CHAPTER 4: ACCOUNTS RECEIVABLE
TECHNICAL KNOWLEDGE
To know -the classification and presentation of receivables,
To know the initial and subsequent measurement of accounts receivable.
No identify the adjustments necessary in determining the
Net realizable value of accounts receivable.
Co understand the gross method and net method of recording credit sales.
To know the accounting for doubtful accounts, worthless accounts written
off and recoveries of accounts written off.
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
1. Trade receivables refer to claims arising from sale of merchandise or
services in the ordinary course of business.
2. Trade receivables include accounts receivable and notes receivable.
3. 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.
4. Other names of accounts receivable are customers' accounts, trade
debtors, and trade accounts receivable.
5. Notes receivable are those supported by formal promises to pay in the form
of notes.
6. Nontrade receivables represent claims arising from sources other than
the sale of merchandise or services in the ordinary course of business.
Loans receivable
1. For banks and other financial institutions, receivables result primarily from
loans to customers.
2. The loans are made to heterogeneous customers and the
3. repayment periods are frequently longer or over several years.
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Classification
Trade receivables which are expected to be realized in cash within the
normal operating cycle or one year, whichever longer, are classified as
current assets.
Nontrade receivables which are expected to be realized in cash within one
year, the length of the 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 states:
"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”.
Presentation
Trade receivables and nontrade receivables which are 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.
For example, the disclosure may appear as follows:
Accounts receivable 5,000,000
Allowance for doubtful accounts (200,000)
Notes receivable 1,000,000
Accrued interest on note receivable 150,0000
Advances to officers and employees 100,000
Dividends receivable 250,000
-------------
Total trade and other receivables 6,300,000
Examples of nontrade receivables
1. Advances to or 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.
2. Advances to affiliates are usually treated as long-term investments.
3. Advances to supplier for the acquisition of merchandise are current assets.
4. Subscriptions receivable are current assets if collectible within one year.
Otherwise, subscriptions receivable should be shown preferably as a
deduction from subscribed share capital.
5. Creditor’s account may have debit balances as a result of overpayment
or return and allowances. These are classified as current asset.
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.
6. 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.
7. 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.
8. 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.
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 Customer’s accounts,
except when the same is not material in which case only the net
accounts receivable may be presented.
For example, the accounts receivable controlling account reports a
balance of P500,000. Examination of the Subsidiary ledgers reveals the
following details in the customer’s account.
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Customer A
Sales 800,000 Collections 400,000
800,000 Debit balances 400,000
800,000
Customer B
Sales 600,000 Collections 450,000
600,000 Debit balances 150,000
600,000
Customer C
Sales 500,000 Collections 450,000
Credit balances 150,000 Debit balances 100,000
550,000 550,000
The accounts receivable should be presented as current asset at
P550,000 representing the accounts of A and B.
The credit balance in the account of C is classified as current liability
and not offset against the debit balances in the accounts of A and B.
No adjustment is necessary to formally recognize the customers'
credit balances because ultimately these are canceled for sales and
cash settlement.
But an adjustment may be made only for worksheet purposes, meaning,
not formally journalized and posted to the ledger as follows:
Accounts receivable 50,000
Customers’ balances 50,000
Initial measurement of accounts receivable
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 amount or
original invoice amount.
Cash flows relating to short-term receivables are not discounted because
the effect of discounting is usually immaterial.
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Accordingly, accounts receivable shall be measured initially at face amount
or original invoice amount..
Subsequent measurement
In accordance with PFRS 9, paragraph 5.2.1, 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 reduce by
adjustments which in the ordinary course of business will reduce the amount
recoverable from the customers.
This is based on the established basic principle that asset shall not be carried
at above their recoverable amount.
Accordingly, in estimating the net realizable value accounts receivable, the
following deductions are made:
1. Allowance for freight charge
2. Allowance for sales return
3. Allowance for sales discount
4. Allowance for doubtful accounts
Terms related $0 freight charge
In order to give proper accounting recognition charge in relation to
accounts receivable, the following should be understood — FOB
destination, FOB shipping freight collect and freight prepaid.
The term FOB destination means that ownership purchased is vested in
the buyer upon receipt
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Accordingly, the seller shall be responsible for charge up to the point of
destination.
