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FAR EASTERN UNIVERSITY – MANILA

INSTITUTE OF ACCOUNTS, BUSINESS AND FINANCE


NICANOR REYES SR. ST., SAMPALOC, MANILA
APPLIED AUDITING

AUDIT OF RECEIVABLES.

 INITIAL MEASUREMENT → FV + TC (for being a financial asset)

 Short-term – face value (original invoice amount) (not discounted – immaterial)


 Long-term
 Interest-bearing – face value (if NR ≠ ER, compute present value)
 Noninterest-bearing – present value

 SUBSEQUENT MEASUREMENT → AC

 Short-term
 AR – NRV (face value less all AR allowances: Allowance for Sales Discounts / Sales Returns / Freight Charges)
 NR – face value (not discounted – immaterial / “under customary trade terms”)
 Long-term
 Interest-bearing – AC (if NR = ER, AC = face value)
 Noninterest-bearing – AC

 TRADE AND OTHER RECEIVABLES to be reported under current assets (exclude noncurrent)

 Trade
- from customers (arising from sale of inventory or normal business operations, not lending)
- noncurrent if collectible beyond the operating cycle or 1 year, whichever is longer

 AR, AC (NRV/CA)
 Postdated/NSF checks from trade accounts – part of trade AR
 Trade installment receivable, AC (CA) – part of trade AR
(AC = trade installment receivable - unearned interest income)
 NR (trade) (and if silent), AC (CA)
(AC = NR - UII)
× Credit balances in customers’ accounts
- current liability (not AP)
- don’t offset unless immaterial
- result from customers’
o overpayments
o advance payments
o returns and allowances

 Nontrade
- noncurrent if collectible beyond 1 year

 Current (usually) (“other” receivables)


 Advances to
- suppliers
- employees
- officers, directors, shareholders
 Accrued income
 Claims receivable
 Debit balances in creditors’ accounts
 Subscriptions receivable
(if collectible within 1 year)
(if silent, deduction from subscribed share capital)

 Noncurrent (usually)
 Advances to
- affiliates
- subsidiaries
(long-term investments)
 Special deposits
- security deposit on lease
- deposit on contract bids
(other noncurrent assets)
 NR (nontrade), AC (CA)
(AC = NR - UII)
 LR, AC (CA)
(AC = LR - UII

Handout – Audit of Receivables /RANNIE O. MEDINA, CPA, MBA 1


 ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

AR

Beg

Net credit (charge) sales Cash collections


(excluding recovery)

Settlement by notes
and other non-cash items
Sales discount forfeited
(under net method)
Write-off
(initial plus additional
per aging if any)

Recovery Recovery collection

End

* AR account
- also “customers’ accounts” or “trade debtors”
- full amount though pledged or assigned

* Net credit (charge) sales (to be debited to AR account)


- net of sales discounts, returns, and allowances from credit customers
- Do not deduct returns and allowances from CASH customers. (Discounts apply only to credit customers.)
- Do not deduct discounts and returns from ALLOWANCE provisions (Allowance for Sales Discounts / Sales Returns)
because their effect will be on the NRV of AR and not on its balance. (However, if the amount of “net credit
sales” is asked, deduct these amounts.)

* Cash collections (excluding recovery)


- net of sales discounts
- exclude overpayments from debtors

* AR, end
- “Balance” of AR
- “Outstanding” AR

AFDA

Beg

Write-off Recovery

“Unadjusted” debit balance “Unadjusted” credit balance

Additional write-off Doubtful Accounts Expense


per aging if any (Recorded +/- adjustment)

End

* AFDA account
- If silent, company uses allowance method (not direct write-off method)
- SFP approach (Entire AR or AR based on Aging):
→ AR, end x % = AFDA, end
- IS approach (Credit or Total, Net or Gross Sales):
→ Sales x % = DAE (If silent, DAE is admin expense, not selling expense.)
- % = bad debt percentage or percentage uncollectible (100% - probability of collection)
→ based on company policy (just follow the policy, e.g., number of past years covered)
→ generally computed as (Total Write-offs – Total Recoveries) / Total Credit Sales
→ [exclude current year amounts if to be applied on current year sales (IS approach)]
→ [include current year amounts if to be applied on current year AR, end (SFP approach)]
- Change in approach is a change in accounting estimate
→ If adjustment involves additional DAE, entry is Dr. DAE Cr. AFDA; otherwise, Dr. AFDA, Cr. DAE

Handout – Audit of Receivables /RANNIE O. MEDINA, CPA, MBA 2


 NOTES RECEIVABLE

- CA = NR – UII (Discount on NR)


