ACC-110: INTERMEDIATE ACCOUNTING 1

LESSON 3:
1st SEMESTER | A.Y. 202Y – 202Y
LECTURER: SIR/MS.

RECEIVABLES ─ Nontrade Receivables represent claims arising from

sources other than the sale of merchandise or services in
Receivables are financial assets that represent a contractual the ordinary course of business.
right to receive cash or another financial asset from another o Not directly related to the business.
entity. o Nontrade Receivables are expected to be realized
in cash within one year, the length of the operating
o Financial Asset – it is a contractual right to receive a
cycle notwithstanding, are classified as current
financial asset from another entity.
assets.
o Receivables are simply claims.
o If collectible beyond one year, nontrade receivables
o Receivables are classified into trade receivables and
are classified as noncurrent assets.
nontrade receivables. o Regardless of the length of its operating cycle, it
should be considered current if it will be realized
Classification of Receivables within 1 year.

 "An entity shall classify an asset as current when the More than 12 months  (noncurrent)
entity expects to realize the asset or intends to sell or
consume it in the entity's normal operating cycle or one Examples of Nontrade Receivables:
year, whichever is longer, are classified as current
1) “Advances to” or “receivables from” shareholders,
assets."
directors, officers or employees.
~ “Advances to” means that you lent something to
TRADE RECEIVABLES them (nagpautang).
~ “Advances/Receivables from” means that you b
─ Trade Receivables refers to claims arising from sale of orrowed something from them (nangutang).
merchandise or services in the ordinary course of business. ~ If collectible in one year, such advances or
o Trade Receivables are expected to be realized in receivables should be classified as current assets.
cash within the normal operating cycle or one year, ~ If the problem is silent, it is classified as noncurrent
whichever is longer, are classified as current assets.
assets.
2) Advances to affiliates.
(12 months or less  current) ~ Non-current investments.
~ These are advances made to related parties.
o This includes accounts receivables and notes ~ Affiliate is another company related to yours (i.e.
receivables. sister company or parent company).
~ If the problem is silent, it is classified as noncurrent
assets.
ACCOUNTS RECEIVABLES
3) Advances to supplier.
 Accounts receivables open accounts arising from the sale ~ It is classified as current assets.
of goods and services in the ordinary course of business ~ You transact with them regularly, so it is normally
and not supported by promissory notes. collectible currently—current assets.
 Open account because it is not yet received or paid.
 These are not supported by formal promissory 4) Subscriptions receivable.
notes. ~ Subscriber is the one who wants to join the stock
 Classified as current assets. corporation.
 Other names of A/R: ~ Subscription is an act promising that they will buy
o Customers’ account shares.
o Trade debtors ~ If the problem is silent, it is assumed that
subscription receivable cannot be collected
immediately—thus, classified as noncurrent asset.
NOTES RECEIVABLES
~ In terms of presentation, subscription receivable is
 Note receivables are those supported by formal promises not classified as noncurrent asset BUT should be
to pay in the form of notes. shown preferably as a deduction from subscribed
 These are supported by formal or written promises. share capital unless collectible currently.
 IF the problem is silent, it is always classified as ~ If the problem stated that subscription receivable is
current assets (trade receivable) because it is part current, then this will be classified as a current
of the operating cycle. asset but NOT a deduction to equity, rather an
ADDITION to current asset.

NONTRADE RECEIVABLES Subscription Receivable

Classification Presentation

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Problem is silent Non-current Asset A deduction from 9) Loans receivable.
the equity ~ Receivables arising from loans extended by
Problem is not silent Current Asset An addition to the financial institutions, such as banks, financing
“current assets” companies, and lending institutions.
section ~ Loans receivable are also supported by promissory
notes and are generally backed by collateral
securities or postdated checks.
5) Creditors' accounts with debit balances as a result of
overpayment or returns and allowances. 10) Customers’ credit balance.
~ These are classified as current assets. ~ Opposite of creditors’ debit balance.
~ A situation when you have given supplier too much ~ This NOT a receivable, but a PAYABLE.
money, so you have a receivable from the supplier.
Accounts Receivable – Customer A
Accounts Payable – Supplier A
100,000 – A/R
100,000 – A/P 50,000 – A/R (downpay)
50,000 – A/P (downpay) 60,000 – return (A/R)
60,000 – return (A/P)
CR. Balance: 10,000 A/R
DR. Balance: 10,000 A/R
~ Customers' credit balances are credit balances in
~ It is originally a “liability” but since it was recorded accounts receivable resulting from overpayments,
in the debit side in order to reduce its liability to returns and allowances, and advance payments
seller because of the return, it is now considered as from customers.
a receivable. ~ Customers' credit balances are classified as current
~ Not offsetting. liabilities and are not offset against the debit
~ It is a transaction between the supplier and buyer balances in other customers' accounts, except
that is why is it current. when the same is not material in which case only
~ If the problem is silent, it is still classified as current the net accounts receivable may be presented.
asset.
Another Example:
6) Special deposits on contract bids.
~ Special deposit is like a promise to pay to other ~ The accounts receivable controlling account reports
party—promising to continue with the contract. a balance of P5,000,000.
~ We are the ones who paid out for the special
deposit, and the same will be collected from them Examination of the subsidiary ledgers reveals the
at the time the contract ends—accounts receivable. following details in the customers' accounts:
~ This is normally are classified as noncurrent assets
Customer A 3,000,000
because such deposits are likely to remain
Customer B 2,500,000
outstanding for a considerable long period of time.
Customer C (500,000)
 Deposits receivables from reimbursable
Account receivable control 5,000,000
deposits paid to potential damages or losses
 Deposits for guarantee of performance or
payment ~ The credit balance in the account of Customer C
 Deposits for returnable items (e.g., crates, resulted from overpayment.
containers, etc.). ~ Understandably, the credit balance in the account
of Customer C is a liability of the entity to Customer
7) Accrued Income. C.
~ Receivables arising from income earned but not yet ~ The accounts receivable should be presented as
collected, such as interest income, dividend current asset at P5,500,000 representing the
income, and the like—but not related to business accounts of A and B.
operations. ~ The credit balance of P500,000 in the account of C
~ These are usually classified as current assets. is classified as current liability and not offset
 Dividend receivable against the debit balances in the accounts of A and
 Accrued rent receivable B.
 Accrued royalties receivable ~ No adjustment is necessary to formally recognize
 Accrued interest receivable the customers' credit balances because ultimately
the credit balances are canceled for sales and cash
8) Claims Receivables. settlement.
~ Claims receivable such as claims against common
carriers for losses or damages, claim for rebates
and tax refunds. PRESENTATION
~ These are normally classified as current assets.
─ Trade receivables and nontrade receivables which are
 Receivables from insurance companies for
currently collectible shall be presented on the face of the
casualties sustained
statement of financial position as one line item called trade
 Defendants under suit, government agencies
and other receivables.
for refundable taxes and other remittances
─ However, the details of the total trade and other
 Common carriers for damaged or lost goods
receivables shall be disclosed in the notes to financial
 Suppliers for returned or damaged goods.
statements.

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 Fair Value (or Face
Receivable Amount + Amortized Cost
Transaction Cost

Net Realizable
Face Amount or
Accounts Value or
Original Invoice
Receivable Recoverable
Amount
Amount
MEASUREMENT OF ACCOUNTS RECEIVABLE

Initial Measurement of Accounts Receivable

NET REALIZABLE VALUE
─ Financial Asset shall be recognized initially at fair value
plus transaction costs that are directly attributable to the  The net realizable value of accounts receivables is the
acquisition. amount of cash expected to be collected or the estimated
─ The fair value of a financial asset is usually the transaction recoverable amount.
price, meaning, the fair value of the consideration given.  The initial amount recognized for accounts receivable shall
o Ex. You sold a merchandise on account for P10,000. be reduced by adjustments which in the ordinary course of
The accounts receivable recorded will be P10,000 business reduce the amount recoverable from the
as well because of the consideration given up, customer.
which is the merchandise inventory that is worth  This is based on the established basic principle that assets
P10,000. shall not be carried at above their recoverable amount.
─ For short term receivables, the fair value is equal to the  The following deductions are made:
face amount or original invoice amount. 1) Allowance for freight charge
─ Accounts receivables shall be measured initially at face 2) Allowance for sales return
amount or original invoice amount. 3) Allowance for sales discount
4) Allowance for doubtful accounts

Subsequent Measurement of Accounts Receivable These allowances are just estimates.

─ After initial recognition, accounts receivable shall be  Allowance for freight charge, allowance for sales return,
measured at amortized cost. and allowance for sales discount are still recoded at their
─ The amortized cost is actually the net realizable value of actual or face value in subsequent measurement.
accounts receivable. o Accounts receivable is short term.
─ The term "amortized cost" has more relevance in long- o When sales occurred during 2021, most of the time,
term note receivable. Thus, the term "net realizable value" freight charge, sales discount, and sales return also
is preferably used in relation to accounts receivable. occur during that year
o Only doubtful accounts that goes beyond from the
year the sales occurred.

Accounts Receivable xxx

Less: Allowance for freight charge (xxx)
Less: Allowance for sales return (xxx)
Less: Allowance for sales discount (xxx)
Less: Allowance for doubtful accounts (xxx)
Initial Subsequent Net Realizable Value xxx

ACCOUNTING FOR ACCOUNTS RECEIVABLE

ACCOUNTING FOR FREIGHT CHARGE  Accordingly, the seller shall be responsible

for the freight charge up to the point of
— Freight is the transportation cost. destination.
o Freight-In (buyer)
o Freight-Out (seller) o FOB-shipping point – buyer shoulders the cost of
freight.
 The ownership of goods will be transferred
FOB (Free on Board)
at the shipping point.
— “Who will shoulder the freight?  This means that ownership of the goods
— It’s the agreement between the seller and the buyer. purchased is vested in the buyer upon
— This relates to the ownership of the goods. shipment thereof.
 Thus, it is incumbent upon the buyer to pay
o FOB-destination – seller shoulders the cost of freight for the transportation charge from the point
 The ownership of goods will be transferred of shipment to the point of destination.
at the time the goods arrive at the
destination.
Freight
 This means that ownership of the goods
purchased is vested in the buyer upon — “Who will actually pay the freight?”
receipt thereof.
o Freight Prepaid

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  The term freight prepaid means that freight Trade Discount
charge on the goods shipped is already paid
by the seller. o This is not recorded.
o This is used to reduce the list price to actual sales price
o Freight Collect which may be due to the volume of transactions (for
 The term freight collect means that freight example, discounts for bulk orders).
charge on the goods shipped is not yet paid.
 The common carrier shall collect the same
Cash Discount
from the buyer.
 Thus, under freight collect, the freight o This is recorded.
charge is actually paid by the buyer. o A cash discount is a reduction from an invoice price by
reason of prompt payment.
— Freight charge is included in the computation for Net
Realizable Value. o It is given to customers to:
o This is because, in the instance that the FOB is
 Encourage early payment
shipping point, seller isn’t the one who prepay the
 Increase sales
cost of freight (freight prepaid), but rather the buyer
 Increase likelihood of collections
(freight collect).
o This could have an effect to the balance of accounts
o A cash discount is known as sales discount on the part of
receivable that will affect the net realizable value as
the seller and a purchase discount on the part of the
well.
buyer.
o In this instance, the accounts receivable of seller to
o A cash discount may be expressed as 2/10, n/30.
buyer is reduced due to the payment of freight—that
is why this is being deducted.
This means that the customer is entitled to a 2%
o The recoverable amount is then reduced.
discount if payment is made in 10 days from the invoice
date.
 2 = discount
Owner of Who will Who pays
 10 = number of days discount is available
the goods shoulder the the freight
 n = otherwise, Net (or all) is due
in transit freight cost? cost?
 30 = credit period
FOB Destination
Seller Seller Seller
Freight Prepaid
Methods of Recording Credit Sales
FOB Destination
Seller Seller Buyer
Freight Collect Rule! Always ignore the first day and include the last day.
FOB Shipping Point
Buyer Buyer Seller Gross Method
Freight Prepaid
FOB Shipping Point  The accounts receivables and sales are recorded at the
Buyer Buyer Buyer invoice amount.
Freight Collect
 Sales discounts are recorded if payment is received
within the discount period.
Example: (Freight Charge)  We record receivables at gross amount
 This does not consider the allowances.
Goods are sold FOB destination but shipped freight collect with  We need to revert it back what has been deducted
the understanding that the buyer will pay for the freight charge before.
and deduct the same when remittance is made by the buyer.
1) Sale of merchandise for P100,000, terms 5/10, n/30.
The invoice amount is P100,000 with terms 2/10, n/30 and the Accounts receivable.
customer paid freight charge of P5,000.
Accounts Receivables 100,000
On the part of the seller, the freight charge is recorded by Sales 100,000
debiting freight out and crediting allowance for freight charge.
2) Assume collection is made within the discount period.
1) To record the sale.
Cash 95,000
Accounts receivable 100,000 Sales discount 5,000
Freight out 5,000 Accounts Receivables 100,000
Sales 100,000
Allowance for freight charge 5,000 3) Assume collection is made beyond the discount
period.
2) To record the collection within the discount period.
Cash 100,000
Cash 100,000 Accounts Receivables 100,000
Sales discount (100,000 x 2%) 5,000
Allowance for freight charge 5,000
Accounts receivable 100,000 Net Method

