INTERMEDIATE ACCOUNTING

Volume 1

ASSETS
 MIDTERM COVERAGE

CHAPTER 1 : CASH AND CASH EQUIVALENTS

CHAPTER 2 : BANK RECONCILIATION
CHAPTER 3 : PROOF OF CASH
CHAPTER 4 : ACCOUNTS RECEIVABLE
CHAPTER 5 : ESTIMATION OF DOUBTFUL ACCOUNTS
CHAPTER 6 : NOTES RECEIVABLE
CHAPTER 7 : LOAN RECEIVABLE
CHAPTER 8 : RECEIVABLE FINANCING
CHAPTER 9 : RECEIVABLE FINANCING
CHAPTER 10 : INVENTORIES
CHAPTER 11 : INVENTORY COST FLOW
CHAPTER 12 : LOWER OF COST AND NET REALIZABLE VALUE
: PAS 41
CHAPTER 13 : GROSS PROFIT METHOD
CHAPTER 14 : RETAIL INVENTORY METHOD
CHAPTER 15 : FINANCIAL ASSET AT FAIR VALUE
 CHAPTER 1
Cash and cash equivalents

CASH

Layman’s term – Cash means money

Money – is the standard medium of exchange in business transactions
– refers to the currency and coins which are in circulation and legal tender

Accounting Parlance: Cash has a special and broader meaning; it connotes more than money

Cash includes money and any other negotiable instrument that is payable in money and
acceptable by the bank for deposit and immediate credit.

Cash includes:
- Checks
- Bank drafts
- Money orders
Because these are acceptable by the bank for immediate deposit or immediate encashment

* but POSTDATED CHECKS are not considered as cash yet because these checks are
unacceptable by the bank for deposit and immediate credit or outright encashment.

UNRESTRICTED CASH

- there is no specific standard dealing with cash

- PAS 1, paragraph 66 – an entity shall classify an asset as current when the asset is cash or cash
equivalent unless it is restricted to settle a liability for more than 12
months after the end of the accounting period.
- Accordingly, to be recorded as “cash”, an item must be unrestricted in use.
- Cash must be readily available in the payment of current obligations and not be subject to any
restrictions, contractual, or otherwise.

! Cash must be unrestricted to be considered as CURRENT ASSET.

! Restricted cash – cash used to pay for non-current liabilities.
! Non-current liabilities – More than 12 months after the end of accounting period
! Current Liability – within the Accounting Period + 1 year
CASH ITEMS INCLUDED IN CASH

1. Cash on Hand
a. Undeposited Cash
b. Other cash awaiting for deposit
i. Customer’s Checks
ii. Cashier’s Checks
iii. Manager’s Checks
iv. Traveler’s Checks
v. Bank Drafts
vi. Money Orders

2. Cash in Bank
a. Demand Deposit
b. Checking Account
c. Savings Account (which are unrestricted as to withdrawal)

3. Cash Fund
a. Cash Fund set aside for CURRENT purposes only
i. Petty Cash Fund
ii. Payroll Fund
iii. Dividend Fund
iv. Travel fund
v. Interest fund
vi. Tax fund
 CASH EQUIVALENTS

- PAS 7, paragraph 6 – Cash Equivalents are short-term assets and highly-liquid investments that
are readily convertible into cash and so near the maturity that they present
insignificant risk of changes in value because of changes in interest rates.
– only highly-liquid investments that are acquired 3 months before
maturity can qualify as cash equivalents.

! Cash equivalents are CURRENT ASSETS.

! Cash equivalents are highly-liquid investments
! Cash equivalents are acquired 3 months before the maturity value.
! Equity Shares – cannot qualify as Cash Equivalents because shares do not have maturity date.
! Date of Purchase is important which should be : 3 months or less before the maturity date.
! BSP Treasury Bill that has remaining maturity date of 3 months or less BUT purchased 1
year ago can still NOT be qualified as Cash Equivalent.

EXAMPLES:

1. Treasury bill
a. 3-month BSP Treasury Bill
b. 3-year BSP Treasury Bill purchased 3 months before date of maturity.

2. Time deposit
a. 3-month Time Deposit

3. Money Market Instrument

a. 3-month Money Market Instrument

4. Commercial Paper
a. 3-month Commercial Paper

5. Preference Shares (has specified redemption date)

a. Preference Share acquired 3 months before redemption date
INVESTMENTS OF EXCESS CASH
(A.K.A Cash Equivalents / Short-term Financial Asset / Long-term Investment)

- Control and proper use of cash is an important aspect of cash management.

- An entity must maintain sufficient cash for use in current operations.
- Cash excess for the use for current operation should be invested in some revenue earning
investment.
- It may be invested in: TIME DEPOSITS, MONEY MARKET INSTRUMENT, &
TREASURY BILL.

