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UNIT 3

AUDIT OF RECEIVABLES, RELATED REVENUES


AND CREDIT LOSSES
Estimated Time: 6.0 HOURS

Discussion questions 3-1

1. Distinguish between test of details of balances and test of transactions for the sales
and collection cycle. Explain how the tests of transactions affect the test of details.

Discussion questions 3-2 Confirmation of receivables

1. Distinguish between a positive and a negative confirmation and state the


circumstances in which each should be used. Why do CPA firms frequently use a
combination of positive and negative confirmations on the same audit?
2. Under what circumstances is it acceptable to confirm accounts receivable prior to the
balance sheet date?
3. What are the implications to the auditors if, during their examination of accounts
receivable, some of the clients customers do not respond to the auditors request for
positive confirmation of their accounts receivable? What procedures should the
auditors perform if there is no response to a second request for a positive
confirmation?

Problem 3-1 Analysis and classification of receivables

Your audit disclosed that on December 31, 2016, the accounts receivable control
account of DDD Company had a balance of P1,432,500. An analysis of the accounts
receivable account showed the following:
Accounts known to be worthless
Advance payments to suppliers on purchase orders
Advances to affiliated companies
Customers accounts reporting credit balances arising from sales return
Interest receivable on bonds
Other trade accounts receivable unassigned
Subscriptions receivable due in 30 days
Trade accounts receivable assigned (DDD Companys equity in assigned
accounts is P75,000)
Trade installment receivable due 1-18 months, including unearned finance
charges of P15,000
Trade receivables from officers due currently
Trade accounts on which post-dated checks are held (no entries were made
on receipts of checks)
Total

P18,750
75,000
187,500
(112,500)
75,000
375,000
412,500
187,500
165,000
11,250
37,500
P1,432,500

1. Trade accounts receivable balance as of December 31, 2016.


2. Net current trade and other receivables balance as of December 31, 2016
3. How much will be presented under noncurrent asset as of December 31, 2016?

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Problem 3-2 Receivables and Sales Cutoff

You were engaged to perform an audit of the accounts of the Hello Corporation for the
year ended December 31, 2016 and have observed the taking of the physical inventory
of the company on December 30, 2016. Only merchandise shipped by the Hello
Corporation to customers up to and including December 30, 2016 has been eliminated
from inventory. The inventory as determined by physical inventory count has been
recorded on the books by the companys controller. No perpetual inventory records are
maintained. All sales are made on an FOB shipping point basis. You are to assume that
all purchase invoices have been correctly recorded.
The following list of sales invoices are entered in the sales books for months of
December, 2016 and January, 2017, respectively.
December 2016

January 2017

Sales Invoice
Amount
A. P30,000
B. 22,000
C. 10,000
D. 40,000
E. 100,000

Sales Invoice Date


December 21
December 31
December 29
December 31
December 30

Cost of Goods
Sold
P20,000
18,000
6,000
24,000
56,000

Date Shipped

F. 120,000

December 30

80,000

December 31, 2016


December 31, 2016
December 30, 2016
January 3, 2017
December 29, 2016*
(shipped to consignee)
January 2, 2017

G. 60,000
H. 40,000
I. 80,000
J 90,000

December 31
January 2
January 3
January 4

40,000
23,000
55,000
64,000

December 30, 2016


January 2, 2017
December 31, 2016
December 29, 2016

*Verification from consignee indicates that 60% of the merchandise is still unsold at
December 31, 2016.