ACCOUNTING FOR SALES DISCOUNT

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  The accounts receivable and sales are recorded at net
amount of the invoice or at the invoice price minus the May 31 Cash 5,000
cash discount whether taken or not taken. Accounts receivable 4,950
 We record receivables initially at its net amount Sales disc. Forfeited 50
immediately.
 Sales discounts forfeited are recorded if payment is
received after the discount period. Example 2: (Sales Discounts)
 Sales discounts account is classified as other income.
o A customer that fails to pay an invoice within the Clark Co. sold its products to a customer on July 1, 2023. The
specified time period forfeits the discount and item had a list price of P5,000,000; trade discounts of 10% and
must pay the full amount 5% were granted by Clark to the buyer. The credit terms of the
 Sales discount is part of Statement of Comprehensive sales were 2/10, n/30. Two days after, the customer returned
Income to be deducted in sales. items worth P500,000 because of wrong specifications. Full
payment was received by the company on July 11.
1) Sale of merchandise for P100,000, terms 5/10, n/30.
Prepare the journal entry to record the sale if Eddy uses:
Accounts Receivables 95,000
a. the gross method
Sales 95,000
b. the net method
c. Suppose the buyer paid Clark on July 31, prepare the
2) Assume collection is made within the discount period.
journal entry on the said date using the gross method and
Cash 95,000 the net method.
Accounts Receivables 95,000
GROSS METHOD
3) Assume collection is made beyond the discount DATE DESCRIPTION DR. CR.
period. Jul 1 Accounts receivable 4,275,000
Sales revenue 4,275,000
Cash 100,000
Accounts Receivables 95,000
Sales discount forfeited 5,000 Trade Discount
5,000,000 x 90% (10%) = 4,500,000
4,500,000 x 95% (5%) = 4,275,000  invoice
Example 1: (Sales Discounts)
Jul 3 Sales return & allowances 500,000
On May 10, Eddy, Inc. sold P5,000 of merchandise to a Accounts receivable 500,000
customer subject to a cash discount of 1/10, n/30. Eddy uses
the periodic method to account for inventory. Jul 11 Cash 3,699,500
Sales discount 75,500
Assume that on May 19, Eddy, Inc. received a check in full
Accounts receivable 3,775,000
payment of the sale made on May 10.

(Instead of payment on May 19, assume that Eddy, Inc. 4,275,000 – 500,000 = 3,775,000
3,775,000 x 98% (2%) = 3,699,500
received a check on May 31, in full payment of the sale made
on May 10).
Jul 31 Cash 3,775,000
Prepare the journal entry to record the sale if Eddy uses: Accounts receivable 3,775,000

a. the gross method

NET METHOD
b. the net method.
DATE DESCRIPTION DR. CR.
GROSS METHOD July 1 Accounts receivable 4,189,500
Sales revenue 4,189,500
DATE DESCRIPTION DR. CR.
May 10 Accounts receivable 5,000
Jul 3 Sales return & allowances 490,000
Sales revenue 5,000
Accounts receivable 490,000

May 19 Cash 4,950

500,000 x 98% (2%) = 490,000
Sales discount 50
Accounts receivable 5,000 Jul 11 Cash 3,699,500
Accounts receivable 3,699,500
May 31 Cash 5,000
Accounts receivable 5,000 Jul 31 Cash 3,775,000
Accounts receivable 3,699,500
NET METHOD Sales disc. Forfeited 75,500
DATE DESCRIPTION DR. CR.
May 10 Accounts receivable 4,950
Allowance for Sales Discount
Sales revenue 4,950
— If customers are granted cash discounts for prompt
May 19 Cash 4,950 payment, then, conceptually estimates of cash discounts
Accounts receivable 4,950

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 on open accounts at the end of the period based on past DATE DESCRIPTION DR. CR.
experience shall be made. Jun 1 Sales returns & allowance 750
— Cash discount or Sales discount is included in the Accounts receivable 750
computation for Net Realizable Value.
o The 2% discount could have been based from the
invoice price.
o However, that 2% discount can no longer be Allowance for Sales Returns
collected—that is why we will deduct it from the net
realizable amount. — The measurement of accounts receivable shall also
— If the amount is material, we can make an allowance. 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
Example: shipment shortages and defects.

Of the accounts receivable of P1,000,000 at the end of the Example:

period, it is reliably estimated that discounts to be taken will
amount to P50,000. For example, an amount of P50,000 of accounts receivable at
year-end represents selling price of goods that will probably be
o For instance, the sale was made on December, the returned.
sales discount is possible to be made in the next
accounting period. o Conceptually, you already assume that the customer
o Conceptually, you already assume that the customer will return goods within the credit period that will be
will pay within the discount period, even if it is not yet in the next accounting.
availed by the customer.
The entry to recognize the probable return is
The adjustment to record the expected sales discount is:
Sales return and allowances 50,000
Sales discount 50,000 Allowance for sales return 50,000
Allowance for sales discount 50,000
o Note! This is only an ESTIMATE based on the
o Allowance for sales discount is a deduction to accounts experience of the seller to a particular customer.
receivable. o This is only done if sales return is expected to be made
in the next accounting period.
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

o Note! This is only done if the sales discount is Bad Debts

expected to be made in the next accounting period.
o Bad debts result from credit customers who will not pay
the business the amount they owe, regardless of
continuing collection efforts.
ACCOUNTING FOR SALES RETURNS  Entity that sells on credit assumes the risk that
some customers will not pay their accounts.
Sales Returns and Allowances
 When an account becomes uncollectible, the
o Sales returns and allowances is included in the entity has sustained a bad debt loss.
computation for Net Realizable Value. o The bad debt loss is simply one of the costs of doing
 This is because the amount equivalent to the business on credit.
products returned can no longer be collected. o In conformity with the matching principle, bad debt
o In sales return, there is a damage and there is the expense should be recorded in the same accounting
physical transfer of merchandise. period in which the sales related to the uncollectible were
 Merchandise returned by a customer to a recorded.
supplier.
o In sales allowance, there is a reduction in the cost of
defective merchandise, but there is no physical transfer
Methods in Accounting for Bad Debt Loss
of merchandise.
 This is not a discount, it is just a reduction of Allowance Method
price.
o Sales Returns and Allowances account is a contra  The allowance method requires recognition of a bad debt
account that reduces Sales Revenue in the current loss if the accounts are doubtful of collection.
accounting period.  If you are already doubtful that the customer will not pay
its payable to you, we can recognize bad debt expense.
 This is just an ESTIMATE.
Example 1: (Sales Returns)
1) Accounts receivable is considered doubtful of collection.
On June 1, a customer of LarCo returns P750 of merchandise
that was damaged. LarCo uses the periodic method to account
The journal entry to recognize the doubtful accounts is:
for inventory.
Doubtful accounts xx
Record the journal entry for the return of merchandise.
Allowance for doubtful accounts xx

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 2) The accounts are proved to be worthless or uncollectible
2) The accounts are previously discovered to be worthless (written-off).
or uncollectible (written-off).
Bad debts (expense) xx
If the doubtful accounts are subsequently found to be Accounts receivable xx
worthless, the accounts are written off as uncollectible.
3) The same accounts that are previously written-off are
Allowance for uncollectible accounts xx unexpectedly recovered or collected.
Accounts receivable xx
Accounts receivable xx
Bad debts recovery xx
The net realizable value is the amount of the accounts
receivable that the business expects to collect. Cash xx
Accounts receivable xx
Accounts Receivable
Less: Allowance for Uncollectible Accounts  Bade debts recovery is part of other income.
= Net Realizable Value  If the recovery is subsequent to the year of write-off and
the direct method is used, the recovery may simply be
credited to other income.
Recoveries of Accounts Written-Off  This approach is often used by small businesses because
it is simple to apply.
 If a collection is made on account previously written off  The Bureau of Internal Revenue recognizes only this
as uncollectible, the customary procedure is first to method for income tax purposes.
recharge the customer's account with the amount  However, the direct write-off method violates the
collected and possibly with the entire amount previously matching principle because the bad debt loss is often
charged off it is now accepted that collection will be recognized in later accounting period than the period in
received in full. which the sales revenue was recognized.
 The collection is then recorded normally by debiting cash  The direct write-off method is not permitted under IFRS.
and crediting accounts receivable.

3) The same accounts that are previously written-off are

unexpectedly recovered or collected. Methods of Estimating Bad Debts

Accounts receivable xx Bad debt expense xx

Allowance for uncollectible accounts xx Allowance for uncollectible accounts xx

Cash xx  The allowance for doubtful accounts is deduction from

Accounts receivable xx accounts receivable (contra accounts to accounts
receivable).
 The recharging of the customer's account is usually  Bad debt expense is normally classified as a selling
followed because it is an evidence of the attempt of the expense and is closed at year-end.
customer to reestablish his credit with the entity.  Bad debt expense is sometimes classified as a
 The generally accepted approach is to simply reverse the administrative expense because it is the management or
original entry of write-off regardless of whether the admin that decides the estimation of doubtful accounts
recovery is during the year of write-off or subsequent as well as the accounts to be written off.
thereto.
 The effect of the recovery of accounts written-off is 0 on
accounts receivable because the recharging and Percent of Sales
collection are offsetting.
 "Income Statement Approach”
 The allowance for doubtful accounts is increased by the
 Percentage of Net Sales (credit)
recovery.
 This focuses on past credit sales to make estimates of
bad debt expense.
Direct Write-off Method  Emphasizes the matching principle by estimating the bad
debt expense associated with the current period’s credit
 The direct write off method requires recognition of a bad sales.
debt loss only when the accounts proved to be worthless
or uncollectible. Amount of sales for the year x Rate
 Worthless accounts are recorded by debiting bad debts = Doubtful Expense Account
and crediting accounts receivable.
 If the accounts are only doubtful of collection, no o The base is sales.
adjustment is necessary. o The rate may be applied on credit sales or total
 IF the uncollectible accounts are immaterial, bad debts sales.
are simply recorded as they occur (without the use of an o IF the problem is silent, the sales is assumed to
allowance account). be credit sales at net.

1) Accounts receivable is considered doubtful of collection. Current Period Credit Sales

x Bad Debt %
No Entry is necessary. = Estimated Bad Debts Expense

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  Bad debt % (rate) = Bad debt expense / Sales 1) Compute the estimate of the Allowance of Uncollectible
o The basis is total sales of the prior periods. Accounts.