CLASSIFICATIONS OF INVESTMENTS IN EXCESS OF CASH

1. Cash Equivalents
a. if the term is 3 months or less
b. included in the “Cash and Cash Equivalents” line

2. Short-term Financial Asset

a. If the term is more than 3 months but within 1 year
b. Temporary investments
c. Presented separately in CURRENT ASSETS as “Short-term financial assets”

3. Long-term Investments
a. If the term is more than 1 year
b. It is a NON-CURRENT ASSET – “Long-term Investments”
c. BUT, if such investments BECOME DUE IN 1 YEAR from the end of
accounting period – they are RECLASSIFIED AS CURRENT OR
TEMPORARY INVESTMENTS

MEASUREMENT OF CASH

- Cash is measured at Face Value.

- Cash in foreign currency is measured at the current exchange rate.
- If in bankruptcy or financial difficulty, Cash should be written down to estimated
realizable value if the amount recoverable is estimated to be lower than the face value.

FOREIGN CURRENCY

- Cash in foreign currency shall be translated in Philippine pesos using the current
exchange rate.
- Deposits in any foreign currency that are subjected to restrictions are classified separately
among NON-CURRENT ASSETS and restrictions are clearly stated.

! Deposits in any foreign currency which are not subjected to any foreign exchange
restriction are included in cash.
FINANCIAL STATEMENT PRESENTATION

- “Cash and Cash Equivalents” – should be shown as first line item under CURRENT
ASSET
- This caption includes all cash items: cash on hand, cash in bank, petty cash fund, cash
equivalents which are unrestricted in use for current obligations.
- Details comprising the cash and cash equivalents should be disclosed in the notes to
financial statements.

CASH FUND for a certain purpose

- If cash fund is set aside for current operations, it’s a current asset
- CASH FUND FOR CURRENT OPERATION = CURRENT ASSET
- Cash fund is included in the “Cash and Cash Equivalents” item

- Examples of CURRENT cash fund

“Cash and Cash Equivalents” :

a. Petty Cash fund
b. Payroll Fund
c. Travel Fund
d. Interest Fund
e. Dividend Fund
f. Tax Fund

- If cash fud is set aside for non-current obligation, it is shown as “LONG-TERM

INVESTMENT”
- LONG-TERM INVESTMENT = NON-CURRENT ASSET

- Examples of NON-CURRENT Cash Fund

Long-term Investment :
a. Sinking Fund
b. Preference Share
c. Redemption Fund
d. Contingent Fund
e. Insurance Fund
f. Fund for acquisition or construction of PPE

CLASSIFICATION OF CASH FUND

- Classification of cash fund should parallel the classification of the related liability.
- A sinking fund that is set aside to pay a bond already due within 1 year after end of
reporting period should be classified as CURRENT ASSETS.
- A cash fund set aside for acquisition of a non-current asset should be classified as
NON-CURRENT ASSET regardless of the year of disbursement.
BANK OVERDARAFT

- Cash in bank has CREDIT BALANCE

- Bank overdraft comes from issuance of checks in excess of deposits
- (sobra yung iniissue na checks kesa sa laman talaga ng bank account mo)
- Classified as CURRENT LIABILITY
- Not necessary to adjust and open a bank overdraft account in ledger.
- Bank overdrafts are not allowed in the Philippines
- EXEPTION:
a. When entity have 2 or more accounts in ONE bank, overdrafts can be offset
b. If amount is immaterial
c. Under IFRS – bank overdraft can be offset against other bank account when
payable on demand and often fluctuates from positive to negative as integral part
of cash management.

COMPENSATING BALANCE

- compensating balance generally take form of minimum checking or demand deposit

account balance that must be maintained in connection with a borrowing arrangement
with a bank
- this arrangement results in reduction of the amount borrowed because the compensating
balance provides a source of fund to the bank as partial compensation for the loan
extended.

CLASSIFICATION OF COMPENSATING BALANCE

- if the deposit is not legally restricted as to withdrawal because of an informal

agreement, the compensating balance is PART OF CASH.
- if the deposit is legally restricted as to withdrawal because of an formal agreement, the
compensating balance is classified separately as “Cash held as compensating balance”
under CURRENT ASSETS if the related loan is short-term. If the loan is long-term, the
compensating balance is classified as noncurrent investment.