Required: Prepare the necessary adjusting journal entries at December 31, 2016 in
connection with the foregoing data.
Problem 3-3 Analysis of accounts receivable and related losses

The following information is based on the first audit Yoga Bear Company. Your new
client has not prepared financial statements for three years since December 31, 2014.
The company used the accrual method of accounting and reported income on a calendar
year basis prior to 2015. During the three years since December 31, 2014 his cash
receipts and cash disbursements records were maintained and sales on account were
entered, when made, directly into an accounts receivable subsidiary ledger. However, no
general ledger postings have been made since the December 31, 2014. Your
examination has disclosed balances at the beginning and the end of the three-year
period as follows:
Aging of accounts receivable
Less than 1 year old
1 to 2 years old
2 to 3 years old
Total accounts receivable
Inventories
Accounts payable merchandise purchases

12/31/2014
P176,120
12,000
188,120
116,000
50,000

12/31/2017
P282,000
18,000
8,000
308,000
188,000
110,000

You have satisfied yourself as to the accuracy of the balances shown above. Other
information available to you is as follows:
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2015
Cash received on account applied to:
Current year accounts
Prior years accounts
Accounts of two years prior
Total
Cash sales
Disbursement for merchandise purchases

P1,480,000
134,000
50,120
P1,664,120
170,000
1,792,500

2016

2017

P1,618,000 P2,088,000
150,000
168,000
4,000
20,000
P1,772,000 P2,276,000
260,000
312,000
1,412,000
1,738,000

No account balances have been written off as uncollectible during the three-year period
and the ratio of gross profit to sales remains constant from year to year.

Required:
1. Compute the total sales for each year 2015 to 2017.
2. What is the average gross profit rate?
3. Compute the gross profit for each year 2015 to 2017.
Problem 3-4 Analysis of accounts receivable and related losses

The Byem Co. sells direct to retail customers and also to wholesalers. Accounts
receivable and an allowance for bad debts are maintained separately for each division.
On January 1, 2016 the balance of the retail accounts receivable was P209,000 while
the bad debts with respect to retail customers was a credit of P7,600.
The following summary pertains only to retail sales since 2013:
Credit Sales
2013
2014
2015
2016

P1,110,000
1,225,000
1,465,000
1,500,000

Bad Debts
Written Off
P26,000
29,500
30,000
31,000

Bad Debts
Recoveries
2,150
3,750
3,600
4,200

Bad debts are provided for as a percentage of credit sales. The accountant calculates
the percentage annually by using the experience of the three years prior to the current
year. The formula is bad debts written off less recoveries expressed as a percentage of
the credit sales for the same period. Cash receipts in 2016 from credit sales to retail
customers was P1,380,200.

Required: Based on the above and the result of your audit, answer the following:
1. The percentage to be used to compute the allowance for bad debts on December 31,
2016
2. For 2016, the provision for bad debts with respect to credit sales
3. The ledger balance of the accounts receivable after necessary adjustments on
December 31, 2016
4. The ledger balance of the allowance for bad debts after necessary adjustments on
December 31, 2016
Problem 3-5 Analysis of accounts receivable and related losses

Maxwell Company produces paints and related products for sale to the construction
industry throughout Cebu City. While sales have remained relatively stable despite a
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decline in the amount of new construction, there has been a noticeable change in the
timeliness with which the companys customers are paying their bills.
The company sells its products on payment terms of 2/10,n/30. In the past, over 75% 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, 2016, 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 sale 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 companys controller has prepared the following report:
Maxwell Company
Accounts Receivable Collections
December 31, 2016
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 2016, this percentage increased to 4%. The accounts receivable balance is
P1,500,000, and the condition of this balance in terms of age and of collection is shown
below:
Proportion to total Age of accounts
Probability of collections
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 2016 amounted to P8,000,000, and write-offs of uncollectible
accounts during the year totaled P292,500.