 When the "percent of sales" method is used in computing Year-end Accounts Receivable x Bad Debt %
doubtful accounts, proper matching of cost against = Required Allowance
revenue is achieved.
 This is so because the bad debt loss is directly related to
2) Bad Debts Expense is computed as:
sales and reported in the year of sale.
 Thus, the present of sales method is an income Estimated Adjusted Balance in Allowance for Uncollectible
statement approach because it favors the income Accounts
statement. — Unadjusted Year-End Balance in Allowance for
 The main argument against this method is that the Uncollectible Accounts
accounts receivable may not be shown at estimated = Estimated Bad Debts Expense
realizable value because the allowance for doubtful
accounts may prove excessive or inadequate.
 Thus, it becomes necessary that from time to time the
Required Allowance
accounts should be "aged" to ascertain the probable loss.
— Credit balance in allowance
 If this method is used, the resulting amount of the
= Estimated Bad Debts Expense
computation is already the amount of the doubtful
accounts expense and not the required allowance, in
contradistinction with the aging method and the percent
Example 1: (Percentage on Accounts Receivable)
of accounts receivable method.
 The allowance balance before adjustment is ignored in Allowance for Uncollectible Accounts
determining the doubtful accounts expense to be
recorded. 1 100,000 Beginning
3 150,000 Allowance
Example 1: (Percent on Sales)

In 2022, MusicLand has credit sales of P4,000,000 and 2 250,000 Ending

estimates that 0.60% of credit sales are uncollectible.

What is Bad Debts Expense for 2022?

Required Allowance 250,000
Current Period Credit Sales 4,000,000 — Credit balance in allowance 100,000
x Bad Debt % 0.60% = Bad Debts Expense 150,000
= Estimated Bad Debts Expense 24,000

DATE DESCRIPTION DR. CR.

DATE DESCRIPTION DR. CR. Dec 31 Bad debt expense 150,000
Dec 31 Bad debt expense 24,000 Allowance for
Allowance for uncollectible accounts 150,000
uncollectible accounts 24,000

Example 2: (Percentage on Accounts Receivable)

Percentage of Accounts Receivables
On Dec. 31, 2022, MusicLand has P500,000 in Accounts
 "Statement Of Financial Position Approach" Receivable and a P20,000 credit balance in Allowance for
 Focuses on the collectability of accounts receivable to Uncollectible Accounts.
make an estimate of uncollectible accounts.
Past experience suggests that 5% of receivables are
 Involves the direct computation of the desired balance in
uncollectible.
the allowance for uncollectible accounts.
What is MusicLand's Bad Debts Expense for 2022?
Amount of Accounts receivable for the year x Rate
= Required Allowance
Year-end Accounts Receivable x Bad Debt %
= Required Allowance
o The base is accounts receivables.
o “Required allowance balance” is the same as 500,000 x 5%
“Allowance for doubtful accounts at year-end” = 25,000

 This procedure has the advantage of presenting the

accounts receivable at estimated net realizable value. Allowance for Uncollectible Accounts
 However, the application of this approach violates the
principle of matching bad debt loss against the sales 1 20,000 Beginning
revenue. 3 5,000 Allowance
 Moreover, the loss experience rate may be difficult to
obtain and may not be reliable.
2 25,000 Ending

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 Required Allowance (500,000 x 5%) 25,000 Example 1: (Aging of Receivables)
— Credit balance in allowance 20,000
= Bad Debts Expense 5,000 At December 31, 2022, the receivables for EastCo, Inc. were
categorized as follows:

EastCo, Inc.
DATE DESCRIPTION DR. CR. Schedule of Accounts Receivable by Age
Dec 31 Bad debt expense 5,000 31-Dec-01
Allowance for Accounts Estimated Estimated
Days Past
uncollectible accounts 5,000 Receivable bad Debts Uncollectible
Due
Balance % Amount
Current 45,000 1% 450
1 – 30 15,000 3% 450
Aging of Accounts Receivables 31 – 60 5,000 5% 250
Over 60 2,000 10% 200
 "Statement Of Financial Position Approach" 67,000 1,350
 The aging of accounts receivable involves an analysis
where the accounts are classified into not due or past
due. EastCo’s unadjusted balance in the allowance amount is P500.
 The credit terms will determine whether an account is
past due. Allowance for Uncollectible Accounts
 Past due refers to the number of days or period beyond
the maximum credit period. 1 500 Beginning
o Ex. if the credit terms were 2/10, n/30, and the 3 850 Allowance
account is 45 days old, it is considered to be 15
days past due.
o Start counting after the credit period is due. 2 1,350 Ending

Example:

1/1 1/16 1/17 Required Allowance 1,350

Sales (with a credit Due date. Start of Past — Allowance balance before adjustment 500
period of 15 days) Due = Bad Debts Expense 850

a. Not due
b. 1 to 30 days past due DATE DESCRIPTION DR. CR.
c. 31 to 60 days past due Dec 31 Bad debt expense 850
d. 61 to 90 days past due Allowance for
e. 91 to 120 days past due uncollectible accounts 850
f. 121 to 180 days past due
g. 181 to 365 days past due
h. More than 1 year past due
Example 2: (Aging of Receivables)
 The major argument for the use of this method is the
more accurate and scientific computation of the An analysis of the accounts receivable of Vaughn Inc. shows
allowance for doubtful accounts. the following information:
 The aging method has the advantage of presenting fairly
the accounts receivable in the statement of financial Age Balance % Collectible
position at net realizable value. Current P4,000,000 99
1 to 30 days past due 3,000,000 97.5
 The objection to the aging method is that it violates the
31 to 60 days past due 1,800,000 96
matching process.
61 to 90 days past due 1,200,000 90
 Moreover, this method could become prohibitively time
91 to 120 days past due 1,000,000 80
consuming if a large number of accounts are involved.
121 to 180 days past due 600,000 60
181 to 360 days past due 400,000 40
1) Year-end Accounts Receivable is broken down into age
More than 360 days past 150,000 0
classifications.
due
2) Each age grouping has a different likelihood of being
uncollectible.
o The more aging the receivable, the higher the Before any adjustments were made, Vaughn’s allowance for
percentage of uncollectible. doubtful accounts had a balance of P100,000.
3) Compute estimated uncollectible amount.
4) Compare estimated uncollectible amount with the balance Prepare the journal entry to adjust Vaughn’s allowance for
in the allowance account. doubtful accounts.

Age Balance % Collectible % Uncollectible Estimated Uncollectible Amount

Current P4,000,000 99 1% 40,000
1 to 30 days past due 3,000,000 97.5 2.5% 75,000
31 to 60 days past due 1,800,000 96 4% 72,000
61 to 90 days past due 1,200,000 90 10% 120,000

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 91 to 120 days past due 1,000,000 80 20% 200,000
121 to 180 days past due 600,000 60 40% 240,000
181 to 360 days past due 400,000 40 60% 240,000
More than 360 days past due 150,000 0 100% 150,000
Required balance of the allowance for doubtful accounts 1,137,000

Allowance for Uncollectible Accounts

100,000 Beginning TRANSACTIONS AFFECTING ACCOUNTS RECEIVABLE

1,037,000 Allowance
Accounts Receivable

o Total Sales (Credit Sales).

1,137,000 Ending
o An increase in accounts receivable.
 This is because we debited the Accounts
Receivables account.
Required Allowance 1,137,000
— Allowance balance before adjustment 100,000 Accounts receivable xxx
= Bad Debts Expense 1,037,000 Sales xxx

Recovery of Accounts Previously Written Off

DATE DESCRIPTION DR. CR.
Dec 31 Bad debt expense 1,037,000 o Also known as Reversal of accounts written off or
Allowance for Collection from customer.
uncollectible accounts 1,037,000 o An increase in accounts receivable.
o We previously write-off something, but we had a
recovery.
 Since the last age classification is already 100% o There is a collection so an increase in the account.
uncollectible, we need to write it off.
 To write it off, debit allowance for uncollectible accounts Allowance for bad debts xxx
and credit accounts receivable to close both accounts. Accounts receivables xxx

Accounts receivables xxx

Allowance for bad debts xxx
Allowance for Uncollectible Accounts

Cash xxx
150,000 Write-off 100,000 Beginning
1,037,000 Allowance Accounts receivables xxx

Dishonored Note
987,000 Ending
o Customer’s Note not paid on Maturity date.
o No longer notes payable.
DATE DESCRIPTION DR. CR. o We need to recognize it as an accounts receivable.
Dec 31 Allowance for 150,000  An increase in accounts receivable.
uncollectible accounts
Accounts receivables xxx
Accounts receivable 150,000
Notes receivables xxx
Interest receivables
Other income*
Summary
 Other charges* (e.g., protest fee)
Income Statement Approach Balance Sheet Approach
Emphasis on Matching Emphasis on (Net) Receivable Collection from Credit Customers
Principle Value
A/R o A decrease in accounts receivable.
Sales
⇔
⇔ Cash xxx
Allowance for Uncollectible
Bad Debt Expense Accounts receivables xxx
Accounts
Income Statement focus Balance Sheet focus
Sales Discount
Note! o A decrease in accounts receivable.
~ In case there is changes in accounting estimates for Cash xxx
doubtful accounts, the treatment will be currently and
Sales discount xxx
prospectively.

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 Accounts receivables xxx TRANSACTIONS AFFECTING ALLOWANCE FOR BAD DEBTS

 Gross Method ─ Contra-Asset Account

 (cash collected + sales discount) ─ Deducted from Accounts Receivables
o Increase in allowance for bad debts (credit)
Cash xxx o Decrease in allowance for bad debts (debit)
Accounts receivables xxx
Sales discount xxx
Accounts Write Off
 Net Method
 (cash collected + sales discount lost) o Total Sales (Credit Sales).
o A decrease in allowance for bad debts.

Total Sales Returns and Allowances Allowance for bad debts xxx
Accounts receivables xxx
o A decrease in accounts receivable.

Sales returns and allowances xxx Recovery of Accounts Previously Written Off
Accounts receivables xxx
o Also known as Reversal of accounts written off or
 Credit sales. Collection from customer.
 Seller issue memorandum – credited the accounts o An increase in allowance for bad debts.
receivables. o We previously write-off something, but we had a
recovery.
Accounts Written Off o There is a collection so an increase in the account.

o A decrease in accounts receivable. Allowance for bad debts xxx

Accounts receivables xxx
Allowance for bad debts xxx
Accounts receivables xxx Accounts receivables xxx
Allowance for bad debts xxx
 Gross Method
Cash xxx
Accounts receivables xxx
o Recovery of Accounts Previously Written Off.

Cash xxx
Year-end Adjustment
Accounts receivables xxx
o An increase in allowance for bad debts.
 Deducted from A/R only if NOT yet included in the
total collections. Bad debt expense xxx
Allowance for bad debts xxx

Accounts Receivables
Allowance for Bad Debts
Beginning Balance Collections
Credit Sales Write-off Written-off Beginning Balance
Recovery Recovery Recovery
Dishonored SRA based on Credit Sales
Conversion
Balance before Adjustment
Bad Debt Expense
(year-end adjustment)
Ending Balance

Ending Balance

NOTES RECEIVABLES

─ Notes receivable are claims supported by formal promises o The note may be payable on demand or at a definite
to pay usually in the form of notes. future date.
─ A negotiable promissory note is an unconditional promise o A promissory note is a written contract in which one
in writing made by one person to another, signed by the person, known as he maker, promises to pay
maker, engaging to pay on demand or at a fixed another person, known as the payee, a definite sum
determinable future time a sum certain in money to order of money.
or to bearer.

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─ Standing alone, the term notes receivable represents only  Since interest-bearing notes have a stated interest
claims arising from sale of merchandise or service in the rate—separate rate from the principal amount, the
ordinary course of business. value of the notes receivable won’t be changed
o IF the problem is silent, notes receivables are initially or subsequently.
classified as current assets.
o Whether it is short-term or long-term, provided
that the notes receivables are part of operations of NONINTEREST-BEARING NOTES RECEIVABLE
the business, it is always current.
 Noninterest-bearing notes do not have a stated interest
o Notes receivables will only be non-current if the
rate because they include the interest element as part of
receivable is NOT part of trading or the business
the face amount.
operations.
 It is simply a case of the interest being included in
o If the notes receivables is more than 1 year, it is
the face amount rather than being stated as a
classified as non-current asset.
separate rate.
o If the notes receivables are short-term, whether
 The face amount of a noninterest-bearing note
part of trading or not, it is classified as current
represents an unspecified principal and an
asset.
unspecified interest.
─ Notes received from officers, employees, shareholders and
 There is no agreed upon rate and there is only one rate
affiliates shall be designated separately.
to be based on—Effective Rate
o Classification will depends on the period/term.
 Actually, the term "noninterest-bearing" is a misnomer
because all notes implicitly contain interest.
Note!
 The initial measurement of short-term noninterest-
~ Current and Noncurrent is different with Short-term and bearing notes are at face value.
Long-term.  The subsequent measurement of short-term
o Short-term means 12 months or less. noninterest-bearing notes are at face value.
o Long-term means more than 12 months.  Short-term noninterest-bearing are initially and
o Short-term and Long-term depends on the period. subsequently measured at face value because of
~ Not all the time, long-term is considered as noncurrent. cost-benefit principle and materiality.