- INFORMAL AGRREMENT = NOT LEGALLY RESTRICTED = “CASH”

- FORMAL AGREEMENT = LEGALLY RESTRICTED:

a. RELATED LOAN IS SHORT-TERM = CURRENT ASSET

 “CASH HELD AS COMPENSATING BALANCE”

b. RELATED LOAN IS LONG-TERM = NON-CURRENT ASSET

 “LONG-TERM INVESTMENT”
UNDELIVERED OR UNRELEASED CHECK

- Merely drawn and recorded but not yet given to the payee before the end of the
accounting period
- (nasulat palang at narecord pero di pa nabibigay sa payee)
- There is no payment when the check is pending delivery to the payee at the end of
accounting period
- Undelivered check is still subject to the entity’s control and may thus be cancelled any
time before delivery discretion to the entity.
- (yung owner paden ng check yung may control sa check, kaya posibleng icancel pa nila
ung check)
- An adjusting entry is REQUIRED to restore the cash balance and set up the liability
- (required irecord, ibalik yung cash pati yung liability)

- Entry for UNDELIVERED CHECK:

Cash xxx
Accounts Payable xxx

- Foregoing adjustment is sometimes ignored because sometimes the amount is immaterial

and there are no evidence that there is an actual cancelation of the check in the same
accounting period

POSTDATED CHECK DELIVERED

- A check drawn, recorded, and already given to the payee but it bears a date subsequent to
the end of reporting period.
- Original entry shall also be reversed.

- Entry for POSTDATED CHECK DELIVERED:

Cash xxx
Accounts Payable xxx

- There is no payment until the check can be presented to the bank for encashment or
deposit.

STALE CHECK OR CHECK LONG OUTSTANDING

- A stale check is a check not encashed by the payee within a relatively long period of
time.
- Presentment must be made within a reasonable time after issue.
- A check becomes stale when not encashed within 6 months from time of issuance.
- Even after 3 months only, the entity may issue a stop payment order for cancelation of
previously issued check.
- Entry if immaterial: Entry if liability is expected to continue:
 Cash Cash
Miscellaneous Income Accounts Payable
ACCOUNTING FOR CASH SHORTAGE

- When cash count is lower than balance per book, a cash shortage is recorded

- Entry for CASH SHORTAGE:

Cash short or over xxx
Cash xxx

- The account “Cash short or over” is a temporary or suspense account. It should be

adjusted when financial statements are prepared.

- Adjusting Entry (If CASHIER is responsible for cash shortage) :

Due from cashier xxx

Cash short or over xxx

- Adjusting Entry (Fails to disclose the cause of shortage) :

Loss from cash shortage xxx

Cash short or over xxx

ACCOUNTING FOR CASH OVERAGE

- When cash count is higher than balance per book, a cash shortage is recorded

- Entry for CASH OVERAGE:

Cash short or over xxx

Cash xxx

- The account “Cash short or over” is a temporary or suspense account. It should be

adjusted when financial statements are prepared.

- Adjusting Entry (If CASHIER is responsible for cash overage) :

Cash short or over xxx

Payable to Cashier xxx

- Adjusting Entry (Fails to disclose the cause of overage) :

Cash short or over xxx

Miscellaneous Income xxx
PETTY CASH FUND
- Is a money set aside to pay small expenses which cannot be paid conveniently by means
of check.
- There are 2 methods of handling petty cash fund:
a. IMPREST SYSTEM & FLUCTUATING SYSTEM

IMPREST SYSTEM
- Is a system of control of cash which requires all cash receipts should be deposited intact
and all cash disbursements should be made by means of check.
- Internal control ideally requires that all payments should be made by means of check
which is sometimes impossible because some transactions are conveniently paid thru
cash, Petty cash fund.
- Imprest system is the one usually followed in handling petty cash transactions
- Accounting Procedures and Entries:

a. Establishment of fund thru check

Petty Cash Fund xxx
Cash in Bank xxx

b. Payment of Expense

 No formal Journal Entries are made

 Only a memorandum entries in the petty cash journal

c. Replenishment
Expenses xxx
Cash in Bank xxx

 Usually equal to petty cash disbursements

 only replenished by use of checks and not from undeposited collections

d. Adjusting of Unreplenished Expenses at YEAR END

Expense xxx
Petty Cash Fund xxx

 Adjustments are reversed at the beginning of the next accounting period

e. Increase in Fund
Petty Cash Fund xxx
Cash in Bank xxx

f. Decrease in Fund
 Cash in Bank xxx
 Petty Cash Fund xxx
FLUCTUATING SYSTEM
- The checks drawn to replenish the fund do not necessarily equal the petty cash
disbursements
- Replenishments are drawn upon the request of the petty cashier.
- Cash disbursements are immediately recorded resulting to fluctuating balance per
book from time to time.

