COLLEGE OF BUSINESS AND ACCOUNTANCY

Topic: Accounts Receivable

Learning Outcomes:
1. Classify receivables as either current or noncurrent assets.
2. State the timing of recognition and measurement of trade receivables.
3. Estimate the recoverable historical cost of trade receivables.

Core Value/Biblical Principles:

Matthew 5:42 ESV
Give to the one who begs from you, and do not refuse the one who would borrow from you.

Learning Activities and Resources:

In studying financial statements, investors often focus on revenues, net income, and earnings per share.
Although investigating a business’s revenues and profits is a good way to get a picture of its overall condition,
analyzing the accounts receivable allows you to go a step deeper in your analysis.

Introduction:
Receivables are created by extending a line of credit to customers and are reported as current assets on a
company's balance sheet. They are considered a liquid asset, because they can be used as collateral to secure
a loan to help meet short-term obligations. Receivables are part of a company’s working capital. Effectively
managing receivables involves immediately following up with any customers who have not paid and
potentially discussing a payment plan arrangement, if needed. This is important because it provides extra
capital to support operations and lowers the company’s net debt.

Body:

DEFINITION OF RECEIVABLE
Receivables are assets that represent contractual rights to receive cash or other assets from another
entity.

Examples of Receivables:
1. Accounts Receivables – receivables supported by oral or informal promises to pay. These are not
supported by formal promissory notes.
2. Notes Receivable – receivables supported by written or formal promises to pay in the form of
promissory notes. Some notes receivables are supported by postdated checks.
3. Loans Receivable – receivables arising from loans extended by financial institutions such as banks,
financing companies, and lending institutions. Loan receivable are also supported by promissory
notes and are generally backed by collateral securities or postdated checks.
4. Advances – receivables arising from advances to officers and employees, advances to suppliers, and
advances to affiliates.
5. Accrued Income – receivables arising from income earned but not yet collected, such as interest
income, dividend income, and the like.
6. Deposits – receivables from reimbursable deposits paid to cover potential damages or losses,
deposits for guarantee of performance or payment, and deposits for returnable items. (e.g., crates,
containers)
7. Claims Receivable – receivables from insurance companies for casualties sustained defendants
under suit, government agencies for refundable taxes and other remittances, common carriers for
damaged or lost goods, and suppliers for returned or damaged goods.

Trade and Non-trade receivables

For non-financial institutions, receivables are classified into:

a. TRADE RECEIVABLES
 are receivables arising from the sale of goods and services in the ordinary course of business.
They include trade accounts receivable and trade notes receivable.
  are classified as current assets when they are expected to be realized in cash within the
normal operating cycle or one year, whichever is longer.

b. NON-TRADE RECEIVABLES
 are receivables arising from other sources.
 are classified as current assets when they are expected to be realized in cash within the
normal operating cycle or one year, whichever is longer.

Trade and non-trade receivables that are current assets are aggregated and presented in the statement of
financial position as “Trade and other receivables.”

Abnormal Balances in Accounts

Credit balance in accounts receivable (Advances from Customers)

Customers’ account (accounts receivable) may at times have credit balances resulting from
overpayments, advance payments, or errors. It is presented as current liabilities and not offset against
receivables.

Debit balance in accounts payable (Advances to Suppliers)

Suppliers’ account (accounts payable) may at times have debit balances resulting also from
overpayments, advance payments, or errors. It is presented as current assets and not offset against
payables.

ILLUSTRATION 1:
Information about the receivable of the ABC Company is shown below:

Account Receivable- net of P10,000 credit balance P 50,000

Notes Receivable – trade 5,000
Notes Receivable – non trade – P5,000 due in one year 25,000
Dividends Receivable 1,000
Subscription Receivable 2,000
Advances to officers and employees – due in 18 months 4,000
Accounts Payable – net of P6,000 debit balance 3,000

REQUIREMENTS: Compute for (a) total trades receivable and (b) total current receivables.

Trade Receivables:
Account Receivable- net of P10,000 credit balance P 60,000
Notes Receivable – trade 5,000
Total Trade Receivables: 65,000

Notes Receivable – non trade – current portion 5,000

Dividends Receivable 1,000
Advances to Suppliers 6,000
Total Trade Receivables 65,000
Total Current Receivables: 77,000

INITIAL MEASUREMENT
Receivables are initially recognized at fair value plus transaction costs.
However, trade receivables that do not have a significant financing component are measured at the
transaction price in accordance with PFRS 15 Revenue from Contracts with Customers.
Transaction price is “the amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties
(e.g., some sales taxes).” (PFRS 15)

As a practical expedient under PFRS 15, an entity non-discounting of the amount of consideration if it is due
within 1 year from the date of transfer of the goods or services.