Current Example:
o It is expected to be realized in, or is intended for sale
 Short-term noninterest-bearing contains “P10,000”
or consumption in the entity's normal operating cycle
promised to pay after 3 days.
(or within the next 12 months).
 Regardless of short-term or long-term. Stated or
o Operating Cycle – it is the period that it takes to
not stated, all notes contain interest.
convert something from inventory or production to
 Since P10,000 is the face value, it is the principal
cash.
amount itself, while the interest is P0.
 However, this only violates the concept that all
~ Note receivables are considered fairly liquid, even if long-
notes implicitly contain interest.
term, because entities may easily convert them to cash,
 In order to correct present value of the principal
although a fee might be paid to do so.
amount, a company might consider to hire an
account to separate the interest from P10,000 that
Although all notes contain an interest element because of the is due after 3 days.
time value of money, entities classify notes as either interest-  After separating the interest, it was determined
bearing or noninterest bearing. that the principal amount is P9,995 with the
interest of P5.
INTEREST-BEARING NOTES RECEIVABLE  This is shows that the entity’s report have become
accurate. However, considering the interest paid for
 Interest bearing notes have a stated interest rate, i.e., 3 days and the salary that the company will pay the
the contracted interest rate stated on the promissory accountant (e,g., 300)—it only illustrates that the
note. cost exceeds the benefit.
 Notes receivable that contains the principal plus  This means that looking for the present value of the
interest. short-term noninterest-bearing note is not worth it
 Other terms for stated interest rate include nominal to look for.
rate, coupon rate, and face rate.
 Nominal Rate is the rate agreed upon by the parties.  The initial measurement of long-term noninterest-
 Nominal rat will be based on either the effective bearing notes are at present value.
rate or higher than the effective rate.  Noninterest-bearing long-term notes are measured
 The initial measurement of short-term and long-term at present value which is the discounted value of
interest-bearing notes are at face value. the future cash flows using the effective interest
 The initial measurement of long-term notes will rate.
depend on whether the notes are interest-bearing  Since noninterest-bearing notes receivable do not
or noninterest bearing. have stated interest rate—as it is already included
 Interest-bearing long-term notes are measured at in the principal amount—the present value of the
face amount which is actually the present value principal amount will not be the same after one year
upon issuance. or during when the receivable will be received.
 The subsequent measurement of short-term and long-  Present value computation is needed to separate
term interest-bearing notes are at face value. the interest element form the principal element.

APRIL KAE APRIL KAE APRIL KAE

 Example:  Cash flows relating to short-term notes receivable are not
discounted because the effect of discounting is usually not
 Long-term noninterest-bearing contains “P10,000” material.
promised to pay after 3 years.
 INTEREST-BEARING LONG-TERM NOTES are measured at
P9,700 100 100 100
face value which is actually the present value upon
Year 0 Year 1 Year 2 Year 3
issuance.
we're here ! due date !
 NONINTEREST-BEARING LONG-TERM NOTES are
 The P10,000-noninterest-bearning note will be paid
measured at present value which is the discounted value
on the 3rd year.
of the future cash flows using the effective interest rate.
 The interest rate is already embedded in the
P10,000.
 There is interest because of the time value of Subsequent Measurement of Notes Receivable
money.
 We need to separate the principal amount and the  Subsequent to initial recognition, long-term notes
interest rate or convert the P10,000 into the receivable shall be measured at amortized cost using the
present value today (without the interest) in order effective interest method.
to determine the present value at Year 0. o Amortized cost is the cost over time.
 For instance, the interest per year is P100, then we o It is the cost change after adding or deducting some
arrived at the present value of P9,700. costs to arrive at the true amount.
o We are considering what happened in between
 The subsequent measurement of long-term noninterest- years.
bearing notes are at amortized cost.
Example:

MEASUREMENT OF ACCOUNTS RECEIVABLE  Long-term noninterest-bearing contains “P10,000”

promised to pay after 3 years.
Initial – Notes receivable was made by maker and received by
the payee. 9,700 9,800 9,900 10,000
Year 0 Year 1 Year 2 Year 3
Subsequent – After some periods from the time the notes we're here ! due date !
receivable was made and received.
 P10,000 is the amortized cost because we consider
Initial Subsequent the time value of money.

Short-term  The amortized cost measurement is in accordance with

Interest-
bearing

Face Value / PFRS 9, paragraph 5.2.1.

Face Value
Present Value
Long-term The amortized cost is the amount at which the note
receivable is measured initially:

Face Value /
Noninterest-

Short-term Face Value a) Minus principal repayment

Present Value
bearing

b) Plus or minus cumulative amortization of any

difference between the initial carrying amount and the
Amortized principal maturity amount
Long-term Present Value
Cost c) Minus reduction for impairment or uncollectibility.

 For long-term noninterest-bearing notes receivable, the

Initial Measurement of Notes Receivable amortized cost is the present value plus amortization of
the discount, or the face amount minus the unamortized
 Conceptually, NOTES RECEIVABLE shall be measured unearned interest income.
initially at present value.
o Short-term: Face Value = Present Value  If nominal rate is equal to effective rate, we measure the
o Long-term (interest-bearing): Face Value = Present carrying value or amortized cost of notes receivable at face
Value value.
o Long-term (noninterest-bearing): Present Value o Because Face Value of Note = Present Value of
Note.
Because in noninterest-bearing Face Value ≠ o No discount or premium – this means that we do
Present Value not need to compute any present value factor.

 The present value is the sum of all future cash flows  If nominal rate is not equal to effective rate, we measure
discounted using the prevailing market rate of interest for the carrying value or amortized cost of notes receivable at
similar notes. present value.
 The prevailing market rate of interest is actually the o This may result to Premium or Discount, depending
effective interest rate. on the rate agreed upon if it is higher or lower than
 SHORT-TERM NOTES RECEIVABLE shall be measured at the effective rate.
face value.
Premium on Notes Receivable

APRIL KAE APRIL KAE APRIL KAE

 o If Nominal Rate > Effective Rate ─ A receivable that bears reasonable interest rate need not
o This expects that the Present Value > Face Value be discounted to present value because its face amount
o Adjunct account of Notes Receivable  this will be is deemed its principal amount.
deducted to the face of accounts receivables ─ No segregation is needed because the principal is already
(normal balance: Debit). specified. The interest element is recognized separately
o Ex. Face Value of Note = P100,000 and its interest in profit or loss over the term of the receivable.
is P10,000
 Press 1.12
(DR. Notes Receivable 100,000; Premium on Nots  Press division sign (÷) twice.
Receivable 10,000 | CR. Sales).  Addition (part of  Press equal sign (=) three times (equal to the ‘n’)
notes receivable).

Discount on Notes Receivable Present Value of an Annuity of ₱1

o If Nominal Rate < Effective Rate ─ "How much do I have to deposit today to be able to make
o This expects that the Present Value < Face Value several equal withdrawals of PI each over equal periods
o Contra-account of accounts receivable  this will in the future?"
be deducted to the face of accounts receivable ─ Under future value of an annuity, there are several
(normal balance: Credit). deposits and one withdrawal
o Discount on Notes Receivable means that interest ─ Under present value of annuity, there is one deposit and
was deducted in advance  Sale of notes at a lower several withdrawals.
value than the face value of the notes receivable. ─ Two types of annuities:
o This is like Accounts Receivable less Allowance = o Ordinary Annuities – the first installment is made
Net Realizable Value / Net Amortized Cost). one period after the deposit
o Annuities Due – it is made immediately (i.e., right
after the deposit is made or in advance).
CONCEPT VALUE OF MONEY

 Time value of money involves interest calculations. PV of an ordinary [1 – (1 + i)-n

=
annuity of ₱1 i
 Two types of interest:
 Simple interest – interest is earned only on the  Press 1.12
principal.  Press division sign (÷) twice.
 Compound interest – interest is earned on both the  Press equal sign (=) three times (equal to the ‘n’)
principal and the interest  Press minus 1
 Press equal sign (=)
 Divide (÷) the resulting amount by the interest rate of
 Two terms often used in conjunction with time value of
12%
money:
 Press equal sign (=)
 Future Value  Disregard the negative sign by pressing (+/-)
 Present Value

 The application of present value in relation to the

accounting for receivables is based on the concept that PV of an annuity due of [1 – (1 + i)-(n-1)
= +1
all notes receivable contain an unspecified principal and ₱1 i
an unspecified interest.
 Press 1.12
 These two elements are segregated using present value  Press division sign (÷) twice.
computations and accounted for as follows:  Press equal sign (=) 9 times (equal to the ‘n’ of 10
 Principal element — represents the measurement minus 1)
of the note receivable.  Press minus 1
 Interest element — initially recognized as unearned  Press equal sign (=)
interest and amortized over the life of the note as  Divide (÷) the resulting amount by the interest rate of
12%
interest income.
 Press equal sign (=)
 Disregard the negative sign by pressing (+/-)
Present Value of a Future Amount (PV of ₱1)

─ "How much do I have to deposit today to receive 1 peso

NOTE!
(P1) in the future?"

PV of ₱1 = (1 + i)-n Time Vale of Money Factor Application

Present Value of ₱1 Future cash flow is in lump

─ “n” is a negative value. (Single Payment) sum
─ Unearned interest income is a deduction to the note
receivable when computing for the note’s carrying Lump-sum payment or
amount. UNEQUAL periodic payment.
─ Initial Carrying Amount of the note receivable is equal to
the Present Value. 1st Year – 100,000
2nd Year – 200,000

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 3rd Year – 300,000
1st installment is made
immediately or in advance.
Present Value of an Future cash flows are in
ordinary annuity of ₱1 installments Advance payment and EQUAL
periodic payment
1st installment is not made
immediately. (Note: Same amount)

EQUAL periodic payment

(e.g., Annual, Semi-annual)

1st Year – 100,000

2nd Year – 100,000
3rd Year – 100,000

Present Value of an Future cash flows are in

annuity due of ₱1 installments
AMORTIZATION TABLE – EFFECTIVE INTEREST METHOD

---------------------------------------------------------- [Interest Only] --------------------------------------------------------

Nominal Rate < Effective Rate = Discount on Notes Receivable

Carrying Value of
Date Nominal Interest Interest Income Amortization of Discount
Notes Receivables

1/1/23 Initial Carrying Value

Carrying Value +
Face Value x Nominal (initial) Carrying Value x Nominal Rate – Effective
12/31/23 Amortization of
Interest Effective Interest Rate
Discount
12/31/24 - - -
12/31/25 - - - Lump Sum of N/R

Nominal Rate > Effective Rate = Premium on Notes Receivable

Carrying Value of
Date Nominal Interest Interest Income Amortization of Premium
Notes Receivables

1/1/23 Initial Carrying Value

Carrying Value –
Face Value x Nominal (initial) Carrying Value x Nominal Rate – Effective
12/31/23 Amortization of
Interest Effective Interest Rate
Premium
12/31/24 - - -
12/31/25 - - - Lump Sum of N/R

 Goal: Carrying Value of Notes Receivable should equal the Face Value of Accounts receivables on the maturity date.