- Accounting Procedures and Entries:

a. Establishment of Fund:
Petty Cash Fund xxx
Cash in Bank xxx

b. Payment of Expense
Expense xxx
Petty Cash Fund xxx

c. Replenishment or Increase of the Fund

Petty Cash Fund xxx
Cash in Bank xxx

 Replenishment check may or not be equal to disbursements

d. NO ADJUSTMENTS AT YEAR END

 Because petty cash disbursements are already recorded outright

e. Decrease of Fund
 Cash in Bank xxx
 Petty Cash Fund xxx
 CHAPTER 4
Accounts Receivable

Receivables – are financial assets that represent a contractual right to receive cash or another
financial asset from another entity.
For retailers or manufacturers, Receivables are classified into 2 :
TRADE RECEIVABLES & NON-TRADE RECEIVABLES

TRADE RECEIVABLES

- Refers to claims arising from sale or merchandise or service in the ordinary course of
business
- ACCOUNTS RECEIVABLE & NOTES RECEIVABLE

Accounts Receivable

- are open accounts arising from selling of goods and services

- in the ordinary course of business
- NOT supported by promissory notes
- Also known as:
a. Customer’s Account
b. Trade Debtors
c. Trade Accounts Receivable

Notes Receivable

- those supported by promissory notes

- supported by formal promises to pay in the form of notes (promissory note)

NON-TRADE RECEIVABLES

- represents claims arising from sources other than the sale of merchandise or services in
the ordinary course of business

Loans Receivable

- for banks and other financial institutions

- receivables result from LOANS
- made to heterogeneous customers
- repayment periods are frequently longer or several years
- can be TRADE or NON-TRADE depending on the course of business
CLASSIFICATION

- Trade Receivables which are to be realized in cash within the normal operating cycle
OR 1 year, whichever is longer, are classified as CURRENT ASSETS
- Trade Receivables
= Realizable within NORMAL OPERATING CYCLE or 1 YEAR, whichever is
LONGER = CURRENT ASSET

! Trade Receivable – ALWAYS CURRENT ASSET

- Non-trade Receivables which are to be realized in cash within 1 year, length of
operating cycle withstanding is classified as CURRENT ASSET.
- Non-trade Receivables if collected beyond 1 year, it is classified as NON-CURRENT
ASSET.

FINANCIAL STATEMENT PRESENTATION

- Trade receivables and non-trade receivables which are currently collectible shall be
presented on the face of the statement of financial position as one line item called
“Trade and other receivables”.
- Details of total trade and other receivables shall be disclosed in the notes to financial
statements.

- Example of Disclosure:

Accounts Receivable xxx

Allowance for Doubtful Accounts (xxx)
Notes Receivable xxx
Accrued Interest on Notes Receivable xxx
Advances to officers and employees xxx
Dividend receivable xxx
Total trade and other receivables xxx
NON-TRADE RECEIVABLES EXAMPLES

a. Advances to shareholders, directors, officers or employees Collectible in 1 year – CURRENT

b. Receivables from shareholders, directors, officers or employees ASSET
Collectible beyond 1 year - NON-
c. Advances to affiliates - Long-term Investments (NON-CURRENT ASSET )
d. Advances to supplier for the acquisition of merchandise – CURRENT ASSET
e. Subscription Receivable - Collectible in 1 year – CURRENT ASSET
- Collectible beyond 1 year – deduction from
subscribed share capital
f. Creditor’s Account with debit allowances – CURRENT ASSETS
g. Special Deposits on contract bids - normally NON-CURRENT ASSETS
- collectible in 1 year – CURRENT ASSET
h. Accrued Income
- Dividend Receivable
- Accrued Rent Receivable CURRENT
- Accrued Royalties Receivable ASSET
- Accrued Interest Receivable on Bond Investment
m. Claims Receivable
- Claims against common carriers for losses or damages CURRENT
- Claim for rebates and tax refunds ASSET
- Claim for insurance entity

CUSTOMERS’ CREDIT BALANCES

- Credit balances in accounts receivable resulting from overpayments, returns and

allowances, and advance payments from customers.
- Classified as CURRENT LIABILITY
- Not offset against other customer’s account, except if not material
- No adjustments are necessary because these are already cancelled for sales
- Adjustment may be only be for worksheet purposes
- Not formally journalized and posted to the ledger

a. Entry for worksheet purposes only (Customer’s credit balance) :

Accounts Receivable xxx
Customer’s credit balance xxx
INITIAL MEASUREMENT OF ACCOUNTS RECEIVABLE

- PFRS 9, paragraph 5.1.1 : financial asset shall be recognized initially at fair value
plus transaction costs that are directly attributable to the acquisition
- Initial Measurement = Fair Value + Direct Transaction Cost
- Fair Value – transaction price
- Short-term receivables – Fair Value = Face Amount
a. Cash flows relating to short-term receivables are not discounted because the effect
of discounting is immaterial.
! Accounts Receivable shall be initially measured at face amount or original invoice amount
SUBSEQUENT MEASUREMENT

