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RECEIVABLES

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Learning Objectives
1. Define receivables and identify the different types of
receivables.
2. Explain accounting issues related to recognition and
valuation of accounts receivable.
3. Assignment of Accounts Receivables.
4. Explain accounting issues related to recognition and
valuation of notes receivable.
5. Explain how receivables are reported and analysed.

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Section 1:
Definition and types
of receivables

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Receivable -Definition
Amounts due from individuals and companies.
Types of receivables:
Account receivables
Notes receivables
Other receivables

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Accounts receivables
Receivable associated with the normal operating
activities of a business
e.g. Credit sales of goods & services to customers

Expected to be collected generally within 30 to 90 days.


Most significant type of claim held by company.
Often called trade receivables.

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Notes receivables
Receivables that are evidenced by a formal written promise
to pay a certain sum of money at a specified date

Normally requires payment of interest and extends for


time periods of 60-90 days or longer

Notes receivables give holder a stronger legal claim to


assets than accounts receivable

Promissory note is a negotiable instrument and may be


transferred to another party by endorsement

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Other receivables
Non-trade receivable

Include all other types of receivable

Arise from a variety of transactions


e.g. Sale of property, advances to directors &
employees, claim for losses or damages.

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Accounts Receivable Issues
Recognition and valuation of accounts
receivable

Trade discounts
Cash discounts
Sales returns and allowances
Valuation of trade debtors

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Accounts Receivable:
RECOGNITION
Recognizing accounts receivables
Companies record accounts receivable at point of sale
Entry is recorded to increase both Accounts
Receivable and Sales as follows:

Journal entry:
DR Accounts Receivable RMXXX
CR Sales RMXXX
(to record sales of RMXXX)

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RECORDING DISCOUNTS
There are two methods:

(1) Gross method records discounts when taken by


customers.

(2) Net method records discounts not taken by


customers.

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RECORDING DISCOUNTS
Gross Method Net Method
Record revenue at gross Record revenue at gross
amount of sales amount of sales less cash
discount
When customer takes the When customer forfeits
discount, record cash discount, record
discounts discounts not taken

Cash discounts reduce Report discounts forfeited


gross sales revenue as other revenue

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Accounts Receivable:
RECOGNITION
Sales discount (Gross method)
Cash (sales) discounts are inducements to customers for
prompt payment of amounts billed.
Cash discounts are normally recorded and appear in
books as a reduction of sales revenue (gross method).

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Accounts Receivable: Recognition
Example: if the sales invoice of RM100 include the credit
terms 2/10, net 60 days -> 2% cash discount on gross
invoiced amount is given if pays within 10 days.
Using the Gross method the transaction would be
recorded as follows:
At date of sale:
Dr Accounts Receivable 100
Cr Sales 100

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Accounts Receivable: Recognition
A) At the date of receipt (assume discount is taken):
Dr Cash 98
Dr Cash discount on sales 2
Cr Accounts Receivable 100
B) At the date of receipt (assume payment is
received after discount period):
Dr Cash 100
Cr Accounts Receivable 100

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Net Method:
At point of sale:
Dr. Accounts Receivable 98
Cr. Sales 98

If pays within discount period:


Dr. Cash 98
Cr. Accounts Receivable 98

If pays after discount period:


Dr. Cash 100
Cr. Accounts Receivable 98
Discount forfeited 2

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Accounts Receivable:
RECOGNITION
Trade discounts

Trade (quantity) discounts are not recorded. Invoiced at


the amount net of the trade discount (net method).

e.g.: The quoted price of RM100 and a trade discount


of 10% resulted in sales and debtor amount
recorded at RM90.

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Accounts Receivable:
RECOGNITION
Sales return & allowances
Allowances are to be made for
Goods that are returned by customers, and/or
Goods that are damaged during shipment, spoiled or defective
goods, or shipment of an incorrect quantity or type of goods.

Net sales and accounts receivable are reduced.

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Accounts Receivable: Recognition
Example:
Assume that books A costing RM700 are sold and
shipped to customer B for RM1,200. Buyer calls to
inform that Book C were actually ordered. Buyer
agrees to accept the goods if a reduction in price is
given. The company allows an allowance of RM250.

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Accounts Receivable: Recognition
The entry to record the sales allowance:

Dr Sales returns and allowance 250


Cr Accounts receivable 250

If buyer returns the good, the entry will be:

Dr Sales returns and allowance 1,200


Cr Accounts receivable 1,200
Dr Inventory 700
Cr Cost of goods sold 700

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VALUATION OF ACCOUNTS
RECEIVABLE
According to FRS 139, loan and receivable are
valued at amortized cost.