Required:
1. How much is the adjusted balance of the allowance for doubtful accounts as of
December 31, 2016?
2. Prepare the necessary adjusting journal entry to adjust the allowance for doubtful
accounts as of December 31, 2016.
Problem 3-6 Analysis of accounts receivable and related losses

In connection with your examination of the financial statements of Ruth Tambok, Inc. for
the year ended December 31, 2016, you were able to obtain certain information during
your audit of the accounts receivable and related accounts.
The December 31, 2016 balance in the Accounts Receivable control accounts is
P837,900.
An aging schedule of the accounts receivable as of December 31, 2016 is presented
below:
Age
Net Debit Balance
Percentage to be
applied after
corrections have
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60 days and under


61 to 90 days
91 to 120 days
Over 120 days

P387,800
307,100
89,800
53,200

been made
1%
2%
5%
Definitely
uncollectible, P9,000;
the remainder is
estimated to be 25%
uncollectible

Total
P837,900
Two entries made in the Doubtful Accounts Expense account were:
1. A debit on December 31 for the amount of the credit to the allowance for Doubtful
Accounts.
2. A credit for P6,100 on November 30, 2016, and a debit to Allowance for Doubtful
Accounts because of a bankruptcy. The related sales took place on October 1, 2016.
The allowance for Doubtful Accounts schedule is presented below:
Debit
January 1, 2016
November 30, 2016
December 31, 2016(P837,900 x 5%)

Credit

P6,100
P41,895

Balance
P19,700
13,600
P55,495

There is a credit balance in one account receivable (61 to 90 days) of P11,000; it


represents an advance on a sales contract.

Required:
1. How much is the adjusted balance of Accounts Receivable as of December 31, 2016?
2. How much is the adjusted balance of the Allowance for Doubtful Accounts as of
December 31, 2016?
3. How much is the Doubtful Accounts expense for the year 2016?
4. How much is the net adjustment to the Doubtful Accounts expense account?
Problem 3-7 Analysis of accounts receivable and related losses with subsequent
recovery and Confirmation replies

In connection with the audit of the financial statements of Charm Corporation, your audit
senior instructed you to examine the companys accounts receivable.
Prior to any adjustments you were able to extract the following balances from Charms
trial balance as of December 31, 2016:
Accounts receivable
Allowance for doubtful accounts

P1,327,500
45,000

From the schedule of accounts receivable as of December 31, 2016, you determined
that this account includes the following:
Accounts with debit balances:
60 days old and below
61 to 90 days
Over 90 days
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P715,500
351,600
256,200

P1,323,300
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Advances to officers
Accounts with credit balances
Accounts receivable per GL

49,200
(45,000)
P1,327,500

The credit balance in customers account represents collection from a customer whose
account had been written-off as uncollectible in 2015.
Accounts receivable for more than a year totaling P63,000 should be written off.
Confirmation replies received directly from customers disclosed the following exceptions:
Customer
A

Customers Comments
The goods sold on December 1
were returned on December 16,
2016.

We do not owe this amount *%#@


(bad word). We did not receive
any merchandise from your
company.

I am entitled to a 10% employee


discount. Your bill should be
reduced by P3,600.

We have not yet sold the goods.


We will remit the proceeds as
soon as the goods are sold.

We do not owe you P60,000. We


already paid our accounts as
evidenced by OR # 1234.
Reduce your bill by P4,500

Audit Findings
The client failed to record credit
memo no. 23 for P36,000. The
merchandise was included in the
ending inventory at cost.
Investigation revealed that
goods sold for P48,000 were
shipped to Ramil on December
29, 2016, terms FOB shipping
point. The goods were lost in
transit and the shipping
company has acknowledged its
responsibility for the lost of the
merchandise.
Anne is an employee of Charm.
Starting November 2016, all
company employees were
entitled to a special discount.
Merchandise billed for P54,000
were consigned to Efem on
December 30, 2016. The goods
cost P39,000.
The sale of merchandise on
December 18, 2016 was paid by
Dodong on January 6, 2017.
This amount represents freight
paid by the customer for the
merchandise shipped on
December 17, 2016, terms, FOB
destination-collect.