- PFRS 9, paragraph 5.2.1 : after initial measurement, Accounts receivable shall be

measured at Amortized Cost
- Amortized Cost = Net realizable Value
- The term Amortized Cost is mostly used in Long-term notes receivable
- Thus, Net Realizable value is preferably used in Accounts Receivable
- Amortized Cost – Long-term Notes Receivable
- Net Realizable Value – Accounts Receivable
! Net Realizable Value – is the amount of cash expected to be collected or the estimated
recoverable amount

NET REALIZABLE VALUE

- The initial amount recognized for accounts receivable shall be reduced by

adjustments which in the ordinary course of business will reduce the amount
recoverable from the customer.
! Basic Principle: Assets shall not be carried at above their recoverable amount.
- Accordingly, in estimating the net realizable value of trade accounts receivable, the
following deductions are made:
a. Allowance for Freight Charge
b. Allowance for Sales Return
c. Allowance for Sales Discount
d. Allowance for Doubtful Account
 FREIGHT CHARGE

Who is the owner of the goods?

Who is responsible for the goods and freight charge?

FOB destination

- Ownership of goods is vested in the buyer upon receipt thereof

- Seller is still the owner of the goods
- If delivered to address, ownership will be transferred to BUYER.
- SELLER – OWNER
- SELLER – RESPONSIBLE FOR THE FREIGHT CHARGE

FOB Shipping Point

- Ownership of the goods purchased is vested in the buyer upon shipment thereof
- Buyer is the owner of the goods
- BUYER – OWNER
- BUYER – RESPONSIBLE FOR THE FREIGHT CHARGE

Who made the actual payment?

Freight Collect

- Freight charge on the goods shipped is not yet paid.

- The payment is collected from the BUYER
- The goods are ACTUALLY PAID by the BUYER

Freight Prepaid

- Freight charge to the goods shipped is paid by the SELLER

ACCOUNTING FOR FREIGHT CHARGE

- FOB Destination but Freight collect

a. The seller should pay the freight but the buyer payed the freight instead so in return,
the seller will deduct the buyer’s accounts payable.

- SELLERS BOOKS:
1. To record sale:
Accounts Receivable xxx
Freight Out xxx
Sales xxx
Allowance for Freight Charge xxx

2. To record the collection within discount period:

Cash xxx
Sales Discount xxx
Allowance for freight charge xxx
Accounts Receivable xxx
ALLOWANCE FOR SALES RETURNS

- Accounts receivable shall recognize the probability that some customers will return
goods that are unsatisfactory or defects due to shipment.

- Entry for Allowance for Sales Return:

Sales Return xxx
Allowance for Sales Return xxx

SALES DISCOUNTS

- Cash Discounts – reduction from an invoice price by reason of prompt payment.

- It may be expressed as 5/10, n/30 which means, the customer is entitled 5% discount
of payment is made in 10 days from the invoice date.
- If payment was made after 5 days, there is no discount already and the customer shall
pay within 30 days.
- There are 2 methods in recording credit sales: GROSS METHOD & NET METHOD

ALLOWANCE FOR SALES DISCOUNT

- If customers are granted cash discounts for prompt payment, then, conceptually
estimates of cash discounts on open accounts at the end of the period based on the
past experience shall be made.

- Adjusted Entry for expected SALES DICOUNT:

Sales Discount xxx
Allowance for Sales Discount xxx

- The adjustment may be reversed at the beginning of the next accounting period in
order that discounts can then be charged normally to sales discount account.
GROSS METHOD

- The accounts receivable and sales are recorded at gross amount of the invoice.
- This is the common and widely used method because it is simply to apply.

- ILLUSTRATION:

1. Sale of merchandise for 100,000, terms 5/10, n/30

Accounts Receivable 100,000
Sales 100,000

2. Assume collection is made within the discount period

Cash 95,000
Sales Discount 5,000
Accounts Receivable 100,000

3. Assume collection is made beyond the discount period

Cash 100,000
Accounts Receivable 100,000

NET METHOD

- Accounts receivable and sales are recorded at net amount of the invoice, meaning the
invoice price minus the cash discount.
- Invoice price – cash discount = Net Amount

- ILLUSTRATION:

1. Sale of merchandise for P100,000, terms 5/10, n/30

Accounts Receivable 95,000
Sales 95,000

2. Assume collection is made within the discount period

Cash 95,000
Accounts Receivable 95,000

3. Assume collection is made beyond the discount period.

Cash 100,000
Accounts Receivable 95,000
Sales Discount Forfeited 5,000

*Sales Discount forfeited is classified as other income.

ACCOUNTING FOR BAD DEBTS

- Business entities sell on credit than only for cash to increase total sales and thereby
increase income
- The entity that sells on credit assumes risk that some customers may not pay their
accounts.
- When an account becomes uncollectible, the entity has sustained a bad debt loss.
- Bad Debt – when an account is uncollectible
- This loss is simply one of the costs of doing business on credit.
- 2 methods in accounting bad debts: ALLOWANCE & DIRECT WRITE OFF
- “Allowance for Doubtful Account” – Deduction from accounts receivable

ALLOWANCE METHOD

- This method requires recognition of a bad debt loss if the accounts are doubtful of
collection.