The term FOB shipping point means that ownership of the goods purchased
is vested in the buyer upon shipment thereof.
Thus, it is incumbent upon the buyer to pay for transportation charge
from the point of shipment to the of destination.
The term freight collect means that freight charge on the shipped is not yet
paid. The common carrier shall collect the same from the. buyer. Thus,
under this, the freight charge is actually paid by the buyer.
The term freight prepaid means that freight charge on the goods shipped is
already paid by the seller.
Accounting for freight charge
Sometimes, 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 paid by him.
On the part of the seller, the freight charge is recorded by debiting freight
out and crediting allowance for freight
For example, an entity has a P 100,000 account receivable at the end of
accounting period.
The terms are 2/ 10, n/ 30, FOB destination and freight collect. The customer
paid freight charge of P5,000.
1. To record the sale:
Accounts receivable 100,000
Freight out 5,000
Sales 100,0
00
Allowance for freight charge 5,000
2. To record the collection within the discount period:
Cash 93,000
Sales discount 2,000
Allowance for freight charge 5,000
Accounts receivable 100,000
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Allowance for sales returns
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.
For example, an amount of P50,000 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 50,000
Allowance for sales return 50,000
Sales discount
Entities usually offer cash discounts to credit Customer. A cash discount is
a reduction from an invoice price by reason of prompt payment
A cash discount is known as sales discount on the part of seller and a
purchase discount on the part of the buyer.
A cash discount may be expressed as 5/10, n/ 30. This means
that the customer is entitled to a 5% discount payment is
made in 10 days from the invoice date.
If the customer fails to pay within the 10-day discount the gross
amount of the invoice price must be paid days from the invoice
date.
Methods of recording credit sales
1. Gross method — The 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.
2. Net method — The accounts receivable and sales are recorded at
net amount of the invoice, meaning the invoice price minus the cash
discount.
Illustration — Gross method
1.. Sale of merchandise for P 100,000, terms 5/ 10, n / 30.
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Accounts receivable 100,000
Sales 100,000
2. Assume collection is made within the discount
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 P 100;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
If customers are granted cash discounts for prompt payment, then
conceptually estimates of cash discounts on open accounts at the end of the
period based on past experience shall be made.
For example, of the accounts receivable of P 1,000,000 at the end of
the period, it is reliably estimated that discounts to be taken will
amount to P50,000.
The adjustment to record the expected sales discount is:
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Sales discount 50,000
Allowance for sales discount 50,000
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.
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 doing business on credit.
Two methods are followed in accounting for this bad debt loss, namely:
1. Allowance method
2. Direct writeoff 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 accounts is:
Doubtful accounts xx
Allowance for doubtful accounts xx
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 follows:
Allowance for doubtful accounts xxx
Accounts receivable xxx
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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 writeoff regardless of whether the recovery is during the year of
writeoff or subsequent thereto.
Illustration – Allowance method
I. Accounts of P30,000 are considered doubtful of collection.
Doubtful accounts 30,000
Allowance for doubtful accounts 30,000
2. The accounts are subsequently discovered 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
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Allowance for doubtful accounts 30,000
Cash 30,000
Accounts receivable 30,000
Direct writeoff method
The direct writeoff method requires recognition of a bad 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 collections, 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 recognize only this
method for income tax purposes.
However, the direct writeoff method violates the matching principle
because the bad debt loss is often recognized in later accountanting period
than the period in which the sales revenue was recognized.
The direct writeoff method is not permitted under IFRS.
llustration — Direct writeoff method
1. Accounts of P30,000 are considered doubtful of collection.
No entry is necessary.
2. The accounts proved to be worthless.
Bad debts 30,000
Accounts receivable 30,000
3. The same accounts that are previously written worthless are
recovered or collected.
Accounts receivable 30,000
Bad debts 30,000
Cash 30,000
Accounts receivable 30,000
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If the recovery is subsequent to the year of writeoff and the direct
writeoff method is used, the recovery may simply be credited to other income.
Doubtful accounts in the income statement
1. Distribution cost
If the granting of credit and collection of accounts ate 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
charge 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.
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