For short-lived debts such as trade receivables


on normal commercial term, the carrying
amount is the amount of debts less any
doubtful debt allowances. (refer to article on
The KPMG Guide: FRS 139 Financial
Instruments: Recognition and Measurement)

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Valuation of Accounts Receivable
Short term accounts receivable are shown at their net
realizable value as follows:
RM
Accounts Receivable (gross) XXX
Less: Provision for bad & doubtful debts _ XX
Amortized cost XX

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Uncollectibles of Accounts
Receivables
It is common for companies to have uncollected
receivables.
Journal entries involved:
Dr. Bad debts expense
Cr. Allowance for doubtful debts
Companies have to estimate
If cannot may make direct write off of the
uncollectible debts

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Methods to estimate bad debts:

i. percentage of sales method


Percentage based upon past experience and anticipate
credit policy.

Achieves proper matching of costs with revenues.

Existing balance in Allowance account not considered.

ii. percentage of receivables method


Not matching.
Reports receivables at cash realizable value.
Companies may apply this method using
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one composite rate, or

an aging schedule using different rates.

Focus is on providing an estimate of accounts


receivable value.
Uses past collection experience to estimate bad
debt expense.
Bad debt expense in the current year is calculated
by taking into account the existing balance in the
provision for bad & doubtful debts.

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Example:Percentage of sales
method
Based on past experience, RGY Company
estimates 2% of credit sales become uncollectible.
If in 2015, net credit sales for RGY are $800,000 it
records bad debt expense as follows:

Dr. Bad debt expense 16,000


Cr. Allowance for doubtful debts 16,000

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Example: Percentage of receivable method
- Aged Receivable Analysis

ABC Sdn. Bhd. - Aging Schedule


Customer Balance < 60 61 90 91 120 >120 Days
Days Days Days
RM RM RM RM RM
Harun 98,000 80,000 $ 18,000
Rashid 320,000 320,000
Kumar 55,000 55,000
Chong 74,000 60,000 14,000
547,000 460,000 18,000 14,000 55,000
Estimated 4% 15% 20% 25%
Uncollectibl
e
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The Balance Sheet Approach
Aged Receivable Analysis
1 Calculate uncollectible accounts (bad debts) expense:
460,000 * .04 RM18,400
18,000 * .15 2,700
14,000 * .20 2,800
55,000 * .25 13,750
Required balance in the
Allowance for Doubtful debts RM37,650
Less: Current Balance RM800
Bad Debts Expense RM36,850

2 Journal entries:
DR Bad debts expense RM36,850
CR Allowance for doubtful debts RM36,850
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Writing off bad debts
Estimated bad debts written off /Allowance
(estimated) write off
Direct write off

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Direct write off
Bad debts are charged directly to expense and removed
from the accounts receivable at the time the account
becomes uncollectible.
Dr Bad debts expense
Cr Accounts receivable
(To write off accounts receivable)

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Direct write off method
The direct write-off method does not match
revenues against expenses

e.g. If the sale was made in October 2003, but the


uncollectible is recognized in March 2004, then
the revenue of a company with December FYE
would be recognized in 2003 and its expense in
2004.

Generally, most companies, in practice, prefer


the allowance method.

The allowance method made a provision of


uncollectible debts 30
Allowance (estimated) write off
Use when it is certain that it cannot be collected.
Allowance account of the doubtful debts already
estimated.
Once confirm cannot be collected, debit the
allowance account, credit the AR account.

Dr Allowance for doubtful debts


Cr Accounts receivable

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Collection of AR After Writing Off Bad
Debts

If the account is collected, after being written


off, then:

Dr. Cash
Cr. Bad debts Recovered
(for the amount collected)

-the bad debts recovered will be


reported as other income in IS.
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Section 2:
Assignment of
Accounts Receivables

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The holder of accounts or notes receivable may
transfer them for cash.
Assingment is an example of how holder of
account/notes receivables may transfer the
receivables for cash.
Assignment is a form of secured borrowings.
Assigning/pledging accounts receivable means
using them as collateral for a loan. Holder retains
ownership.
Assigning accounts receivable provide off-balance
sheet financing.
The transaction normally does not appear in in
your financial statements and your customers may
never knew that their accounts were assigned.
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Why use receivables as a source of cash?
Providing customer financing is mandatory in many
industries, e.g. autos, industrial and farm equipment,
durable goods.
Access to normal financing may be unavailable or
expensive, e.g., further borrowing may violate existing
debt covenants.
Seller may prefer to leave billing and collection to a
more specialized agency.
Receivables financing may be cheaper than debt, as
the former conveys ownership rights to the purchaser.

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Assignment of receivables
Trade debt may be assigned or pledged with a
banker to obtain funds to meet companys cash
needs.
Trade debts are used as collaterals to obtain the
financing.
Risk of bad debts are not passed on to the banker
because it has the full recourse on the company in
the event that the trade debtors are unable to settle
their debts.