- Entry to recognize doubtful account:

Doubtful Accounts xxx
Allowance for Doubtful Accounts xxx

- Entry if account is worthless / uncollectible (sure na):

Allowance for Doubtful Accounts xxx
Accounts Receivable xxx

- Entry of recovery of accounts written off:

Accounts Receivable xxx
Allowance for doubtful accounts xxx

Cash xxx
Accounts Receivable xxx

- Generally accepted accounting principles requires the use of allowance method

because it conforms with the matching principle.
- Moreover, accounts receivable would be properly measured at net realizable value.
DIRECT WRITE-OFF METHOD

- Requires recognition of bad debt loss only when the accounts proved to be worthless
or uncollectible.
- No adjustments of accounts are only doubtful
- Often used by small businesses because it is simple to apply
- Bureau of Internal Revenue (BIR) recognizes only this method for income tax
purposes.
- This method violates matching principle because the bad debt loss is often recognized
in later accounting period than the period in which the sales revenue was recognized.
- This method is not allowed by the IFRS.

- ILLUSTRATION:
1. Accounts of P30,000 are considered doubtful collection.
No entry is necessary

2. The accounts proved to be worthless

Bad Debts xxx
Accounts Receivable xxx

3. The same account written off are recovered

Accounts Receivable xxx
Bad Debts xxx

Cash xxx
Accounts Receivable xxx

DOUBTFUL ACCOUNTS IN THE INCOME STATEMENT

1. Distribution Cost
a. If the granting of credit and collection of accounts are under the charge of the
sales manager, doubtful accounts shall be considered as distribution cost.

2. Administrative Expense
b. If the granting of credit and collection of accounts are under the charge of an
officer other than sales manager, doubtful accounts shall be considered as
administrative expense.
 CHAPTER 5
Estimation of Doubtful Accounts

Methods of Estimating doubtful Accounts

1. Aging the Accounts Receivable Method – “Statement of Financial Position

Approach”
2. Percent of Accounts Receivable Method – “Statement of Position Approach”
3. Percent of Sales Method – “Income Statement Approach”

AGING METHOD METHOD  REQUIRED ALLOWANCE

- Involves an analysis where the accounts are classified into: not due or past due.
a. Not due
b. 1 to 30 days past due
c. 31 to 60 days past due
d. 61 to 90 days past due
e. 91 to 150 days past due
f. 151 days to 180 past due
g. 181 to 365 past due
h. More than 1 year past due

- The allowance is computed by multiplying the total of each classification by the rate
or percent of loss experienced by the entity for each category.
- Allowance for Doubtful Account = (total of each classification) (percentage of loss)
- Advantage: Presenting fairly the accounts receivable in the statement of financial
position at NET REALIZABLE VALUE.
- Disadvantage: violates matching principle
- Disadvantage: Prohibitively time consuming if a large number of accounts are
involved.

! Aging Method is more accurate and scientific computation of the allowance for doubtful
account.

ILLUSTRATION:

Balance Experience Rate Required Allowance

Not Due 500,000 1% 5,000
1-30 days past due 300,000 2% 6,000
31-60 days past due 200,000 4% 8,000
61-90 days past due 100,000 7% 7,000
91-180 days past due 50,000 10% 5,000
181-365 days past due 30,000 30% 9,000
More than 1 year 20,000 50% 10,000
1,200,000 50,000
! The amount computed by aging method represents the required allowance for doubtful
account.
Continuation…
Therefore, if there is a beginning balance of allowance for doubtful accounts of P10,000 before
adjustment, the doubtful account expense is computed as follows:

Computation for doubtful accounts expense:

Required Allowance 50,000

Less: Allowance balance before adjustment (10,000)
Doubtful Account Expense 40,000

Journal Entry to record doubtful accounts expense:

Doubtful Accounts Expense 40,000

Allowance for doubtful accounts 40,000

ACCOUNT PAST DUE

- “past due” is the date beyond the credit term

- Credit term – period given for the account to be paid
- Ex: 2/10, n/30  30 days = credit term
- When account is 45 days old, the account is 15 day past due

PERCENTAGE OF ACCOUNTS RECEIVABLE METHOD (AR) * (%) = REQUIRED ALLOWANCE

- a certain rate is multiplied by the open accounts at the end of the period in order to get
the required allowance balance.
- Rate used is from past experience of the entity
- Advantage: Presenting the accounts receivable at NET REALIZABLE VALUE
- Disadvantage: violates the matching principle: bad debt loss  sales revenue
- Loss experience rate may be difficult to obtain and may not be reliable.