Based on your discussion with Charms Credit Manager, you both agreed that an
allowance for doubtful accounts should be maintained using the following rates:
60 days old and below
61 to 90 days
Over 90 days

1%
2%
5%

Required: Based on the above and the result of your audit, answer the following:
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1. The adjusted balance of accounts receivable in the 60 days and below category as of
December 31, 2016
2. The adjusted balance of accounts receivable as of December 31, 2016
3. The adjusted allowance for doubtful accounts as of December 31, 2016
4. The entry to adjust the allowance for doubtful accounts
Problem 3-8 Analysis of notes receivable and related accounts

During the course of the audit of the financial statements of N, Inc. for the year ended
December 31, 2016, you examined the Trade Notes Receivable account represented by
the following items.
a. A four-month note dated November 30, 2016 from the R Co., P100,000; interest rate,
10% discounted without recourse on November 30, 2016 at 8%. N recorded the
proceeds received as a credit to Liability on Discounted Notes.
b. A 90-day note dated November 1, 2016 from E, P250,000; interest rate at 8%; the
note is for subscriptions to 2,500 shares of the preference share capital of N, Inc. at
P100 per share.
c. A 60 day note dated May 3, 2016 from H Company P30,000: interest rate, 6%;
dishonored at maturity; judgment obtained on October 10, 2016, collection doubtful.
d. A one-year noted dated January 31, 2016 from the president of N, Inc. P800,000; no
interest; president confirmed. Market rate of note on January 31, 2016 was 9%.
e. A 120-day note dated September 14, 2016, from the D Company, P60,000; interest
rate, 9%, note is held by bank as collateral.
f. A two year non-interest bearing note from B Company for P200,000 received and
dated August 31, 2016. The note was received in exchange for an agreement sold.
The equipment had an original cost of P400,000 and had an accumulated
depreciation on January 1, 2016 of P160,000. Such equipment is being depreciated
at a rate of 10% a year, rounded to the nearest month. The prevailing interest rate for
a note of this type is 12%. N recorded the sale by debiting notes receivable and
crediting equipment of the face value of the note. No depreciation has yet been
provided on this equipment for the year 2016.

Required: (Round off your present value factors to four decimal places)
1. Audit adjustment entries at December 31, 2016.
2. Correct balance of Trade Notes Receivables, Interest Receivable/Accrued Interest
Income and Interest Income.
Problem 3-9 Analysis of noncurrent receivables and related accounts

The statement of financial position M Corporation reported the following long-term


receivables as of December 31, 2015:
Notes receivable from sale of plant
Note receivable from officer

P6,000,000
1,600,000

In connection with your audit, you were able to gather the following transactions during
2016 and other information pertaining to the companys long-term receivables:
a. The note receivable from sale of plant bears interest at 12% per annum. The note is
payable in 3 annual installments of P2,000,000 plus interest on the unpaid balance
every April 1. The initial principal and interest payment was made on April 1, 2016.

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b. The note receivable from officer is dated December 31, 2015, earns interest at 10%
per annum, and is due on December 31, 2018. The 2016 interest was received on
December 31, 2016.
c. The corporation sold a piece of equipment to K, Inc. on April 1, 2016, in exchange for
an P800,000 noninterest bearing note due on April 1, 2018. The note had not ready
market, and there was no established exchange price for the equipment. The
prevailing interest rate for a note of this type at April 1, 2010, was 12%. The present
value factor of 1 for two periods at 12% is 0.7972.
d. A tract of land was sold by the corporation to B Co. on July 1, 2016, for P4,000,000
under an installment sale contract. B Co. signed a 4-year 11% note for P2,800,000
on July 1, 2016, in addition to the down payment of P1,200,000. The equal annual
payments of principal and interest on the note will be P902,500 payable on July 1,
2017, 2018, 2019, and 2020. The land had an established cash price of P4,000,000,
and its cost to the corporation was P3,000,000. The collection of the installments on
this note is reasonably assured.