RECOGNITION
Trade receivable is recognized when the entity has right to consideration that is unconditional. This
is normally the case when the control over the promised goods or services is transferred to the customer.
However, there may be instances where receivable is recognized before control over a promised good
or service is transferred to the customer, such as when the unconditional right results from a contractual
provision.

Unconditional right – if only passage of time is required before payment of that consideration is due, even if
the amount is subject to refund in the future.

TERM OF SALE CONTRACT

The term of a sale contract is considered when determining the timing of transfer of control over the
goods sold. The following are relevant contract terms.

1. FOB shipping point

 Ownership of the sale of goods sold is transferred to the buyer upon shipment
 Sales and accounts receivable are recognized on shipment date.

2. FOB destination
 Ownership of the sale of goods sold is transferred only when the buyer receives the goods.
 Sales and accounts receivable are recognized when the buyer receives the goods

Accounting for Freight Charges

1. Freight Prepaid – means the seller has paid the freight in advance before shipment. However, this
does not mean that the seller is the one who is responsible to pay for the freight.

2. Freight Collect - means the freight is not yet paid upon shipment. The carrier will collect the
shipping costs from the buyer upon delivery. However, this does not mean that the buyer is the one
who is responsible to pay for the freight.

As a rule, the entity who owns the goods being shipped should pay for the shipping costs.

ILLUSTRATION 2:

On December 27, 20x1, ABC Co. received a sales order for a credit sale of goods with selling price of P1,000.
ABC Co. shipped the goods on December 31, 20x1. The buyer received the goods on January 2, 20x2. The
related shipping costs amounted to P10. ABC C.o. collected the receivables on January 5, 20x2.

FOB shipping point, Freight collect

December 27, 20x1 No Entry
December 31, 20x1 Accounts Receivable 1,000
Sales 1,000
January 2, 20x2 No Entry
January 5, 20x2 Cash 1,000
Accounts Receivable 1,000
 FOB destination, Freight prepaid
December 27, 20x1 Prepaid Freight 10
Cash 10
December 31, 20x1 Accounts Receivable 1,000
Sales 1,000
January 2, 20x2 Freight-out 10
Prepaid Freight 10
January 5, 20x2 Cash 1,000
Accounts Receivable 1,000

FOB shipping point, Freight prepaid

December 31, 20x1 Accounts Receivable 1,010
Sales 1,000
Cash 10
January 2, 20x2 No Entry
January 5, 20x2 Cash 1,010
Accounts Receivable 1,010

FOB destination, Freight collect

December 31, 20x1 No Entry
January 2, 20x2 Accounts Receivable 990
Freight-out 10
Cash 1,000
January 5, 20x2 Cash 990
Accounts Receivable 990

TRADE DISCOUNTS AND CASH DISCOUNTS

Trade Discounts are given to encourage orders in large quantities or to avoid frequent changes in catalogs, to
alter prices for different quantities purchased, or to hide the true invoice price from competitors.
 Trade discounts are deducted from list price when determining the invoice price.
 Trade discounts are not recorded by either the buyer or seller

Cash Discounts are given to encourage prompt payment.

 Cash discounts are deducted from the invoice price when determining the net amount collectible
within the discount period.
 Cash discounts are accounted for separately.

Accounting for Cash Discounts

1. PFRS 15 Revenue from Contracts with Customers

 The entity is required to estimate the amount to which it expects to be entitled in exchange
for transferring the promise goods or service.
 Constraining estimate of variables consideration - the entity assesses whether there is a high
probability that the estimated amount will not significantly change once the uncertainty is
resolved.

2. Traditional GAAP
a. Gross Method – accounts receivable and sales are initially recorded at amount gross of
cash discounts.
- Sales Discounts - cash discounts that are taken by the buyer.
- Cash discounts that are not taken by the buyer are not recorded.
 b. Net Method - accounts receivable and sales are initially recorded at amount net of cash
discounts.
- Cash discounts that are taken by the buyer are not accounted for.
- Sales Discounts Forfeited – cash discounts that are not taken by the buyer.