--------------------------------------------------- [Face Value and Interest] ---------------------------------------------------

Nominal Rate < Effective Rate = Discount on Notes Receivable

Carrying Value of
Date Nominal Interest Interest Income Amortization of Discount
Notes Receivables

1/1/23 Initial Carrying Value

Carrying Value +
Face Value x Nominal
(initial) Carrying Value x Nominal Rate – Effective Amortization of
12/31/23 Interest
Effective Interest Rate Discount – Annual
Collection

12/31/24 - - -

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 12/31/25 - - - -0-

LOAN RECEIVABLE

─ Loan receivable is a financial asset arising from a loan Initial Carrying Amount xxx
granted by a bank or other financial institution to a
o Transaction price = Fair value
borrower or client.
o Direct Origination Cost – Origination Fees =
o The term of the loan may be short-term but in most
Transaction Cost
cases, the repayment periods cover several years.
o Fair value + Transaction price = Initial Carrying
Amount
MEASUREMENT OF LOAN RECEIVABLE

 Initial Measurement – an entity shall measure a loan Journal Entries (Loans Receivable)
receivable at fair value plus transaction costs that are
1) To record the loan.
directly attributable to the acquisition of the financial
asset. Loan receivable xx
o Loan receivable is also interest bearing. Cash xx
o Face value and fair value are also called as
“transaction price.”
2) To record the origination fees received.
 The fair value of the loan receivable at initial recognition is
normally the transaction price which is actually the amount Cash xx
of the loan granted. Unearned interest income xx

 Transaction costs that are directly attributable to the loan o The origination fees received from borrower are
receivable include direct origination costs. recognized as unearned interest income and
o When the borrower applied for a loan in the bank, amortized over the term of the loan.
before the bank approves the loan, they have the o Unearned interest income – this is because the
step of “processing.” This is where they investigate origination fees charged to the borrower weren’t
the borrower’s background in order to know if the only charged during the period the borrower paid.
borrower has the capacity to pay its loan. o For instance, if the term of the loan is 10 years,
o Whenever the bank process, there is a cash out. It then the benefit or interest earned from the
means that there are expenses when evaluating the origination fees are also charged for 10 years.
borrower—transaction cost—in order to o Since time has not yet run, it is still unearned.
continue/approve the loan.
3) To record the direct origination costs incurred.
 Origination Fees are the fees charged by the bank against
the borrower for the creation of the loan Unearned interest income xx
o Lending activities usually precede the actual Cash xx
disbursement of funds and generally include efforts
to identify and attract potential borrowers and to
Sample 1:
originate a loan.
If the origination fees received EXCEED the direct origination
Origination fees include compensation for the following: costs, the difference is unearned interest income and the
o Evaluating the borrower’s financial condition amortization will increase interest income.
o Evaluating guarantees, collateral, and other
security Transaction Price xxx
o Negotiating the terms of the loan Direct Origination Cost 50,000
o Preparing and processing the documents related to Origination Fees received (70,000)
the loan Initial Carrying Amount xxx
o Closing and approving the loan transaction

 Direct origination costs and origination fees received To record the origination fees received.
should be included in the initial measurement of the loan
Cash 70,000
receivable.
Unearned interest income 70,000
o “Direct” because the cost incurred by the bank is
directly related to the processing of the loan.
o Direct origination cost is capitalized – added to the To record the direct origination costs incurred.
evaluation.
Unearned interest income 50,000
o However, indirect origination costs should be
Cash 50,000
treated as outright expense (e.g., meal fed to the
client).
Sample 2:
Transaction Price xxx
Direct Origination Cost xxx
Origination Fees received (xxx)

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If the direct origination costs EXCEED the origination fees  IF the initial carrying amount is HIGHER than the initial
received, the difference is charged to direct origination costs amount (face value), there is a decrease in income.
and the amortization will decrease interest income. o The amortization of the difference is deducted from
the carrying amount.
Transaction Price xxx o This means that the direct costs are higher than the
Direct Origination Cost 50,000 origination fees.
Origination Fees received (30,000) o Deduction to income.
Initial Carrying Amount xxx
Transaction Price 1,000,000
Direct Origination Cost 50,000
To record the origination fees received.
Origination Fees received (30,000)
Initial Carrying Amount 1,020,000
Cash 30,000
Direct origination costs 70,000

o If the origination fees are not chargeable against the  IF the initial carrying amount is LOWER than the initial
borrower, the fees are known as direct origination costs. amount (face value), there is an increase in income.
o The direct origination costs are expense to our POV. o The amortization of the difference is added to the
carrying amount.
o This means that the origination costs are higher
To record the direct origination costs incurred.
than the origination fees.
Direct origination costs 50,000 o Addition to income.
Cash 50,000
Transaction Price 1,000,000
Direct Origination Cost 30,000
o The direct origination costs are deferred and also Origination Fees received (50,000)
amortized over the term of the loan. Initial Carrying Amount 980,000
o However, when direct origination costs are amortized, it is
not recorded as expense.
o The bigger picture is that, in the long run, you will still earn  Amortization cost – the income or expense is gradually
because of the loan. reduced or pay off during the period in order to go back to
o Rather, there is a decrease in income at the side of the P1,000,000 (loan receivable – interest bearing that is
borrower. same as the face value).
o Normal balance of direct origination cost is credit.
1,020,000 20,000 (– income) 
When the direct origination cost is amortized:

Interest income xx 1,000,000 = Initial Subsequent = 1,000,000

Direct origination cost xx

Reduction in income is better than expense. 980,000 20,000 (+ income) 

o This journal entry for amortization is whether the direct

origination exceeds the origination fees or vice versa.  Nominal rate – interest rate indicated in the coupon
(coupon rate or stated rate).
 Subsequent Measurement – loan receivable is measured  This nominal rate are subject to changes since there were
subsequently at amortized costs using the effective changes to the face amount or the principal amount, the
interest method. interest rate attached to it are automatically should be
o Since there has been an addition or changes to the changed.
initial cost, the correct measurement is the o This means that if there was an additional income
amortized cost. from the carrying amount, it is more likely to have
 Amortized cost is not applicable to loan receivable. a higher interest rate.
o Since loan receivable (interest bearing) is o This means that if there was a reduction in income
measured at face value. from the carrying amount, it is more likely to have
o Ex. If the face amount of the loan receivable initially a lower interest rate.
is 1,000,000, then the subsequent measurement is
still 1,000,000.
 Amortized cost is only applicable to direct origination cost
IMPAIRMENT OF LOANS RECEIVABLES
or unearned interest income.
Credit Risk
 The amortized cost is the amount at which the loan
receivable is measured initially:  Credit risk is the risk that one party to a financial
o Minus principal repayment instrument will cause a financial loss for the other party
o Plus or minus cumulative amortization of any by failing to discharge an obligation.
difference between the initial carrying amount and  The risk that the borrower won’t be able to pay for
the principal maturity amount its loan.
o Minus reduction for impairment or uncollectibility  The risk that the issuer will fail to perform a
particular obligation.

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  The credit risk of the collateralized liability is surely  An entity may use various sources of data both internal or
less than the credit risk of the noncollateralized entity-specific and external in measuring expected credit
liability. losses.
 The credit risk for a collateralized liability may be
zero.  The following guideline may be of help in assessing
whether accounts receivable should be considered
impaired:
Impairment of Loan (a) Individually significant accounts receivable should
be considered for impairment separately and if
 PFRS 9, paragraph 5.5.1, provides that an entity shall
impaired, the impairment loss is recognized.
recognize a loss allowance for expected credit losses on
(b) Accounts receivable not individually significant
financial asset measured at amortized cost.
should be collectively assessed for impairment.
 Objective Evidence of Loan Impairment:
(c) Accounts receivable not considered impaired should
 Significant financial difficulty of the borrower
be included with other accounts receivable with
 Breach of contract (such as a default or delinquency
similar credit-risk characteristics and collectively
in interest or principal payments)
assessed for impairment.
 Debt restructuring
 Probable that borrower will enter bankruptcy or
other financial reorganization
 Disappearance of an active market Computation of Impairment Loss
 Observable data (including that there is a
measurable decrease in the estimated future cash  The impairment loss is the difference between the carrying
flows from the financial asset). amount of loan and the present value of the cash flows.
 IF Carrying Amount is greater than the Present Value of
estimated cash flow, then there is an impairment.
Measurement of Impairment
o Example:
 PFRS 9, para. 5.5.1 provides that an entity shall recognize
a loss allowance for expected credit losses on financial Carrying amount of loan 1,000,000
asset measured at amortized cost. Present value of cash flows 400,000
 An entity shall measure the loss allowance for a financial Impairment of Loss 600,000
instrument at an amount equal to the lifetime expected
credit losses if the credit risk on that financial instrument
o The carrying amount of the loan receivable shall be
has increased significantly since initial recognition.
reduced either directly or through the use of an
 Credit losses are the present value of all cash receipts.
allowance account.
 The amount of impairment loss can be measured as the
difference between the carrying amount and the present
value of estimated future cash flows discounted at the Journal Entry for Impairment Loss
original effective rate.
o Carrying amount – recorded receivable balance in Direct Method
the book (stated value today – amortized cost).
o Estimated future cash flows – estimated collections Impairment Loss xxx
in the future. Loans receivable xxx
o Since future cash flows are only an estimate, we
convert it into present value in order for the
Allowance Method
carrying amount and future cash flow to have to
have same time standing.
Loan impairment Loss xxx
o Original Rate is used since it is what has been used Allowance for loan impairment xxx
to compute for the carrying amount.

o Allowance for loan impairment is being deducted to the

Expected credit losses are an estimate of credit losses over the recovered carrying amount to arrive at the Net Carrying
life of the financial instrument. Amount.

When measuring expected credit losses, an entity should

consider:
Three-Stage Impairment Approach
(1) The Probability-weighted outcome — the estimate should
reflect the possibility that a credit loss occurs and the Stage 1 – Receivable is performing (initial recognition)
possibility that no credit loss occurs.
(2) The time value of money — the expected credit losses When a loan is originated or purchased, expected credit losses
should be discounted. (ECLs) resulting from default events that are possible within
(3) Reasonable and supportable information that is available the next 12 months are recognized (12-month ECL) and a loss
without undue cost or effort. allowance is established.

 PFRS 9 does not prescribe particular method of measuring On subsequent reporting dates, 12-month ECL also applies to
expected credit losses. existing loans with no significant increase in credit risk since
their initial recognition.

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Interest revenue is calculated on the loan's gross carrying A lifetime expected credit loss is recognized.
amount (that is, without deduction for ECLs).
 Lifetime Expected Credit Loss is defined as the expected
In determining whether a significant increase in credit risk has credit loss that results from all default events over the
occurred since initial recognition, a bank is to assess the expected life of the instrument.
change, if any, in the risk of default over the expected life of  Lifetime expected credit loss shall always be recognized for
the loan (that is, the change in the probability of default, as trade receivables through aging, percentage of accounts
opposed to the amount of ECLs). receivable and percentage of sales.

 1st Year – our assessment is only within the 12 months Stage 3 – Receivable is non-performing (credit impaired
 2nd Year – no significant increase in credit risk, assessment assets)
continues to be within the 12 months.
If the loan's credit risk increases to the point where it is
If there has been a significant increase in credit risk considered credit-impaired, interest revenue is calculated
occurred, we could assess more than 12 months. based on the loan's amortized cost (that is, the gross carrying
amount less the loss allowance). Lifetime ECLs are recognized,
as in Stage 2.

