FINANCIAL ACCOUNTING & REPORTING 1

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Accounting for Receivables (Part 1)

Module 006 Accounting for Receivables (Part 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 into trade or non-trade receivables.
PFRS 9, paragraph 5.1.1, provides that a financial asset shall be recognized
initially at fair value plus transaction costs that are directly attributable to
the acquisition. Based on IAS 39, loans and receivables shall be measured in
the statement of financial position at amortized cost using the effective
interest method.
At the end of this module, you will be able to:
1. Define receivables
2. Understand the nature and classification of receivables
3. Explain the accounting for receivables
The common application of the lessons that are under this module consists of
being able to distinguish receivables and account for them.

Definition, nature, and classification of receivables

Receivables
➢ Are financial assets that represent a contractual right to receive cash or another
financial asset from another entity.
➢ Represent any legitimate claim from others for money, goods, or services.

CLASSIFICATION OF RECEIVABLES
For retailers or manufacturers, receivables are classified into trade or non-trade
receivables.

As to Source
• Trade Receivables – refer to claims arising from the sale of merchandise or rendering of
services in the ordinary course of business. It includes accounts receivable and notes
receivable.
➢ Accounts Receivables - open accounts not supported by promissory notes.
➢ Notes Receivables - are those supported by formal promises to pay in the form of
promissory notes.

• Non-trade Receivables – represent claims arising from sources other than the sale of
merchandise or services in the ordinary course of business.

Specific examples of non-trade receivables are:

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➢ Loans to officers and employees

➢ Advances to affiliates
➢ Accrued interest and dividends
➢ Deposits to guarantee performance or payment or to cover possible damages or
losses.
➢ Subscriptions for the entity’s securities
➢ Deposit with creditors, claims for losses and damages
➢ Claims for tax refunds or rebates
➢ Claims against common carriers for damaged or lost goods
➢ Claims against creditors for returned, damaged, or lost goods

Accounting for receivables (Recognition, Initial and subsequent measurement,

and uncollectibility of receivables)
Initial Measurement
PFRS 9, paragraph 5.1.1, 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.
For short-term receivables, the fair value is equal to the face value or original invoice
amount. For long-term receivables that are interest-bearing, the fair value is equal to the
face value. However, for those that are noninterest-bearing, the fair value is equal to the
present value of all future cash flows discounted using the prevailing market rate of
interest for similar receivables.

Subsequent Measurement
Based on IAS 39, loans and receivables shall be measured in the statement of financial
position at amortized cost using the effective interest method. For accounts receivable, they
are valued subsequently at Net Realizable Value (NRV).

Net Realizable Value- is the amount of cash expected to be collected or the estimated
recoverable amount. This is obtained by subtracting the accounts receivable account from
the allowance for doubtful accounts.

Recognition of Accounts Receivable

Items to be noted in recognizing accounts receivable:

• Trade discounts
• Sales discounts
• Sales returns and allowances
• Uncollectible accounts

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Trade discounts
• are means of converting a catalog list price to the prices actually charged
• are not recognized for financial accounting purposes.

Example:
Assume that on July 16, 2017, ABC Manufacturing sells merchandise on account with a list
price of P100,000, fewer trade discounts of 10%, 10%, and 5%. The invoice price of the
merchandise is computed as follows:

List price P100,000

Less: 10%x10,000 10,000
Total 90,000
Less: 10%x90,000 9,000
Total 81,000
Less: 5%x81,000 4,050
Invoice Price 76,950

Alternatively, you can compute by:

100,000 x 0.90 x 0.90 x 0.95 = 76,950

Accounts Receivable 76,950

Sales 76,950

Cash (sales) discounts

• Are inducements to customers for prompt payment of an account.
• Are accounted for either by gross, net, or allowance method

Gross method –cash discount is only recorded when it is taken, that is when the customer
pays within the discount period. This is the commonly used method.

Example:
Assume in the previous example that the credit terms were 2/10, n/30. FOB Shipping Point
and freight paid to the shipper by ABC manufacturing amounted to P2,000. The sale on July
16, 2017is recorded as follows:
Accounts receivable 78,950
Sales 76,950
Cash 2,000

Assume that collection was made on July 25, 2017, which is within the discount period of
10 days; the journal entry is:
Cash 77,411
Sales discount 1,539
Accounts receivable 78,950

If the account is collected after the discount period, the journal entry is
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Cash 78,950
Accounts receivable 78,950

Net method –cash discount is only recorded when it is not taken; that is, when the
customer pays after the discount period.

The sale on July 17, 2017, is recorded as follows:

Accounts receivable 77,411
Sales 75,411
Cash 2,000

Assume that collection was made on July 25, 2017, which is within the discount period of
10 days; the journal entry is:
Cash 77,411
Accounts receivable 77,411

If the account is collected after the discount period, the journal entry is
Cash 78,950
Sales Discounts Forfeited 1,539
Accounts receivable 77,411

Allowance method –the sales discount is recognized when it is offered to the customer
using the account allowance for sales discount.

The sale on July 17, 2017, is recorded as follows:

Accounts receivable 78,950

Allowance for Sales Discounts 1,539
Sales 75,411
Cash 2,000

Assume that collection was made on July 25, 2017, which is within the discount period of
10 days; the journal entry is:
Cash 77,411
Allowance for Sales Discounts 1,539
Accounts receivable 78,950

If the account is collected after the discount period, the journal entry is
Cash 78,950
Allowance for Sales Discounts 1,539
Sales Discounts Forfeited 1,539
Accounts receivable 78,950

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Sales Returns and Allowances

• A contra revenue account that reports 1) merchandise returned by a customer and 2)
the allowances granted to a customer because the seller shipped improper or defective
merchandise.
• This, of course, will reduce the seller's accounts receivable and is subtracted from sales
(along with sales discounts) to arrive at net sales.

