 31, 2021 and the note payable.

The entity accepted sales returns of 150,000 on the assigned accounts and
wrote off assigned accounts of 200,000.

1. What amount of cash was received from the assignment of accounts

receivable on December 1, 2021 ?
a. 4,000,000
b. 3,000,000
c. 3,800,000
d. 2,850,000

Solution :

Note payable 3,000,000

Finance fee (5% x 3m) ( 150,000)

Cash received on December 1 2,850,000 d

 2. What is the carrying amount of note payable on December 31. 2021?

a. 1,000,000
b. 1,100,000
c. 1,130,000
d. 1,460,000

Solution :

Note payable 3,000,000

Principal payment

Remittance 1,900,000

Interest 3MX12%X1/12 ( 30,000) 1,870,000

Note payable December 31 1,130,000 c

3. What is the balance of accounts receivable assigned on December 31,

2021 ?
a. 2,100,000
b. 2,000,000
c. 1,650,000
d. 1,850,000

Solution :

Accounts receivable assigned 4,000,000

Collections (1,900,000 )

Sales discounts ( 100,000 )

Sales returns ( 150,000 )

Accounts written off ( 200,000)

Accounts receivable assigned December 31 1,650,000 c

Face amount of accounts collected 2,000,000

Sales discounts ( 100,000 )

Collection of accounts assigned 1,900,000

Accounts receivable assigned 1,650,000

Note payable 1,130,000

Equity of ROSE Company in assigned accounts 520,000

The note payable is reported as current liability and the accounts

receivable assigned should be included in total accounts receivable

The equity in assigned accounts is disclosed only.

RECEIVABLE FINANCING – is the financial flexibility or capability of an

entity to raise money out of the receivables.

The common forms of receivable financing are pledge, assignment,

factoring of accounts receivable and discounting of notes receivable .

PLEDGE OF ACCOUNTS RECEIVABLE

When loans are obtained from the bank or any lending institution , the
accounts receivable maybe 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 de biting cash and discount on note payable if loan
is discounted , and crediting note 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 is made in a note to financial statements

ASSIGNMENT OF ACCOUNTS RECEIVABLE

- Means that a borrower called the assignor transfers rights in some of

accounts receivable to a lender called the assignee in consideration
for a loan.

Assignment is more formal type of pledging of accounts receivable . it is

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

Pledging is general because all accounts receivable serve as collateral

security for the loan.

Assignment is specific because specific accounts receivable serve as

collateral security for the loan.

FACTORING OF ACCOUNTS RECEIVABLE

Factoring is a sale 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.

A gain or loss is recognized for the difference between the proceeds

received and the carrying amount of the accounts receivable factored.
Factoring differs from an assignment in that an entity actually transfers
ownership of the accounts receivable to the factor.

The factor assumes responsibility for uncollectible factored accounts . in

assignment, the assignor retains ownership of the accounts assigned .

Because of the nature of 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 .

DISCOUNTING OF NOTE RECEIVABLE

- Is a transfer of endorsement of a promissory note by the payee in

favor of another party , usually a bank

To discount the note , the payee must endorse it

The payee legally becomes an endorser and the bank becomes an endorsee

Endorsement may be with recourse which means that the endorser shall
pay the endorsee if the maker dishonors the note.

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 maturity

In the absence of contrary statements, endorsement is assumed to be with

recourse.

ACCOUNTS RECEIVABLE PLEDGED – against borrowing shall still be

included in total accounts receivable but the amount of accounts receivable
involved should be properly disclosed.

ACCOUNTS RECEIVABLE ASSIGNED – should be included in total accounts

receivable but disclosure is necessary.

The reason is that assignment of account receivable is a secured borrowing

and not a sale of account receivable.
The assignor should disclose its equity in the assigned accounts , which is
equal to the accounts receivable assigned minus note pay able to the
bank.

ACCOUNTS RECEIVABLE FACTORED – should be excluded from total

accounts receivable.

The reason is that factoring is an absolute sale of accounts receivable and

therefore the accounts receivable factored should be derecognized .

If the factor withholds a certain portion or percentage of the accounts

receivable purchased , the portion retained by the purchaser should be
included in receivables by the seller.

The amount withheld by the factor is known as factor’s holdback, which is

actually an amount due from the factor.

NOTES RECEIVABLE DISCOUNTED – without recourse shall be excluded

from total notes receivable without separate disclosure.

Notes receivable discounted with recourse shall be excluded from total

notes receivable but the contingent liability shall be appropriately
disclosed.

Some believe that if a note receivable is discounted with recourse, the

transactions shall be accounted for as a secured borrowing ,

In such a case, an entity shall not derecognize the note receivable

discounted but instead shall record an accounting liability for an amount
equal to the face amount of the note discounted .

PROBLEMS :

FACTORING OF ACCOUNTS RECEIVABLE

ZALDY COMPANY factored 6,000,000 of accounts receivable to a finance
entity at the end of the current year. Control was surrendered by Zaldy
Company

The factor assessed a fee of 3 % and retained a holdback equal to 5% of

the accounts receivable

In addition , the factor charged 15% interest computed on a weighted

average time to maturity of the accounts receivable of 54 days.

1. What is the amount of cash initially received from the factoring ?

a. 5,296,850
b. 5,386,850
c. 5,476,850
d. 5,556,850

Solution:

Accounts receivable 6,000,000

Factor’s holdback (6,000,000x5%) ( 300,000 )

Factoring fee (6,000,000x 3%) ( 180,000 )

Interest (6,000,000x15%x54/365 ) ( 133,150 )

Cash initially received from factoring 5,386,850 b

2. If all accounts are collected, what is the cost of factoring the

accounts ?
a. 313,150
b. 180,000
c. 433,150
d. 613,150

Solution

Factoring fee 180,000

Interest 133,150
Total cost of factoring 313,150 a

DISCOUNTING OF NOTE RECEIVABLE

REAL Company received from a customer a one year 500,000 note bearing
annual interest of 8%

After holding the note for six months , the entity discounted the note
without recourse at 10%

What amount of cash was received from the bank ?

a. 540,000
b. 523,810
c. 513,000
d. 495,238

Solution

Principal 500,000

Add; interest (500,000 x 8 %) 40,000

Maturity value 540,000

Less ; discounts (540,000x10%x6/12) 27,000

Net proceeds 513,000 c

Principal 500,000

Accrued interest receivable

500,000x8%x6/12 20,000

Carrying amount of N/R 520,000

Net proceeds 513,000

Carrying amount of N/R ( 520,000)

LOSS ON NOTE receivable

Discounting 7,000

Maturity value – principal plus interest for the full term of the note

Interest = principal times interest rate times the full term of the note

Discount – maturity value times discount rate x discount period .