- Trade
Cash
NR
Sales / Service Revenue
UII
- Nontrade
Cash
NR
Accumulated depreciation
Loss on sale*
Asset
UII
Gain on sale*

* Sales / Service Revenue = Cash price (PV of NR + DP if cash price is not given)
* Cash price = invoice price (not list price); UII = NR + DP - Cash price

- Nominal Rate (NR) ≠ Effective Rate (ER) → Compute PV (PV of Principal + PV of Interest)
(Discount if NR ↓, Premium if NR ↑.)
- Time value of money (computation of present value factor of 1 or lump-sum, ordinary annuity, or annuity due)
- Amortization table:
Date Interest Collection Interest Income Amortization Principal Collection Present Value
(Interest date) (o/s Prin., beg x NR) (PV, beg x ER) (Int. Inc. - Int. Coll.) (if any) (PV, beg
+ A if discount
- A if premium
- Prin. Coll.)
* PV = PV, beg * (1 + ER) - Int. Coll. - Prin. Coll.

 LOANS RECEIVABLE

- Direct origination cost – added to get LR, CA


- Origination fees – deducted to get LR, CA (“charged a four-point origination fee” → 4% x LR) (charged to borrower)
- If DOC > OF, excess is direct origination cost (premium) (NR > ER)
- If OF > DOC, excess is unearned interest income (discount) (ER > NR)
- Indirect origination cost – outright expense
- Computation of ER
 trial and error
 interpolation
→x-↓ (x = PV using exact ER) (↓ = PV using lower ER) (↑ = PV using higher ER)
→↑-↓ (resulting answer is added to ↓ ER to get the exact ER)

 IMPAIRMENT OF RECEIVABLES

 Impairment loss = (CA + Interest Receivable, end) - PV


(If silent, interest is accrued.)
 PV = PV of estimated future cash flows (principal and/or interest) (using original ER)
(Use original NR if no ER is given or if ER cannot be computed.)
 Allowance for loan impairment = CA as if not impaired - CA as impaired

 RECEIVABLE FINANCING

 Pledging / Hypothecating
- all AR
- disclosure only (balance still included in AR)

 Assignment
- specific AR only
- reclassified (balance still included in AR)
- non-notification or notification basis

 Factoring
- sale of AR
- Casual factoring: ordinary sale derecognizing related AFDA and recognizing gain or loss
- Factoring as a continuing agreement: Net cash proceeds = AR - commission – recv. from factor - interest - DTC)

 Discounting
- Net cash proceeds = maturity value – discount
MV = principal + (principal x interest rate x term)
Discount = MV x discount rate x discount period/12 (If silent, discount rate is annual.)
- Without recourse: credit NR (If silent, discounting is with recourse)
- With recourse – conditional sale: credit NR discounted
- With recourse – secured borrowing: credit Liability for NR discounted (debit Interest expense instead of Loss)
- Dishonored discounted NR → Dr. AR (MV + protest fee and other bank charges) Cr. Cash (paid to bank)

Handout – Audit of Receivables /RANNIE O. MEDINA, CPA, MBA 3


PROBLEM 1

On December 31, AAA Co.’s Accounts Receivable balance per ledger of P2,530,000 includes:

1. MasterCard or VISA credit card sale of merchandise to customer P150,000


2. Overpayment to supplier for inventory purchased on account 90,000
3. Insurance claim on automobile accident 10,000
4. Advance to sales manager due in one year 40,000
5. 5-year note receivable due from company president
(This was issued by the president for the loan granted to him.) 500,000
6. Interest due on the 5-year note from company president,
interest payable annually 60,000
7. Acceptance of 6-month note for past due account
arising from sale of inventory 90,000
8. Accrued interest receivable on the note above 10,000
9. Overpayment by customer of an account receivable (20,000)
10. Accounts receivable to customers definitely uncollectible 40,000
11. Other trade accounts receivable – unassigned 100,000
12. Trade accounts receivable – assigned 50,000
13. Note receivable from a customer (This is for a cash loan
made to this customer collectible in 3 years.) 60,000
14. Claim for tax refund from last year 20,000
15. Prepaid insurance – 4 months remaining in the policy period 40,000
16. Advances to subsidiaries 400,000
17. Inventory in-transit as of December 31 purchased FOB shipping pt. 150,000
18. Subscriptions receivable (currently collectible) 200,000
19. Special deposits on contract bids 80,000
20. Dividends receivable 50,000
21. Note receivable dishonored 20,000
22. Accrued rent receivable 20,000
23. Claims against common carriers 30,000
24. Acceptance of 8-month note from employees arising from sale of inventory 20,000
25. Trade installment receivable normally collectible within 16 months,
net of unearned interest income of P20,000 320,000
TOTAL P2,530,000

Based on the above and the result of your audit, compute the following:

1. Trade accounts receivable as of December 31


2. Trade notes receivable as of December 31
3. Trade and other receivables to be presented as current assets as of December 31
4. Noncurrent receivables as of December 31
5. Non-trade receivables as of December 31
6. Current non-trade receivables as of December 31
7. Amount that should be reclassified as a current liability as of December 31

PROBLEM 2

From inception of operations, BBB Co. carried no allowance for doubtful accounts.