 This stage covers debt instruments that have not declined

significantly in credit quality since initial recognition or that  This stage covers debt instruments that have objective
have low credit risk evidence of impairment at the reporting date.
o This means that the risk is not that high.
o “Performing” means “able to pay.”
o Recognizes only those that have low credit risk but Interest Income
we are already estimating.
a) Under stages 1 and 2, interest income is computed based
A 12-month expected credit loss is recognized. on the gross carrying amount or face amount.
─ This is because, it is not yet totally impaired, we
 12-month Expected Credit Loss is only a portion of the only make an estimate.
lifetime expected credit loss from default events that are ─ There is an allowance.
possible within 12 months after the reporting period.
b) Under stage 3, interest income is computed based on the
 If we have the feeling that the credit risk is increasing, it net carrying amount which is equal to the face amount
is the only time we proceed to stage 2. minus allowance for loan impairment.
─ There is no allowance, but rather directly removing
Stage 2 – Receivable is underperforming (significant increase the Loan Receivable Account.
in credit risk)
Stage 1 Stage 2 Stage 3
If a loan's credit risk has increased significantly since initial
recognition and is not considered low, lifetime ECLs are Recognition of Expected Credit
recognized. Losses

The calculation of interest revenue is the same as for Stage 1. 12-month of expected credit
losses

Lifetime expected credit

 This stage covers debt instruments that have declined losses
significantly in credit quality since initial recognition but do
not have objective evidence of impairment. Interest Revenue
o “Underperforming” means “cannot pay
immediately.” Effective interest on gross Effective interest on net
o There is rebutable presumption that there is a carrying amount carrying amount
significant increase in credit risk if the contractual
payments are more than 30 days past due. Performing Underperforming No-performing

Amortization Table – Effective Interest Method

Date Interest Income Interest Received Amortization Carrying Amount
1/1/23 Initial Carrying Amount

Carrying amount x Effective Nominal Rate – Effective Carrying Value +

12/31/23 Principal x Nominal Rate
rate Rate Amortization

12/31/24 - - -

12/31/25 - - - Principal

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Illustration: (Impairment of Loans Receivable)

Customer Amount Assessment Expected Credit Loss (ECL)

Customer A 1,000,000 Not impaired 0
Customer B 1,500,000 Not impaired 0
Customer C 2,500,000 Partially impaired 1,500,000
Customer D 3,000,000 Partially impaired 1,000,000
Customer E 2,000,000 Totally impaired 2,000,000
Other customers’ accounts 4,000,000
P14,000,000

It is reliably determined that a composite rate of 5% is appropriate to measure impairment on

all other accounts receivable.

The impairment loss is computed as follows

Customer C Partially impaired 1,500,000
Customer D Partially impaired 1,000,000
Customer E Totally impaired 2,000,000
Other accounts receivable (5% of 6,500,000)

*A – 1,000,000 +
*B – 1,500,000 +
*Others – 4,000,000 325,000
Total Impairment Loss 4,825,000

RECEIVABLE FINANCING

─ Receivable financing is the financial flexibility or capability of an entity to raise money out of its receivables.
o The company is raising funds out of its receivables.
o The entity then would be in a financial distress as collections of receivable are delayed but cash payments for obligations
must be maintained.
o If the situation becomes very critical, the entity may be forced to look for cash by financing its receivables.
─ The common forms of receivable financing are:
o Pledge of Accounts Receivable
o Assignment of Accounts Receivable
o Factoring of Accounts Receivable

PLEDGE OF ACCOUNTS RECEIVABLES

 The accounts receivable may be pledged as collateral security for the payment of the loan.
 We are still the owner of the receivables because the receivables were only for a collateral for the payment of loan applied
in the bank.
 This refers to borrowing money from the bank or any financial institution in which receivables in general are used as
collateral.
 This is sometimes called General Assignment.
 Ex. An entity borrowed a loan for P10 million and pledged P60 million. It is not identified here to whom the P60 million are
assigned to.

 Normally, the borrowing entity makes the collection of the pledged accounts but may be required to turn over the collections to
the bank in satisfaction for the loan.

 No entry is needed for the pledging of accounts receivable.

 It is sufficient that disclosure thereof is made in a note to financial statements.

Journal Entries
B. Interest deducted in advance.
1) Borrowing a loan.
Cash xxx
Cash xxx Discount on loans payable xxx
Note payable—bank* xxx Note payable—bank xxx

*Loans payable, Notes payable or Banks payable o Discount on loans payable – contra liability account.
o Discount on loans payable – includes interest.
A. Interest NOT deducted in advance. o The interest here will eventually be transferred to
interest expense.
Cash xxx
Loans payable xxx

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2) Payment of Interest / Amortization of Discount. Interest expense xxx
Discount on loans payable xxx
A. Interest NOT deducted in advance.
o We will no longer pay interest expense since it has
Interest expense xxx already been advanced through discount on loans
Cash xxx payable.

B. Interest deducted in advance.

Example 1: (Pledging of Accounts Receivables)

Dylan Corp., a company that operates on a calendar-year basis, has been approved of a loan from Manila Bank on July 1, 2023, for
P10,000,000. The loan, which matures on June 30, 2024, bears an interest of 10% per annum. According to the agreement, Dylan
pledged P16,000,000 of its accounts receivable as a security for the loan.

1) Prepare the entries needed on the books of Dylan to record the loan, to accrue interest expense, and to record the payment of
the loan.
2) Prepare the notes on Dylan's financial statements that should be disclosed in relation to the note and the corresponding pledged
receivables.

DATE DESCRIPTION DR. CR.

07-01-23 Cash 10,000,000
Notes payable 10,000,000

12-31-23 Interest expense 5,000,000

Interest payable 5,000,000

06-30-24 Notes payable 10,000,000

Interest expense 500,000
Interest payable 500,000
Cash 11,000,000

Note Disclosure: (12-31-23)

On July 1, 2023, the Company obtained a loan from Manila Bank in the amount of P10 million with an interest
of 10% per annum and payable on June 30, 2024. The Company pledged P16 million accounts receivable as a
support for the payment of the loan.

Notes:

[Dec 31]
 10,000,000 x 6 / 12 = 5,000,000
 July to Dec = 6 months
 5,000,000 x 10% = 500,000

[Jun 30]
 Interest expense = Jan 1 to Jun 30 (2024)
 Interest payable (debited) = July 1 to Dec 31 (2023)

ASSIGNING ACCOUNTS RECEIVABLES

 The concept is that you have accounts receivable from your customers. But you cannot compel them to pay you, even if it is not
yet due. What you can do is to borrow from a bank and pledge a specific accounts receivable as a collateral security for the loan.
 Assignment of accounts receivable means that a borrower (assignor) transfer rights in some accounts receivable to a lender
(assignee) in consideration for a loan.

 Assignment is a more formal type of pledging of accounts receivable.

 Assignment is secured borrowing evidenced by a financing agreement and a promissory note both of which the assignor
assigns.
 It should be specified in the financing agreement to whom the receivables are assigned (or assignee).
 Assignment is specific because specific accounts receivable serve as collateral security for the loan.
 In assigning accounts receivables, the pledge accounts receivables are specifically identified to who it is assigned.

Characteristics of Assignment:

(1) The loan is at a specified percentage of the face value of the collateral. Interest and service fees are charged to the assignor.

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  The assignee usually lends only a certain percentage of the face value of the accounts assigned because the assigned
accounts may not be fully realized by reason of such factors as sales discount, sales return and allowances and
uncollectible accounts.
o The percentage maybe 70%, 80%, or 90% depending on the quality of the accounts
 The assignee usually charges interest for the loan that it makes and requires a service or financing charge or commission
for the assignment agreement.

(2) The debtors are occasionally notified to make payments to the assignee but most of the assignments are not on a notification
basis.
 Assignment may be done either on a nonnotification or notification basis.
 When accounts are assigned on a nonnotification basis, customers are not informed that their accounts have been
assigned.
o As a result, the customers continue to make payments to the assignor, who in turn remits the collections to the
assignee.
 When accounts are assigned on a notification basis, customers are notified to make their payments directly to the assignee
(bank or other financing company).

(3) Assigned accounts are Loans Payable should segregated from other accounts. The loans payable should be deducted from Accounts
Receivable-assigned to determine the equity in assigned accounts receivable.
 Loans payable and Accounts Receivable—assigned are compared to know the equity in assigned accounts receivable.
 “Equity in assigned accounts receivable” = the amount that will not be paid to the bank. This is part of the notes to
financial statements.

Journal Entries (Nonnotification)

3) Assigned accounts are proved worthless.
1) Assignment of accounts receivable.
Allowance of doubtful accounts xxx
Accounts receivable—assigned xxx Accounts receivable—assigned xxx
Accounts receivable xxx
o Same journal entry to both situations
(nonnotification or notification).
3) Borrowing a loan.
4) Assigned accounts are collected.
Cash xxx
Note payable—bank* xxx Cash xxx
Accounts receivable—assigned xxx
*Loans payable, Notes payable or Banks payable
o Same journal entry to both situations
A. Borrowing a loan (with service fees). (nonnotification or notification).
Cash xxx
5) Assigned accounts are collected with sales discount.
Service fees xxx
Note payable—bank xxx
Cash xxx
Sales discount xxx
o The interest charged to the assignor depends on Accounts receivable—assigned xxx
the characteristics of the loan.
o There are interest that is paid at the end of the o Same journal entry to both situations
period, therefore you will not record here the (nonnotification or notification).
interest expense.
o But there are instances that the interest are 6) Remitted the total collections to the bank plus interest for
deducted in advance. one month.

B. Borrowing a loan (with service fees and interest is Note payable—bank xxx
deducted in advance). Interest expense xxx
Cash xxx
Cash xxx
Service fees xxx
Discount on loan payable xxx 7) To transfer the remaining balance of assigned accounts to
Loans payable xxx
the accounts receivable.

Accounts receivable xxx

2) Issued a credit memo for sales returns. Accounts receivable—assigned xxx

Sales return xxx

Accounts receivable—assigned xxx Journal Entries (Notification)

o Same journal entry to both situations 1) Assignment of accounts receivable.

(nonnotification or notification).

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 Accounts receivable—assigned xxx Discount on loan payable xxx
Accounts receivable xxx Loans payable xxx

2) Borrowing a loan. 3) Received a notice from bank that the assigned accounts
are collected.
Cash xxx
Note payable—bank* xxx Note payable—bank xxx
Interest expense xxx
*Loans payable, Notes payable or Banks payable Accounts receivable—assigned xxx

A. Borrowing a loan (with service fees). 4) Received a notice from bank that the assigned accounts
are collected with sales discount.
Cash xxx
Service fees xxx Note payable—bank xxx
Note payable—bank xxx Sales discount xxx
Interest expense xxx
B. Borrowing a loan (with service fees and interest is Accounts receivable—assigned xxx
deducted in advance).

Cash xxx
Service fees xxx

Example 1: (Assignment of Accounts Receivables – NONNOTIFICATION BASIS)

The following transactions relate to Stalla Inc. in 2023:

Aug 1 Assigned P6,000,000 of accounts receivable to Manila Universal Bank under a non-notification basis. The bank
advanced 75% of the face value of the receivables less a service charge of P2,500. Stalla signed a promissory note
agreeing to pay monthly interest of 1% of the unpaid balance of the loan.
4 Issued a P60,000 credit memo for sales allowance granted to a customer whose account was assigned
9 Collected 50% of the face value of the assigned accounts. Sales discounts of 3% were granted to 60% of the face
value of the collected accounts.
31 Remitted the collection to Manila along with the monthly interest.
Sept 1 Issued credit memo amounting to P80,000 to a customer whose account was assigned for merchandise returned.
29 Collected P2,000,000 of assigned accounts
30 Remitted the amount due to manila to pay the loan balance plus interest due

Prepare the necessary journal entries.

DATE DESCRIPTION DR. CR.

Aug 1 Accounts receivable—assigned 6,000,000
Accounts receivable 6,000,000
To separate the assigned accounts.

Cash 4,497,500
Service charge 2,500
Notes payable—bank 4,500,000
To record the loan.

Aug 4 Sales allowance 60,000

Accounts receivable—assigned 60,000
Issued credit memo for sales allowance.

Aug 9 Cash 2,946,000

Sales discount 54,000
Accounts receivable—assigned 3,000,000
To record collection with sales discount.

Aug 31 Notes payable—bank 2,946,000

Interest expense 45,000
Cash 2,991,000
To record the remittance.

Sept 1 Sales return 80,000

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 Accounts receivable—assigned 80,000
Issued credit memo for sales return.

Sept 29 Cash 2,000,000

Accounts receivable—assigned 2,000,000
To record collection of P2 million assigned accounts.

Sept 30 Notes payable—bank 1,554,000

Interest expense 15,540
Cash 1,569,540
To record the remittance..

Accounts receivable 860,000

Accounts receivable—assigned 860,000
To transfer the remaining balance.