ILLUSTRATION:

Accounts Receivable Balance 2,000,000

Allowance for doubtful account (credit) 10,000
Doubtful Accounts 3% of AR

Computation for doubtful accounts expense:

Required Allowance (2,000,000 * 3%) 60,000

Less: Allowance balance before adjustment (10,000)
Doubtful Account Expense 50,000
Journal Entry to record doubtful accounts expense:
Doubtful Accounts Expense 50,000
Allowance for doubtful accounts 50,000
PERCENTAGE OF SALES METHOD ( Sales ) * (%) = DOUBTFUL ACCOUNTS EXPENSE

- Amount of sales of the year is multiplied by a certain rate to get the doubtful
accounts expense.
- The rate may be applied on credit sales or total sales.
- RATE = Bad debt losses in prior years / Charge of sales of prior years
- There is no substantial difference if in the computation of the rate, the basis is total
sales of the prior period.
- Obtained rate is then multiplied to current year’s sales to arrive at doubtful accounts
expense
- (Sales ) * (%) = DOUBTFUL ACCOUNTS EXPENSE
- “Income Statement Approach” because it favors the income statement
- Advantage: Eliminating extra work of making record of cash sales and credit sales.
- Advantage: Proper matching of cost against revenue is achieved(matching principle)
*the bad debt loss is directly related to sales and reported in the year of sale
- Disadvantage: Unsatisfactory when there is considerable fluctuation in the
proportion of cash and credit sales periodically.
- Disadvantage: Accounts Receivable may not be shown at estimated realizable value
because the allowance for doubtful accounts may prove excessive or
inadequate.
- the rate applied on sales should be revised accordingly
- the resulting amount of the computation is already the doubtful account expense
- the allowance before adjustment is ignored in getting doubtful account expense
- but, the allowance for doubtful accounts shall be adjusted

ILLUSTRATION:

Accounts Receivable 1,000,000

Sales 5,050,000
Sales Return 50,000
Allowance for doubtful accounts 20,000 *ignored in percent of sales
method

* Doubtful Accounts : Estimated at 1% of net sales

Doubtful Expense computation : (5,000,000) (1%) = 50,000

*the resulting amount of the computation is already the doubtful account expense

Journal Entry for Allowance for Doubtful Account:

Doubtful account 50,000
Allowance for doubtful account 50,000
CORRECTION IN ALLOWANCE FOR DOUBTFUL ACCOUNTS

- The correction is a natural result of estimate.

- This is the consequence of estimating accounts receivable.
- especially when using the Percentage of Sales Method
- Aging accounts receivable is necessary to test the reasonableness of this allowance.
- The excess or inadequacy shall be corrected.
- The correction is to be reported in the income statement either as addition or
subtraction to doubtful accounts expense.

- Adjustment Entry if allowance is inadequate:

Doubtful Accounts xxx
Allowance for doubtful accounts xxx

- Adjustment Entry if allowance is excessive

Allowance for doubtful accounts xxx
Doubtful Accounts xxx

DEBIT BALANCE IN ALLOWANCE ACCOUNT

- “Allowance for doubtful account” – Normal balance is: CREDIT

- Debit balances does not indicate that allowance is inadequate because the accounts
written off during the year and charged to the allowances may have arisen from the
current year sales.
- But it may have DEBIT BALANCE when:
 Policy of the entity to adjust the allowance at year end of the period
 And written offs are recorded during the year

ILLUSTRATION:
 January 1 Allowance before adjustment (credit) 30,000
 Written off (50,000)
 December 31 Allowance before adjustment (debit) 20,000

 December 31 Required Balance 40,000

Required Allowance 40,000

Add: Debit balance in allowance 20,000
Doubtful Account Expense 60,000

Adjustment Entry should be:

Doubtful Account 60,000
Allowance for doubtful account 60,000
 CHAPTER 6
Notes Receivable

- Notes Receivable – claims supported by formal promises to pay usually in the form of notes.
- Claims arising from sale of merchandise or service in the ordinary course of business.
- Negotiable Promissory Note – is an unconditional promise in writing made by one person to
another, signed by the maker, engaging to pay on demand or at a fixed determinable future
time a sum certain in money to order or to bearer.
- Maker – writer of the note
- Payee – the person to be payed by the maker
- Note is payable on demand or at definite future date.
- Notes received from officers, employees, shareholders and affiliates shall be designated
separately.

DISHONORED NOTES

- A dishonored note is a promissory note that is not paid.

- These are removed from notes receivable and transferred to accounts receivable.
- The amount debited to accounts receivable should be include:
 face amount
 interest
 other charges

INITIAL MEASUREMENT OF NOTES RECEIVABLE

- Notes receivable shall be measured at face value.