Uncollectible accounts were expensed as written off and recoveries were credited to income as collected.

During 2018, management recognized that the accounting policy with respect to doubtful accounts was not correct
and determined that an allowance for doubtful accounts was necessary.

A policy was established to maintain an allowance for doubtful accounts based on historical bad debt loss percentage
applied to year-end accounts receivable.

The historical bad debt loss percentage is to be recomputed each year based on all available past years up to a
maximum of five years.

Year Credit sales Writeoffs Recoveries


2014 P1,500,000 P15,000 P 0
2015 2,250,000 38,000 2,700
2016 2,950,000 52,000 2,500
2017 3,300,000 65,000 4,800
2018 4,000,000 83,000 5,000

The entity reported accounts receivable of P1,250,000 on December 31, 2017 and P2,000,000 on December 31, 2018.

Handout – Audit of Receivables /RANNIE O. MEDINA, CPA, MBA 4


Based on the preceding information, answer the following:

1. What is the bad debt rate in 2017?


2. What is the bad debt rate in 2018?
3. What is the net realizable value of accounts receivable on December 31, 2017?
4. What is the net realizable value of accounts receivable on December 31, 2018?
5. What is the doubtful accounts expense for 2018?

PROBLEM 3

Nets Company produces paints and related products for sale to the construction industry throughout Metro Manila.
While sales have remained relatively stable despite a decline in the amount of new construction, there has been a
noticeable change in the timeliness with which the company’s customers are paying their bills.

The company sells its products on payment terms of 2/10, n/30. In the past, over 75 percent of the credit customers have
taken advantage of the discount by paying within 10 days of the invoice date. During the year ended December 31,
2017, the number of customers taking the full 30 days to pay has increased. Current indications are that less than 60% of
the customers are now taking the discount. Uncollectible accounts as a percentage of total credit sales have risen from
the 1.5% provided in the past years to 4% in the current year.

In response to your request for more information on the deterioration of accounts receivable collections, the company’s
controller has prepared the following report:

Nets Company
Accounts Receivable Collections
December 31, 2018

The fact that some credit accounts will prove uncollectible is normal, and annual bad debt write-offs had been
1.5% of total credit sales for many years. However, during the year 2018, this percentage increased to 4%. The
accounts receivable balance is P1,500,000, and the condition of this balance in terms of age and probability of
collection is shown below:

Proportion to total Age of accounts Probability of collection


64% 1 – 10 days 99.0%
18% 11 – 30 days 97.5%
8% Past due 31 – 60 days 95.0%
5% Past due 61 – 120 days 80.0%
3% Past due 121 – 180 days 65.0%
2% Past due over 180 days 20.0%

At the beginning of the year, the Allowance for Doubtful Accounts had a credit balance of P27,300. The
company has provided for a monthly bad debt expense accrual during the year based on the assumption that
4% of total credit sales will be uncollectible. Total credit sales for the year 2018 amounted to P8,000,000, and
write-offs of uncollectible accounts during the year totaled P292,500.

Based on the foregoing, answer the following:

1. How much is the adjusted balance of the allowance for doubtful accounts as of December 31, 2018?
2. The necessary adjusting journal entry to adjust the allowance for doubtful accounts as of December 31, 2018 would
include a credit to allowance for doubtful accounts of

PROBLEM 4

DDD Corporation included the following in its notes receivable as of December 31, 2018:

Note receivable from sale of land P 1,760,000


Note receivable from consultation 2,400,000
Note receivable from sale of equipment 3,200,000