ILLUSTRATION 3: Traditional GAAP (Gross and Net Method)

An entity sells inventory with a list price of P10,000 on account under credit terms of 20%, 10%, 2/10, n/30.
Gross Method Net Method
Sales on account
Accounts Receivable 7,200 Accounts Receivable 7,056
Sales 7,200 Sales 7,056
Assume collection is made within the discount period
Cash 7,056
Sales Discounts 144 Cash 7,056
Accounts Receivable 7,200 Accounts Receivable 7,056
Assume collection is made beyond the discount period
Cash 7,200 Cash 7,200
Sales Discount Forfeited 144
Accounts Receivable 7,200
Accounts Receivable 7,056

ILLUSTRATION 4.A: PFRS 15

An entity sells inventory with a list price of P10,000 on account under credit terms of 20%, 10%, 2/10, n/30.
The entity estimates that only 80% of the cash discount will be taken and concludes that it is highly probable
that a significant reversal in the cumulative amount of revenue recognized will not concur as the uncertainty
is resolved.

Sales on account
Invoice Amount 7,200
Variation:
AccountsEstimate does not coincide
Receivable 7,084.80 with the result The PFRS 15 treatment is similar to the Net Method of Traditional
Multiply by: Cash discount 2%
AssumeSales
that only 70% of the discount 7,084.80
is actually taken. Total Available Discount 144
PFRSMultiply
15 requires
by: the entity to consider the probability that the av
80%
Portion collected within the discount period AnyDiscount
differenceexpected
between to
thebeestimate
Sales on account taken 115.20 actual outcome is rec
and the
Cash (7,200 x 80% x 98%) 5,644.80
Accounts Receivable 7,084.80
Accounts Receivable 5,644.80
Sales 7,084.80
Portion collected beyond the discount period Invoice Amount7,200.00 Less: Discount
Portion collected within the discount period expected to be taken 115.20 Transaction
Cash (7,200 x 20%) 1,440.00 Price7,084.80
Accounts Receivable 1,440.00
Cash (7,200 x 70% x 98%) 4,939.20
Accounts Receivable 4,939.20

Accounts Receivable (7,200 x 10% x 2%) 14.40

Revenue 14.40
Portion collected beyond the discount period
Cash (7,084.80 - 4,939.2 + 14.40) OR (7,200 X 30%) 2,160.00
Accounts Receivable 2,160.00
Cash (7,084.80 - 4,939.2 + 14.40) OR (7,200 X 30%) 2,160.00
Accounts Receivable 2,160.00

ILLUSTRATION 4.B: PFRS 15 (Use of Sales Discount account)

SalesLife
on account
Application:
Accounts
The 6Receivable
best ways to increase your accounts7,200 receivable turnover ratio: Illustration 4.A Illustration 4.B
Sales
1. Improve your billing efficiency. 7,200
2. Take initial deposits at the start of a project 7,084.80 7,200.00
Acc. Receivable
Sales Discount
3. Regularly audit your balance sheet.115.20
Allowance 0 (115.20)
4. Use for yourSales Discount
digital calendar to set reminders 115.20
on payments Allow. for S/Disc.
5. Be proactive
Portion collected within theindiscount
your invoicing
period practices Acc. Receivable – NET 7,084.80 7,084.80
6. Provide
Cash (7,200 x 80% x 98%) discounts or incentives for early
5,644.80 payments.
Allowance for Sales Discount 115.20
Summary:
Accounts Receivable 5,760.00 Sales 7,084.80 7,200.00
 Accounts receivable
Portion collected beyond the discount periodmeasures the money that customers owe to a business for goods or services
0 (115.20)
Sales Discount
already provided.
Cash (7,200 x 20%) 1,440.00 Net Sales 7,084.80 7,084.80
 Companies that allow customers to purchase goods or services on credit will have receivables on
Accounts Receivable 1,440.00
their balance sheet.
 Receivables are recorded at the time of a sale when a good or service has been delivered but not yet
been paid for.
 Receivables will decrease when payment from customers is received.
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References: INTERMEDIATE ACCTG 1A [by: Millan, Zeus Vernon B. (2021)]
Financial Accounting Volume 1 [by: Valix, C. T., Peralta, Jose F., Valix, C A M. (2015).]
https://www.investopedia.com/articles/investing/052815/importance-analyzing-accounts-receivable.asp
https://www.fundthrough.com/blog/working-capital/accounts-receivable-explained-how-to-take-charge-of-
your-business-capital/
https://www.investopedia.com/terms/r/receivables.asp