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Assignment of receivables
Bill of exchange trade debt financing arrangements
to acknowledge its liability.
The trade debts are remained in the accounting
records and the cash received and the corresponding
bill payable should be recognized in the accounts.

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Assignment of receivables
Transferor records for note payable and finance charge.
No effect on accounting for accounts receivable.
Transferor collects accounts receivable.
Transferor records sales returns and sales discounts.
Transferor absorbs bad debts expense.
Transferor records interest expense on notes payable.
Transferor pays on the note periodically from collections.
Meanwhile, the banker will record for note receivables,
finance revenue, interest revenue and cash paid and
received.

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Assignment of receivables
Example 1
On January 2005, Provo Mercantile Co. assigns specific
receivables totaling RM300,000 to Salem Bank as collateral on a
RM200,000, 12% note. Salem assesses a 1% finance charge on
assigned receivables in addition to the interest on the note.
Provo is to make monthly payments to Salem with cash
collected on assigned receivables. The entry should be as
follows:

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Assignment of receivables
1/1/2005
DR Cash RM197,000
DR Finance charge RM3,000
CR Notes payable RM200,000
(to record the loan with Salem Bank)

The trade debts of RM300,000 still remains in Provos


accounts.

Dr. Accounts receivable assigned RM300,000


Cr. Accounts receivable RM300,000
( to reclassify the assigned account receivable)

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In the bankers book:

1/1/2005
DR Note Receivable 200,000
CR Finance revenue 3,000
CR Cash 197,000
(to record loan to Provo Co.)

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Assignment of receivables
31/1/05

Collection of assigned accounts during January 2005 of


RM180,000 less cash discounts of RM1,000; Sales return in
January RM2,000

31/1/05 RM RM

Cash 179,000
Cash Discounts 1,000
Sales return 2,000
Accounts Receivable Assigned 182,000
(to record collection in January)

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Assignment of receivables
1/2/05
February 2005, Payment to Salem Bank on amount
owed plus interest on note payable

Journal entries-1/2/05 RM RM

DR Notes payable 179,000


DR Interest expense (200,000 x12%x1/12) 2,000
CR Cash 181,000
(To record loan repayment)

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In the bankers book:

1/2/05
DR Cash 181,000
CR Note receivable 179,000
CR Interest revenue 2,000
(to record receipts from Provo Co. and recognize interest
revenue)

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Assignment of receivables

28/2/05
Collection of the remaining 118,000 of receivables assigned

RM RM

DR Cash 118,000
CR Accounts Receivable 118,000
Assigned
(To record collection in February)

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Assignment of receivables

1/3/05
Remittance of balance due to Salem Bank

RM RM
DR Notes payable(200,000-179,000) 21,000
DR Interest expense (21,000 x 12% x 1/12) 210
CR Cash 21,210
(to record loan repayment)

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Section 4:
Notes receivable

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Introduction
A promissory note is a written promise to pay a sum of
money on a specified date in the future

The parties to a promissory note are:


1. The maker/borrower/customer - the party that
promises to repay the amount borrowed
2. The payee - the party that will receive the payment

E.g. RM1,000, 60-day note, 12% interest p.a.


RM50,000, 6-month note, 10% interest p.a.

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Terms used in Note Receivable
Principal - the amount borrowed/ the face value/ the
stated amount of the note

Maturity date - the date the note is to be repaid/due

Term - the time period/life of the note (in days or


months)

Interest - the amount charged on the borrower for the


use of the money borrowed

Maturity value - the amount of cash to be repaid


including principal and interest on the maturity date

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Due date
The life of a note may be expressed in months or days.

When the life of a note is expressed in terms of months, the


due date is found by counting the months from the date of
issue.

When the due date is stated in terms of days, it is necessary


to count the exact number of days to determine the maturity
date.

In counting the life of a note, the date the note is issued is


omitted but the due date is included.

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Example

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Computing interest
The formula for computing INTEREST is PRT:

Principal(Face Value) x Rate (annual interest


rate) x Time (in Terms of one year)

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Computing interest

RM99
RM5099

RM5099

365 RM99

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Entries to record notes receivables
At the time a note is received, it is recorded at
face value with no interest added.

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Entries to record notes receivables
Notes receivable are reported at their cash (net) realizable
value

A note is honored when it is paid in full at maturity

Interest revenue is recorded when the note is paid.


However, if interim financial statements are prepared,
interest on notes receivable is accrued and shown as interest
revenue as it is earned.

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Entries to record notes receivables

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Entries to record notes receivables
If a note is not paid in full at maturity, it is called a
dishonored note. If it can reasonably be assumed
that the amount due will ultimately be collected, it is
usually transferred to an Account Receivable.

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Entries to record notes receivables

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