Computation

Notes payable—bank 4,500,000

Less: Payment (2,946,000)
Remaining balance 1,554,000

Accounts receivable—assigned 6,000,000

Less: Sales allowance (60,000)
Less: Collection (3,000,000)
Less: Sales return (80,000)
Less: Collection (2,000,000)
Balance 860,000

Notes:

 Assignor: Stalla Inc.

 Assignee: Manila University Bank

[Aug 1]
 Accounts receivable-assigned = Manila University Bank (assignee)
 Accounts receivable (credited) = Stella, Inc. (assignor)
 75% of the face value of the receivables = 4,500,000
 4,500,000 – 2,500 = 4,497,500

[Aug 9]
 50% of the face value of the assigned accounts = 3,000,000
 Sales discount = (60% of the face value of the assigned accounts) x 3%
Sales discount = 1,800,000 x 3%
Sales discount = 54,000
 Total cash received = 3,000,000 – 54,000 = 2,946,000

[Aug 31]
 Total collection = 2,946,000
 Interest expense = 4,500,000 (75% of the receivables) x 1% = 45,000

[Sept 30]
 There is a reversing entry of the assigned accounts to transfer the remaining accounts receivables.

Example 2: (Assignment of Accounts Receivables – NOTIFICATION BASIS)

The following transactions relate to Stalla Inc. in 2023:

Oct 31 Rhea Corp. assigned P4,000,000 of its assigned accounts to Makati National bank under a notification basis. The
bank forwarded 80% of the face value of the assigned accounts, less 0.25% of the face value of the assigned
accounts as service charge. The loan is evidenced by a promissory note which provides for a monthly interest of
1.5% of the unpaid balance of the loan.
Nov 30 Received notice from Makati that 60% of the assigned accounts was collected. 2.5% sales discount was granted
to half of the accounts collected. Rhea paid the interest to Makati.

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 Dec 31 Received notice from Makati stating that P1,500,000 of the assigned accounts were collected. Final settlement was
made by the bank for the excess collections together with the uncollected assigned accounts.

Prepare the necessary journal entries.

DATE DESCRIPTION DR. CR.

Oct 31 Accounts receivable—assigned 4,000,000
Accounts receivable 4,000,000
To separate the assigned accounts.

Cash 3,190,000
Service charge 10,000
Notes payable—bank 3,200,000
To record the loan.

Nov 30 Cash 2,370,000

Sales discount 30,000
Accounts receivable—assigned 2,400,000
To record notice from the bank.

Interest expense 48,000

Cash 48,000
To record the payment of monthly interest.

Dec 31 Cash 1,500,000

Accounts receivable—assigned 1,500,000
To record notice from the bank.

Cash 657,550
Interest expense 12,450
Notes payable—bank 830,000
Accounts receivable—assigned 1,500,000
To record notice received from bank and final
settlement.

Accounts receivable 100,000

Accounts receivable—assigned 100,000
To record final settlement.

Computation

Loan from bank 3,200,000

Less: November collection (2,370,000)
Remaining balance 830,000

Accounts receivable—assigned 4,000,000

Less: Collection with discount (2,400,000)
Less: Collection with discount (1,500,00)
Balance 100,000

December collection 1,500,000

Less: Loan balance (830,000)
Excess collection 6,700,000
Less: interest (1.5% of 830,000) 12,450
Remittance from bank 657,550

How much is the equity in assigned accounts as of November 30, 2023?

Accounts receivable—assigned 1,600,000

Less: Notes payable—bank 830,000
Equity in Assigned Accounts 770,000

Accounts receivable—assigned (Oct) 4,000,000

Less: Accounts receivable—assigned (Nov) (2,400,000)
Accounts receivable—assigned 1,600,000

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Notes:

 Assignor: Rhea Corp

 Assignee: Makati National bank

[Oct 31]
 80% of the face value of the receivables = 3,200,000
 Service charge = 4,000,000 x 0.25% = 10,000
 Notes payable-bank = 3,200,000 – 10,000 = 3,190,000
 Rhea Corp

[Nov 30]
 60% of the assigned accounts was collected = 4,000,000 x 60% = 2,400,000
 2.5% sales discount was granted to half of the accounts collected = 2,400,000 / 2 = 1,200,000
 1,200,000 x 2.5% = 30,000
 Interest Expense = 3,200,000 x 1.5% = 48,000

FACTORING OF ACCOUNTS RECEIVABLES

 Factoring is a sale of accounts receivable to a financing company (factor) usually on a without recourse, notification basis.
 In a factoring arrangement, an entity sells accounts receivable to a bank or finance entity called a factor.
 Without recourse – “wala nang habol” – this means that when a customer did not pay its liability, the factor cannot run
after the company. They cannot disclaim any liability to the subsequent holder of a financial instrument.
 Notification basis – this means that the customer will be informed that his or her accounts receivables has been factored.
 Accordingly, a gain or loss is recognized for the difference between the proceeds received and the net carrying amount of
receivables factored.

 Factoring differs from an assignment in that an entity actually transfers ownership of the accounts receivable to the factor.
 Thus, the factor assumes responsibility for uncollectible factored accounts.
 It is the factor’s loss in case that the accounts receivables are not collected.
 The factor assumes risk of collectivity and generally handles the billing and collection.
 In assignment, the assignor retains ownership of the accounts assigned.

 Because of the nature of the 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.
 The seller of the accounts receivable no longer accounts for the receivables, as it is outright sale.

 Factoring may take the form of the following:

 Casual factoring
 Factoring as a continuing agreement.

CASUAL FACTORING

 If an entity finds itself in a critical cash position, it may be forced to factor some or all of its accounts receivable at a substantial
discount to a bank or a finance entity to obtain the much needed cash.
 The accounts receivables should be existing already.
 In case that the entity needs an immediate fund, they can its fund out its receivables—factoring.
 Casual factoring can mean that there is only one time or two factoring agreement.

Journal Entries (Casual Factoring) o Receivable from factor – other things that are
related to accounts receivables are not part of the
1) To record sale. sale.
 Ex. Sales returns – customer will return it
Cash xxx
back to you instead of factor (the bank).
Allowance for doubtful accounts xxx
 The company cannot transfer the
Loss on factoring* xxx
responsibility to the factor, being the new
Receivable from factor xxx
owner of the receivable, unless they had an
Accounts receivable xxx
agreement about it.
 This is why it is advised to have an allowance
o Loss on factoring – it is most likely that the upon the sale of accounts receivables—
company will receive less value from sale of factors holdback.
accounts receivable.

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  In case there will be a problem, it will be 3) Final settlement with the factor.
deducted to it.
o *Recourse liability – when a company has a Cash xxx
secondary liability. This is not shown in the Receivable from factor xxx
accounts above because it is already or may be
included in the “Loss on Factoring” account which 4) Assuming the accounts are not collected by the factor.
will increase in effect.
Recourse liability xxx
Cash xxx
2) To record sales returns and allowances.

Sales returns and allowances xxx o The company is the one to pay for it.
Receivable from factor xxx

Example 1: (Factoring of Accounts – Casual)

Palacios Corp. factored its accounts receivables having a face value of P1,000,000 and net realizable value of P900,000 for P850,000
on December 31.

Prepare the entry to record the transaction.

DATE DESCRIPTION DR. CR.

Dec 31 Cash 850,000
Allowance for doubtful accounts 100,000
Loss on Factoring 50,000
Accounts receivable 1,000,000
To record factoring of accounts receivables.

Notes:

 Gross amount = 1,000,000

 Net Realizable Value = 900,000
 Allowance for uncollectible amounts = 100,000
 Accounts receivable was sold for 850,000
 Loss on factoring = 900,000 – 850,000 = 50,000

Factoring as a Continuing Agreement

 Factoring may involve a continuing arrangement where a finance entity purchases all of the accounts receivable of a certain
entity.
 In this setup, it is possible that the accounts receivables are not yet existing but there is already an agreement (existing
and future receivables).
 In casual factoring, the accounts receivable should already be existing.

 In this setup, before a merchandise is shipped to a customer, the selling entity requests the factor's credit approval.

 If it is approved, the account is sold immediately to the factor after shipment of the goods.
 The factor then assumes the credit function as well as the collection function.
 There are portion of receivable that may be not sold maybe because it was not approved by the factor – these are accounts
receivables that remain in the entity that are not transferred.
 For compensation, typically the factor charges a commission or factoring fee of 5% to 20% for its services of credit approval,
billing, collecting, and assuming uncollectible factored accounts.
 The factor is already the one that decides.

 Moreover, the factor may withhold a predetermined amount as a protection against customer returns and allowances and other
special adjustments.
 This amount withheld is known as the "factor's holdback".
 The factor's holdback is actually a receivable from factor and classified as current asset.

 Final settlement of the factor's holdback is made after the factored receivables have been fully collected.

Journal Entries (Factoring as a Continuing Agreement) 1) To record sale.

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 Cash xxx Cash xxx
Allowance for doubtful accounts xxx Receivable from factor xxx
Interest expense xxx
Factoring fee xxx
Receivable from factor
Accounts receivable xxx
Exemption: With recourse – “may habol pa.”
o Interest expense
 Interest expense and loss on factoring are 4) To record recourse liability.
somewhat the same, the only difference is
Cash xxx
the treatment.
Allowance for doubtful accounts xxx
 Interest expense in Factoring as a
Interest expense xxx
Continuing Agreement is a function of time.
Factoring fee xxx
This means that if the accounts receivables Receivable from factor xxx
are not yet collected, the factor charged the Loss on recourse obligation
company for their waiting time until the Accounts receivable xxx
accounts receivables were collected. Recourse liability xxx
 The loss on factoring account is like one-tem
aggregated all the loss, including the
o Recourse liability (current liability) is just an
interest expense.
estimate in case the customers are unable to pay
o Factoring fee – commissions, service charge,
in the future.
assuming risk etc.
o When the customer wasn’t able to pay the factor,
the company has secondary liability—contingent
2) To record sales returns and allowances.
liability because it still depends what will happen in
Sales returns and allowances xxx the situation.
Receivable from factor xxx o This means that the company incurred a loss 
Loss on recourse obligation.
3) Final settlement with the factor.

Example 1: (Factoring of Accounts Receivables, Continuing Arrangement)

Citi Inc. factored accounts receivable from different customers to Hunter Financials amounting to P10,000,000 immediately after the
shipment of the goods on July 1, 2023. The credit terms of the sale are 3/10, n/30. Hunter charged a commission of 5% based on the
gross amount of the receivable factored and withheld 30% of the face value of the accounts assigned to cover sales returns and
allowances. On July 5. Citi granted credit worth P400,000 to a customer whose account was factored for goods that were damaged.

On July 11, Citi was informed that the full payment, less applicable discount, was received by Hunter from a certain customer whose
account was factored. The invoice price of the goods paid by such customer amounted to P3,500,000.

On July 31, Citi received a notification from Hunter stating that the remaining factored accounts were collected with no additional
returns or allowances. Accordingly, the final settlement was made with Hunter.

Prepare the necessary journal entries to be recorded in the books of Citi.

Computation

Gross Amount 10,000,000

Less: Sales discount (3% x 10,000,000) 300,000
Less: Commission (5% x 10,000,000) 500,000
Less: Factor’s holdback (30% x 10,000,000) 3,000,000 (3,800,000)
Cash Received from factoring 6,200,000

Factor’s holdback 3,000,000

Less: Sales discount 388,000
Receivable from factor 2,612,000

Gross Amount 10,000,000

July 11

Less: Sales Returns and Allowances (400,000)

Less: Collection (3,500,000)
Remaining balance 6,100,000

DATE DESCRIPTION DR. CR.

July 1 Cash 6,200,000
Sales discount 300,000

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 Commission 500,000
Receivable from factor 3,000,000
Accounts receivable 10,000,000
To record factoring of accounts receivables.

July 5 Sales Returns and Allowances 400,000

Receivable from factor 12,000
Sales Discount 388,000
To record sales returns.

July 31 Cash 2,612,000

Receivable from factor 2,612,000
To record final settlement notice received from the
bank.