For example, an amount of P5,000 of the total accounts receivable at year-end indicates a
selling price of goods that will be returned. The journal entry to recognize the probable
return is:
Sales return 1, 000
Allowance for sales return 1,000

Doubtful Accounts Expense (Bad Debts/ Uncollectible Accounts Expense)–loss due to

account receivables that are not collected.
- This forms part of operating expenses as an entity that sells on credit assumes the risk
that some customers will not pay their accounts.
Recovery of an uncollectible account
If a collection is made on an 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 accepted procedure 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
Two methods are used in accounting for uncollectible accounts:
(1) The direct write-off method and
(2) The allowance method.

Direct write-off method for uncollectible accounts –requires recognition of a bad debt
loss only when the accounts prove to be worthless or uncollectible.
-violates the matching principle because the bad debt loss is often recognized in a later
accounting period than the period in which the sales revenue was recognized.
Example:
1. Accounts of P1,500 are considered doubtful of collection. - No entry is necessary
2. The accounts provided are worthless
Doubtful Accounts Expense 1,500
Accounts receivable 1,500

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3. The same accounts that were previously written off as worthless are recovered or
collected.
Accounts Receivable 1,500
Doubtful Accounts Expense 1,500
Cash 1,500
Accounts receivable 1,500

Allowance method for uncollectible accounts -requires recognition of bad debt losses if the
accounts are doubtful of collection.

-GAAP requires the use of the allowance method because it conforms with the matching principle.
Example:
1. Accounts of P1,500 are considered doubtful of collection
Doubtful Accounts Expense 1,500
Allowance for Doubtful Accounts 1,500
2. The accounts provided are worthless
Allowance for Doubtful Accounts 1,500
Accounts receivable 1,500
3. The same accounts that were previously written off as worthless are recovered or
collected.
Accounts Receivable 1,500
Allowance for Doubtful Accounts 1,500
Cash 1,500
Accounts receivable 1,500

ESTIMATING THE ALLOWANCE

The doubtful accounts expense must be estimated at the end of each accounting period.
Companies use one of the three methods in the estimation of uncollectible:
1. Aging the accounts receivable
2. Percentage of sales
3. Percentage of receivables

AGING THE ACCOUNTS RECEIVABLE

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

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• The allowance is then determined by multiplying the total of each classification by

the rate or percent of loss experienced by the entity for each category.

Example. The following data are summarized in aging the accounts receivable at the end of
the period.
Balance 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 1 year 20,000 50% 10,000
1,200,000 50,000
The amount computed by aging the 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 expense of the doubtful account is determined as follows:

Required allowance 50,000

Less: Allowance balance before adjustment 10,000

Doubtful accounts expense 40,000

The journal entry to record the expense of the doubtful account is:
Doubtful Accounts Expense 40,000
Allowance for Doubtful Accounts 40,000
PERCENTAGE OF SALES
• The amount of sales for the year is multiplied by a certain rate to get the expense of
the doubtful account.
• The rate may be applied to credit sales or total sales.
• There is a proper matching of cost against revenue since bad debt loss is directly
related to sales and reported in the year of sale.
• This is an income statement approach.

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Example: 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 expense of the doubtful account is
P50,000 (1% x P50,000,000) and recorded as follows:
Doubtful Accounts Expense 50,000
Allowance for Doubtful Accounts 50,000

PERCENTAGE 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.
• This presents the accounts receivable at estimated net realizable value.
• However, the application of this approach violates the principle of matching the bad
debt loss against the sales revenue.
• This is a balance sheet approach.
Example: 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.
The journal entry to record the expense of the doubtful account is:

Doubtful Accounts Expense 50,000

Allowance for Doubtful Accounts 50,000

Required allowance 60,000

Less: Credit balance in the allowance 10,000

Doubtful accounts expense 50,000

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Glossary
Accounts Receivables: open accounts not supported by promissory notes.

Doubtful Accounts Expense: loss due to account receivables that are not collected.

Net Realizable Value: is the amount of cash expected to be collected or the estimated
recoverable amount.

Notes Receivables: are those supported by formal promises to pay in the form of
promissory notes.

Gross method: cash discount is only recorded when it is taken; that is, when the customer
pays within the discount period.

Net method: cash discount is only recorded when it is not taken; that is when the customer
pays after the discount period.

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

Sales discounts: are inducements to customers for prompt payment of an account.

Trade discounts: are means of converting a catalog list price to the prices actually
charged.

References and Supplementary Materials

Books and Journals
1. Robles, N. S., & Empleo, P. M. (2014). Intermediate Accounting (2014 ed., Vol. 1).
Manila, Philippines.

2. Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol.
1).Manila, Philippines.

3. Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol.
2).Manila, Philippines.

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Online Supplementary Reading Materials

1. 7.1 Accounts Receivable and Net Realizable Value;
http://open.lib.umn.edu/financialaccounting/chapter/7-1-accounts-receivable-and-
net-realizable-value/;19 October 2017

Online Instructional Videos

1. Accounting for Receivables;
https://www.youtube.com/watch?v=ecm1kSCa6MI; 18 October 2017

2. Financial Accounting - Receivables;

https://www.youtube.com/watch?v=bO6lpdKy6hc; 18 October 2017

3. Accounting for Receivables;

https://www.youtube.com/watch?v=PJSxQu8uqNU; 18 October 2017

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