In connection with your audit, you were able to gather the following transactions during 2018 and other information
pertaining to the company’s notes receivable:
I. On January 1, 2018, DDD sold a tract of land. The land, purchased 10 years ago, was carried on DDD’s books at a
value of P1,000,000. DDD received a noninterest-bearing note for P1,760,000. The note is due on December 31, 2019.
There is no readily available market value for the land, but the current market rate for comparable notes is 10%.
II. On January 1, 2018, DDD finished consultation services and accepted in exchange a promissory note with a face
value of P2,400,000, a due date of December 31, 2020, and a stated rate of 5%, with interest receivable at the end
of each year. The fair value of the services is not readily determinable and the note is not readily marketable. Under
the circumstances, the note is considered to have an appropriate imputed rate of interest of 10%.
III. On January 1, 2018, DDD sold an equipment with a carrying amount of P3,200,000 to X Corporation. As payment, X
gave DDD a P4,800,000 note. The note bears an interest rate of 4% and is to be repaid in three annual installments of
P1,600,000 plus interest on the outstanding balance. The first payment was received on December 31, 2018. The
market price of the equipment is not reliably determinable. The prevailing interest rate for similar notes is 8%.

Handout – Audit of Receivables /RANNIE O. MEDINA, CPA, MBA 5


Based on the result of your audit, determine the following (round off present value factors to four decimal places, e.g.,
0.8264, 1.7355):

1. Gain on sale of land in 2018


2. Carrying amount of note receivable from sale of land at December 31, 2018
3. Consultation service revenue in 2018
4. Carrying amount of note receivable from consultation at December 31, 2018
5. Gain on sale of equipment in 2018
6. Carrying amount of note receivable from sale of equipment at December 31, 2018
7. Amount of notes receivable that should be presented as current assets at December 31, 2018
8. Amount of notes receivable that should be presented as noncurrent assets at December 31, 2018
9. Total interest income in 2018
10. Total interest income in 2019

PROBLEM 5

On January 1, 2015, DDD Co. loaned P3,000,000 to DEF Co. The terms of the loan were payment in full on January 1, 2020
plus annual interest payments at 11%. The interest payment was made as scheduled on January 1, 2016, however, due
to financial setbacks DEF Co. was unable to make its 2017 interest payment. DDD Co. considers the loan impaired and
projects the following cash flows from the loan as of December 31, 2017 and 2018. Assume that DDD Co. accrued the
interest at December 31, 2016, but did not continue to accrue interest due to the impairment of the loan.

Amount projected as of
Date of flow December 31, 2017 December 31, 2018
December 31, 2018 P200,000 200,000
December 31, 2019 400,000 600,000
December 31, 2020 800,000 1,200,000
December 31, 2021 1,200,000 1,000,000
December 31, 2022 400,000

Your client requested you to determine the following: (Round off present value factors to four decimal places, e.g.,
0.8264, 1.7355.)

1. Loan impairment loss in 2017


2. Interest income in 2018 assuming the P200,000 was collected on December 31, 2018
3. Allowance for loan impairment as of December 31, 2018
4. Under PFRS 9, gain on reversal of impairment loss in 2018
5. Interest income in 2019 assuming the P600,000 was collected on December 31, 2019
6. Carrying amount of loan receivable as of December 31, 2019

PROBLEM 6

E Co. showed the following balances on December 31, 2016:

Accounts receivable P6,000,000


Allowance for doubtful accounts (180,000)

The following transactions transpired for E Co. during the year 2017:
a. On May 1, received a P900,000, six-month, 12% interest-bearing note from GHI, a customer, in settlement of an
account.
b. On June 30, factored P1,200,000 of its AR to a finance company. The finance company charged a factoring fee of
5% of the accounts factored and withheld 20% of the amount factored.
c. On August 1, E Co. discounted the GHI note at the bank at 15%.
d. On November 1, GHI defaulted on the P900,000 note. E Co. paid the bank the total amount due plus a P36,000
protest fee and other bank charges.
e. On December 31, E Co. assigned P1,800,000 of its accounts receivable to a bank under a nonnotification basis. The
bank advanced 80% less a service fee of 5% of the accounts assigned. E Co. signed a promissory note for the loan.
f. On December 31, E Co. collected from GHI in full including interest on total amount due at 12% since default date.
g. On December 31, it is estimated that 5% of the accounts receivable may prove uncollectible.

Based on the above data, compute the following:

1. Amount of cash received on June 30 factoring P900,000


2. Amount of cash received on August 1 discounting P918,225
3. Amount paid on November 1 default on the P900,000 note P990,000
4. Amount of cash received on December 31 assignment of accounts receivable P1,350,000
5. Amount of cash received on December 31 collection of accounts of GHI P1,009,800
6. Balance of allowance for doubtful accounts as of December 31, 2017 P195,000
7. The net realizable value of accounts receivable as of December 31, 2017 P3,705,000

Handout – Audit of Receivables /RANNIE O. MEDINA, CPA, MBA 6