Notes:

[July 5]
 400,000 (3% — withheld 3% of the face value of the accounts assigned to cover sales returns and allowances) =
12,000

[July 11]
 No entry for July 11, because all transactions are entered in the books. Hunter only informed Citi that that out of the
factored receivables, some of the creditor customers paid.
 6,100,000 – already collected and no journal entry

[July 31]
 Final settlements by Hunter means it is expected that there is no longer sales returns in the future.
 The 2,612,000 will be collected from the factor.

CREDIT CARD  This is because whatever amount you incurred with

the mercury will be paid initially by the Masters
 Classic example of factoring with continuing agreement. Card or Visa.
 A credit card is a plastic card which enables the holder to  As far as Mercury or other establishments are
obtain up to a predetermined limit from the issuer of the concerned, they are paid by those Credit Card
card for the purchase of goods and services. Companies.
 The credit card has enabled retailers and other
businesses to continue to sell goods and services where  Generally, if a customer buys goods and uses a credit
the customers obtain possession of the goods card, the credit card receipt must be forwarded by the
immediately but do not have to pay for the goods for retailer to the card issuer who will then pay the retailer
about one month. the appropriate amount minus the credit service charge.
 Most banks offer credit cards to their depositor. The
major credit cards in the Philippines are Diners Club,  Two entries are necessary:
American Express, VISA and MasterCard.  At the time of sale
 These entities are generally responsible for  When payment is received from the card.
approving the credit of customers and collecting the
receivables for a service fee from 1% to 5% of the
credit card sales.
 Ex. Mercury has an agreement with VISA and
Masters Card—whenever someone bought
medicines from them, VISA or Masters Card can be
used as payment to those.
 If the customer used the credit card to purchase the
goods, the customer is do not have payable to
mercury, but rather to Masters Card or VISA.

Example 1: (Credit Card Sales)

Luke Co. accumulated P7,500,000 McAndrew Bank credit card receipts on August 1, 2023. These receipts were forwarded to the bank
on that date and Luke received the payment from the bank less a 4% service charge.

1) Prepare the journal entries needed on the books of Luke.

2) Suppose that Luke deposits the McAndrew Bank credit card receipts to a current account, and Luke's account is immediately
increased by such deposits. Prepare the entries needed on the books of Luke.

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 DATE DESCRIPTION DR. CR.
Aug 1 Accounts receivable – McAndrew Bank 7,500,000
Sales 7,500,000
To record the credit card sales.

Cash 7,200,000
Credit card service charge (4% x 7,500,000) 300,000
Accounts receivable – McAndrew Bank 7,500,000
To record the payment from McAndrew Bank.

Cash 7,200,000
Credit card service charge (4% x 7,500,000) 300,000
Sales 7,500,000
To record sale.

Notes:

[Aug 1]
 If the payment is directly to the bank, it is no longer passed through the receivable. (Last JE)

DISCOUNTING ACCOUNTS RECEIVABLES

 As a form of receivable financing, discounting specifically pertains to note receivable.

 In a promissory note, the original parties are the maker and payee.
 The maker is the one liable and the payee is the one entitled to payment on the date of maturity.

 When a note is negotiable, the payee may obtain cash before maturity date by discounting the note at a bank or other financing
company.
 To discount the note, the payee must endorse it.
 Legally the payee becomes an endorser and the bank becomes an endorsee.

 Discounting of Notes is a sale of the note to a third party, usually a bank.

 Endorsement is the transfer of right to a negotiable instrument by simply signing at the back of the instrument.
o When the company (endorser) endorsed the notes receivable to the bank (endorsee), the company won’t be able to
receive its receivable at full amount.
o The bank will already deduct a portion to it  discounting of a note (a sale of the note to the third party)
o The interest to expect to be earned by the company from the date of discounting to date of maturity will no longer
be received by them.
o Rather, it already belongs to the bank, as the company did not wait until the date of the maturity date.

 Endorsement or Sale of note may be with recourse which means that the endorser shall pay the endorsee if the maker dishonors
the note.
 Upon the default of the debtor, the seller of the note becomes liable for its maturity value.
 This means that the debtor dishonors the note, the seller (company) is secondary liable to the endorsee (bank) on the date
of maturity.
 In the legal parlance, this is the secondary liability of the endorser.
 In the accounting parlance, 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 any evidence to the contrary, endorsement is assumed to be with recourse.

CUSTOMER COMPANY BANK

Debtor / Maker Payee / Endorser 3rd Part / Endorsee

Term of the Note

* ---------------------------- * ------------------------------- *
(Date of the Note) (Date of Discounting) Date of Maturity

1) Net proceeds refer to the discounted value of the note o The amount of proceeds the company was able to
received by the endorser from the endorsee. receive after the sale of accounts receivable.

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 Net proceeds = Maturity value – Discount o The carrying amount is the amount the company
gave up.
2) Maturity value is the amount due on the note at the date
of maturity. 7) Present Value

Maturity value = Principal + Interest Present Value = Noninterest bearing note x PV rate

Maturity date is the date on which the note should be paid.

Journal Entries (Discounting without recourse)
Principal is the amount appearing on the face of the note.
1) To record sale of note.
o It is also referred to as, face value.
Cash (Net proceeds) xxx
3) Interest is the amount of interest for the full term of the Loss on N/R discounting xxx
note. Notes receivable xxx
Interest Income (accr. inte)
Interest = Principal x Interest Rate x Time
o If the discounting is without recourse, the sale of
Interest rate is the rate appearing on the face of the note. the note receivable is absolute and therefore there
is no contingent liability.
4) Time is the period within which interest shall accrue. o The note receivable account is credited directly
o For discounting purposes, it is the period from date because the sale of the note receivable is without
of note to maturity date. recourse or absolute.
o In other words, the term "time" is the entire period  The amount that we gave up in selling the
or "full term" of the note. note.
o The interest income is credited for, the actual
5) Discount is the amount of interest deducted by the bank interest earned on the date of discounting,
in advance.

Discount = Maturity Value x Discount Rate x Journal Entries (Discounting with recourse)
Discount Period
─ If the discounting is with recourse, the transaction is
Discount rate is the rate used by the bank in computing accounted for as either of the following:
the discount. a) Conditional sale of note receivable recognizing a
o The discount rate should not be confused with the contingent liability
interest rate. b) Secured borrowing
o The discount rate and interest rate are different
from each other.
Conditional Sale
o If no discount rate is given, the interest rate is
safely assumed as the discount rate.  In case that the note is dishonored by maker
(debtor/customer), the contingent liability of the payee
Discount period is the period of time from date of is recognized.
discounting to maturity date.  Conditional sale means that the sale has not yet
o The discount period is the unexpired term of the proceeded.
note.
1) To record conditional sale of note.
Discount Period = Term of the notes – the expired
portion up to the date of discounting Cash (Net proceeds) xxx
Loss on N/R discounting xxx
Notes receivable discounted xxx
6) Gain or Loss on Note Discounting is difference between the Interest Income xxx
net proceeds from discounting and the carrying amount of
the notes receivable. o The note receivable discounted account is credited
o If Net Proceeds is less than the Carrying Amount  to show that we are net derecognizing the notes
LOSS. receivable.
o Since the conditional sale is has not begun yet, we
Gain or Loss = Net Proceeds – Carrying amount are not yet removing the notes receivable account.
o We make another account called “Notes receivable
o Accrued Interest is the interest earned (receivable) discounted” with a normal balance of credit.
from Date of the Note to the Date of the Maturity. o The difference between the notes receivable and
notes receivable discounted is 0 because the fact
Accrued Interest = Principal x Rate x Time (up to the that we already sold the note, then there should be
date of the discounting) no notes receivable left.

Carrying Amount is the face value of the notes receivable. Notes receivable xxx
Less: Notes receivable discounted xxx
Carrying Amount = Principal + Accrued Interest Equity in Assigned Accounts 0

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 o Cash and Interest Income do not have an effect in
the conditional sale. 2) Note is paid by the maker on maturity.
o Loss on notes receivable discounting account can
still be used. This is because, at the end of the day, Liability for note receivable xxx
sale will still be proceeded. discounted
Notes receivable xxx
2) Note is paid by the maker on maturity.
o The liability for note receivable discounted and note
Notes receivable discounted xxx receivable are derecognized.
Notes receivable xxx
3) Note is dishonored by the maker.
o If the notes receivable is honored, then the
contingent liability is simply extinguished. Accounts receivable xxx
o The company has no liability, since the customer Cash xxx
already paid for it.
o The total payment is charged to accounts
3) Note is dishonored by the maker. receivable.
o Since it is already dishonored, there are no
Accounts receivable xxx remaining notes receivables.
Cash xxx o Considering that we are not the sole liability to what
has been paid to the bank. The company will run
o The total payment is charged to accounts after the debtor (customer).
receivable.
o Since it is already dishonored, there are no Liability for note receivable xxx
remaining notes receivables. discounted
o Considering that we are not the sole liability to what Notes receivable xxx
has been paid to the bank. The company will run
after the debtor (customer). o This is in order to derecognize the liability for note
receivable discounted and note receivable.

Note receivable discounted xxx

Note receivable xxx Example: (Discounting Notes Receivable)

Alhambra Inc. discounted a P1,800,000, 10-month, 10% note

o This is in order to cancel the contingent liability.
dated May 1, 2023, it received from a customer to Mason
Financials on August 1. The note was discounted at 14%.
Secured Borrowing
Prepare the journal entries needed on the books of Alhambra
 If the discounting is treated as a secured borrowing, the on August 1 and on the date of the note's maturity given the
note receivable is not derecognized but instead an following independent assumptions:
accounting liability is recorded at an amount equal to the
1) The note was paid by the maker.
face amount of the note receivable discounted.
2) The note was dishonored by the maker. Alhambra paid
 Company borrowed money from the bank using the
the whole maturity value of the note plus protest fees of
notes receivable by the customer
P2,500. The maker paid Alhambra 10 days after the
o Notes receivable is like a collateral (that is why it
maturity, including interest of 18% from the date of the
is “secured”).
note’s maturity.
 Some argue that if this is a real sale, then there should
also be a transfer of risk and rewards. Face value 1,800,000
Interest to Maturity (1,800,000 x 10% x 150,000
1) To record borrowing from a bank through a secured note. 10/12)
Maturity value 1,950,000
Cash (Net proceeds) xxx
Discount (1,950,000 x 14% x 7/12) (159,250)
Loss on N/R discounting xxx
Proceeds 1,790,750
Liability for note receivable xxx
discounted
Interest Income xxx
Note is paid by the maker.
o The “note receivable discounted” account is
DATE DESCRIPTION DR. CR.
removed because, according to the POV, there were
Aug 1 Cash 1,790,750
no money gave up. Rather, only liability occurred.
Interest expense 9,250
o It is replaced by Liability for note receivable
Notes receivable 1,800,000
discounted.
discounted
o It is also inappropriate to use “Loss on notes
To record discounting of
receivable discounting” account here because it is notes receivables
believed that this is just a borrowing.
o It is replace by Interest expense account. Feb 28 Notes receivable 1,800,000
o There is no gain or loss if discounting is accounted discounted
for as secured borrowing.
Notes receivable 1,800,000

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 To record maturity of the Cash 1,952,500
net To record payment.

o Since the maker dishonored the note, Alhambra

need to pay that receivable.
Note is dishonored by the maker—with recourse (assumed).
o They credited cash for the payment they made and
debited accounts receivable because Alhambra will
DATE DESCRIPTION DR. CR.
Aug 1 Cash 1,790,750 run after the debtor or maker, he need to establish
a receivable again. However, since notes receivable
Interest expense 9,250
is already closed, they just opened the accounts
Notes receivable 1,800,000
receivable.
discounted
To record discounting of DATE DESCRIPTION DR. CR.
notes receivables
Mar 10 Cash 1,962,263
Accounts receivable 1,952,500
Feb 28 Notes receivable 1,800,000
Interest income 9,763
discounted
To record collection of
Notes receivable 1,800,000 accounts receivable.
To record maturity of the
not
o (1,952,500 x 18% x 10/360 = 9,763).
Feb 28 Accounts receivable 1,952,500

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