Required: (Round off your present value factors to four decimal places)
1. Current portion of long-term receivables as of December 31, 2016
2. Noncurrent receivables as of December 31, 2016
3. Accrued interest income/Interest receivable as of December 31, 2016
4. Interest income for the year 2016
Problem 3-10 Impairment of receivables

Algertina Bank granted a loan to a borrower in the amount of P10M. The loan is 10%
payable annually starting December 31, 2015. The loan matures in five years on
December 31, 2020. Algertina Bank incurs P130,900 of direct loan origination cost and
P50,000 of indirect loan origination cost. In addition, Algertina Bank charges the
borrower a 5-point nonrefundable loan origination fee. The new effective rate is 11%
after origination.
The borrower paid the interests due on December 31, 2016 & 2017. However, during
2017 the borrower began to experience financial difficulties, requiring the bank to
reassess the collectibility of the loan. As of December 31, 2017, the bank expects that
only P8,000,000 of the principal will be recovered. The P8,000,000 principal amount is
expected to be collected in two equal installments on December 31, 2019 and December
31, 2021. The prevailing interest rates for similar type of notes as of December 31, 2016
and 2017 are 15% and 16%, respectively.

Required: Based on the above and the result of your audit, determine the following:
(Round off your present value factors to four decimal places)
1. The interest income to be recognized in 2016
2. The carrying amount of the loan as of December 31, 2016
3. The loan impairment loss to be recognized in 2017
4. The interest income to be recognized in 2018
5. The carrying amount of the loan as of December 31, 2018

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Problem 3-1 Objective Evidence of Impairment of Receivables

On December 31, 2016, the Manarang Company assesses whether there is any
objective evidence that its maturing loans receivables are impaired as of that date. For
each of the loan receivable below, indicate the amount of impairment loss that Manarang
should recognize on December 31, 2016. (Round present value factors to four decimal
places).

From Company S Principal P4,000,000 and accrued interest income of P480,000,


based on annual interest rate of 12%, original due date December 31, 2016. It has
come to your attention that Company S, as of December 31, is undergoing
bankruptcy proceedings and has negotiated for restructuring of its loan with
Manarang as follows: P1,120,000 annual payment with first payment due on
December 31, 2017. No further interest will be collected during the extended fouryear term.

From Company T Principal amount of P1,000,000 with accrued interest income of


P120,000. Manarang granted a concession to Company T to extend maturity date of
the principal by one year. The interest of P120,000 is to be collected on due date,
January 1, 2017, but interest is reduced from 12% to 10% during extended period.

From Company U Principal amount of P2,000,000 with accrued interest income of


P200,000 as of December 31, 2016, based on interest rate of 12%, maturity date of
March 1, 2017. Company U is in good financial standing as of December 31, 2016
but it is more likely than not that it will undergo bankruptcy proceeding since 2017
due to a landslide loss suffered by the company late January 2017. Company U is
the owner/developer of ABC Subdivision, which was destroyed by a landslide caused
by flood. The government had held Company U liable for the loss not only of
properties but lives due to the disaster.

From Company V - Principal amount of P3,000,000. Company V pay the accrued


interest on its loan of P360,000 based on interest rate of 12%, on December 31,
2016 and negotiated for an extension of the maturity date of the loan to December 31,
2015. Based on the agreement between Manarang and Company V, the latter will
continue to pay the annual interest of 12% on the loan.

Required: (Round off your present value factors to four decimal places)
1. Impairment loss to be recognized on December 31, 2016 on the receivable from
Company S, T, U and V.
2. Assume that each of the foregoing described receivable, taken alone, will have a
material effect on the financial statements of XYZ at December 31, 2016. The
landslide loss suffered by Company U in 2017 is considered (choose the correct
statement)
a. An event that does not require adjustment or disclosure in the notes to the
financial statements.
b. An event requiring adjustment.
c. An event requiring both adjustment and disclosure in the notes to the financial
statements.
d. An event requiring disclosure in the notes to the financial statements.
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