Handout: Accounts Receivable FAR0_1st Sem_AY2019-20

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

Related Terms and Definitions

1. Financial Instrument – any contract that gives rise to a financial asset of one entity and a financial liability or an
equity instrument of another entity.
2. Financial Asset – any asset that is (a) cash; (b) a contractual right to receive cash or another financial asset from
another entity; (c) a contractual right to exchange financial instrument with another entity under conditions that are
potentially favorable; or (d) an equity instrument of another entity.
3. Financial Liability – a contractual obligation to (a) deliver cash or another financial asset to another entity; or (b) to
exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to
the entity
4. Equity Security – represents ownership interest in another entity in the form of ordinary shares, preference shares and
rights or options to acquire ownership shares.

Classification of Receivables
1. Trade receivables – pertain to claims arising from sale of merchandise or services in the ordinary course of business.
Trade receivables that are expected to be realized in cash (collected) within the normal operating cycle or one year,
whichever is longer, are classified as current assets.
2. Nontrade receivables – refer to claims arising from sources other than the sale of merchandise services in the ordinary
course of business. Nontrade receivables that are expected to be realized in cash (collected) within one year, the
length of the operating cycle notwithstanding, are classified as current assets.

Financial Statement Presentation of Receivables

Trade receivables that are expected to be realized in cash (collected) within the normal operating cycle or one year,
whichever is longer, and nontrade receivables that are expected to be realized in cash (collected) within one year, the length of
the operating cycle notwithstanding, shall be presented on the face of the statement of financial position as a single line item,
collectively referred to as “trade and other receivables”.

Classification Rules Related to Nontrade Receivables

Type of Nontrade Receivables Classification Rules
Advances to shareholders, officers Classified as current assets if collectible within 1 year from the end of the reporting
and/or employees period; noncurrent if otherwise.
Advances to affiliates Are usually realizable into cash beyond 1 year, hence are classified as long-term
investments; short-term investments if otherwise
Advances to suppliers for the Classified as current assets
purchase of merchandise
Subscriptions receivable Classified as current assets if collectible within 1 year; contra – equity if otherwise
Creditors’ accounts (accounts Normally classified as current assets. Alternatively, the same can be offset against
payable) with debit balances other creditors’ accounts with credit balances if the amount is immaterial.
Special deposits on contract bids Normally classified as noncurrent assets; current assets if collectible within 1 year
from the end of the reporting period
Accrued income Normally classified as current assets since they are usually collectible currently;
noncurrent assets if otherwise
Claims receivable Normally classified as current assets since they are usually collectible currently;
noncurrent assets if otherwise

Rules on customers’ accounts with credit balances

1. Customers’ credit balances resulting from overpayments, returns and allowances, and advance payments from
customers are classified as current liabilities and are not offset against customers’ accounts with debit balances.
2. Alternatively, the same can be offset against other customers’ accounts with debit balances if the amount is
immaterial.

Measurement of Accounts Receivable:

a. Initial – face amount or original invoice amount (fair value)
b. Subsequent – net realizable value (amortized cost)

Net realizable value

The net realizable value of accounts receivable is the outstanding face amount of the receivables reduced by (1) allowance for
freight charge; (2) allowance for sales return; (3) allowance for sales discount; and (4) allowance for doubtful accounts

Accounting for Freight Charge

Owner of the goods
Party that initially
in transit/ Party
Freight Terms pays the cost of Pro-forma entry (seller’s point of view)
liable to shoulder
freight
the cost of freight
FOB Shipping Point, Accounts receivable xx
Buyer Buyer
Freight Collect Sales xx
FOB Destination, Accounts receivable xx
Freight Prepaid Freight out xx
Seller Seller
Sales xx
Cash xx
Handout: Accounts Receivable FAR0_1st Sem_AY2019-20

Owner of the goods

Party that initially
in transit/ Party
Freight Terms pays the cost of Pro-forma entry (seller’s point of view)
liable to shoulder
freight
the cost of freight
FOB Shipping Point, Accounts receivable xx
Freight Prepaid Buyer Seller Sales xx
Cash xx
FOB Destination, Freight Accounts receivable xx
Collect Freight out xx
Seller Buyer
Sales xx
Allowance for freight charge xx

Accounting for Allowances for Sales Return and Sales Discount

Type of Allowance Adjusting Entry at year-end Reversing Entry (optional)
1. Allowance for sales return Sales return xx Allowance for sales return xx
Allowance for sales return xx Sales return xx
2. Allowance for sales discount Sales discount xx Allowance for sales discount xx
Allowance for sales discount xx Sales discount xx

Methods of Recording Credit Sales

1. Gross Method – The accounts receivable and sales are recorded at the gross amount of the invoice (before deducting any
offered cash discount)
2. Net Method – The accounts receivable and sales are recorded at the net amount of the invoice (after deducting any offered
cash discount)

Types of Discounts
1. Trade discount – refer to discounts that are offered to encourage transactions in high volume (sales or purchases in bulk)
and/or to reward customer patronage
2. Cash discount – pertain to discounts that are offered to encourage prompt collection/payment of accounts

Accounting for Doubtful Accounts:

Particulars/ Transactions Allowance Method Direct Write – Off Method
1. Timing on the When accounts become doubtful of When accounts are proven worthless
recording of expense collection
2. Accounts become Doubtful accounts expense xx
No entry
doubtful of collection. Allowance for doubtful accounts xx
3. Accounts are Allowance for doubtful accounts xx Bad debts expense xx
eventually proven Accounts receivable xx Accounts receivable xx
worthless.
4. Recovery of accounts If recovery is made during the same accounting
Re-establishment entry:
previously written off: period where write-off was recognized:
Accounts receivable xx
Reversal entry:
Allowance for doubtful accounts xx
Collection entry: Accounts receivable xx
Bad debts expense xx
Cash xx Collection entry:
Accounts receivable xx
Cash xx
Accounts receivable xx
If recovery is made in subsequent accounting
period:
Cash xx
Miscellaneous income xx

Classification of Doubtful Accounts in the Income Statement

1. Distribution cost (selling expense) – if the credit and collection function is under the charge of the sales department
2. Administrative expense – if the credit and collection function is under the charge of a department other than the sales
department

Methods of Estimating Doubtful Accounts

Method Advantage Disadvantage
1. Percent of sales (income There is proper matching of cost The accounts may not be shown at estimated
statement approach) against revenue. realizable value because the allowance may
prove excessive or inadequate.
2. Percent of accounts receivable Presents fairly the accounts receivable There is no proper matching of cost against
(statement of financial position in the statement of financial position at revenue.
approach) net realizable value.
3. Aging of accounts receivable Presents fairly the accounts receivable There is no proper matching of cost against
(statement of financial position in the statement of financial position at revenue. Further, it is relatively more time
approach) net realizable value. consuming than Methods 1 & 2.