- Present Value : Sum of all future cash flows discounted using the prevailing market
rate of interest for similar notes.
- Prevailing Market Rate = Effective Interest Rate
- Short-term Notes Receivable – measured @ face value
- Long-term Notes Receivable – measured depending if interest or non-interest
bearing
- The initial measurement of long-term notes will depend on whether the notes are
interest-bearing or non-interest bearing.

Interest Bearing Notes Receivable

- Interest-bearing long-term notes are measured @ face value (present value at
issuance)

Non-interest Bearing Notes Receivable

- Interest-bearing long-term notes are measured @ Present Value
- Present Value – discounted value of the future cash flows using the effective interest
rate
- “Non-interest bearing” – misnomer because all notes implicitly contains interest
! Interest is already included in the face amount in Non-interest bearing note
SUBSEQUENT MEASUREMENT

- Long-term notes receivable shall be measured at amortized cost using the effective
interest method.

AMORTIZED COST

- Amount which the notes receivable are measured initially:

a. Minus Principal repayment
b. Plus or minus cumulative amortization of any difference between the initial
carrying amount and the principal maturity amount
c. Minus the reduction for impairment or uncollectability

Initial measurement – Principal Repayment +/- (Initial CA-Principal CA) - Impairment

- Long-term non-interest bearing notes receivable:

Amortized Cost = PV + Amortization (FV – unamortized unearned interest income)

! Compounded – any accrued interest also earns interest

 CHAPTER 7
Loans Receivable
 CHAPTER 8
Receivable Financing

- Receivable Financing – is the financial flexibility or capability of an entity to raise money

out of its receivable.
- Forms of Receivable Financing:
1. Pledging
2. Assignment
3. Factoring
4. Discounting

PLEDGE OF ACCOUNTS RECEIVABLE (PLEDGING)

- When loans are obtained from a bank or any lending company, the accounts
receivable may be pledged as collateral security for the payment of the loan.
 CHAPTER 10
Inventories

- Inventories are assets held for sale in the ordinary course of business, in the process
of production for such sale or in the form of materials or supplies to be consumed in
the production process or in the rendering services.
- GOODS PURCHASED AND HELD FOR SALE:
a. Merchandise purchased by a retailer and held for sale
b. Land and other properties held for resale by a subdivision entity and real estate
developer
- FINISHED GOODS
- GOODS IN PROCESS
- MATERIALS AND SUPPLIES AWAITING USE IN PRODUCTION PROCESS

CLASSES OF INVENTORIES
- Classified into 2: inventories of a trading concern & manufacturing concern
- Trading concern: buys and sells goods in the same form purchased.
- The term “Merchandise Inventory” is generally applied to goods by a trading concern
- Manufactured concern: buys goods which are altered or converted into another
form before they are held available for sale.

UNDER MANUFACTURED CONCERNS:

1. Finished Goods
a. Completed products which are ready for sale
b. Have been assigned their full share of manufacturing cost
2. Goods in Process or work in process (WIP)
a. Are partially completed products which require further process or work before
they can be sold.
3. Raw Materials
a. Goods that are to be used in the production process.
b. No work has been done on them yet by the entity inventorying them.
c. Cover all materials used in the manufacturing operations.
d. Restricted to materials that will be physically incorporated in the production of
other goods and which can be traced directly to the end product of the
production process
4. Factory or manufacturing supplies
a. Are similar to raw materials but their relation to the end product is indirect.
b. This can be referred as indirect materials
c. Indirect because they were not physically incorporated in the products being
manufactured.
d. Ex: Paint and nails
e. Amounts are insignificant therefore it is impractical to attempt to allocate their
cost directly to the product
f. These supplies find their way to the product cost as part of the manufacturing
overhead.
GOODS INCLUDABLE IN THE INVENTORY:

! ALL goods which the entity has title shall be included in the inventory, regardless of location.
- The phrase “passing of title” is a legal language which means “the point of time at which
ownership changes”.

Legal Test:
a. Goods owned and on hand
b. Goods in transit and sold FOB Destination
c. Goods in transit and purchased FOB Shipping point
d. Goods out on consignment
e. Goods in the hands of salesman or agents
f. Gods held by customers on approval or on trial

Exception to the Legal test:

- Installment contracts may provide for retention of title by the seller until the selling
price is fully collected.

OWNER OF GOODS IN TRANSIT

- Depending on the terms.
- FOB - free on board
- FOB Destination : ownership of goods purchased is transferred only upon receipt of
the goods by the buyer at the point of destination.
- FOB Destination : Goods in transit is still the property of seller. (responsible for
freight charges and other expenses up to point of destination)
- FOB Shipping Point : ownership is transferred upon shipment of goods
- FOB Shipping Point : Goods in transit is the property of buyer. (responsible for
freight charges and other expenses up to point of destination)
- Normally: accountants records purchase when goods are received and records sales
when goods are shipped, regardless of exact moment.