Chapter 2 ~ Receivables Case 4. Long-Term Installment Note Receivable (Stated Interest Rate is Lower than the Market Rate of Interest) On January 1, 2022, ABC Manufacturing sold a tract of land that originally cost P400,000. ABC received a P600,000 note as payment for the land. The note is payable in three annual installments of P200,000 beginning December 31, 2022, plus interest at the rate of 4% based on the outstanding balance. On January 1, 2022, the prevailing interest rate for a similar obligation is 10%. If a cash price for the land is determinable at the date of the sale, the cash price is the selling price and, consequently, the note's present value. Thus, ABC Manufacturing should compute an imputed interest rate. Otherwise, the selling price is the note's fair value, which is the present value of all future collections (principal and interest) discounted at the prevailing interest rate for similar notes, as illustrated here. The computation of the present value of the note on January 1, 2022, is as follows: Interest Due Total, Present Present Principal | (Balance Amount Value | Value, Jan. Due Date (P) Due of Px 4%) Due Factor 1, 2022 12/31/22 200,000 P24,000 P224,000 0.90909 P203,636 12/31/23 200,000, 16,000 _ 216,000 0.82645, 178,313 12/31/24 200,000 8,000 208,000 0.75132 156,275 TOTAL P538,424 Face value of the note P600,000 Present value of the note 538,424 Discount on notes receivable P_61L576 Present value of the note (Selling Price) P538,424 Carrying amount of land 400,000 Gain on sale of land P138,424 ‘The journal entries for the sale of land and subsequent collection of installments on the note, including amortization of discount, follow (See amounts from the amortization table): 2022 Jan. 1 Notes Receivable 600,000 Discount on Notes Receivable 61,576 Land 400,000 Gain on Sale of Land 138,424 o1Chapter 2 - Receivables 00 Dec. 31- Cash 759,892 Discount on Notes Receivable "200,000 Notes Receivable 53,842 Interest Revenue 4 Dee. 31° Cash 216,000 Discount on Notes Receivable DO att ane bon Notes Receivable 36,827 Interest Revenue 2 2024 Dec. 31 Cash ae ear Discount on Notes Receivable 10,907 ae tes Receivable 4 Notes Receival 18,907 Interest Revenue Amortization Table Note Effective | Nominal | Discount Principal Carrying Date Interest | Interest | Amortization | Payment Value 01/01/22 538,424 12/31/22 53,842 | 24,000 29,842 200,000 368,266 200,000 189,093 12/31/23 | 36,827 | 16,000 20,827 12/31/24 18,907* 8,000 10,907* 200,000 = ‘adjusted; difference is due to rounding off The balance of Notes Receivable and the related Discount on Notes Receivable on December 31, 2022 is analyzed as follows: Non- Total Current Current Notes Receivable P400,000 P200,000 P200,000 Discount on Notes Receivable 31,734 20,827 10,907 Carrying Amount 368.266 179.173 189,093 Case 5._Long-Term Installment Note Receivable (Stated Interest Rate is Higher than the Market Rate of Interest) 7 On January 1, 2022, ABC Manufacturing sold a tract of land that originally cost P400,000. ABC received a P600,000 note as payment for this transaction. The note is payable in three annual installments of P200,000 beginning December 31, 2022, plus interest at 14% based on the outstanding balance. On January 1, 2022, the prevailing interest rate for a similar obligation is 10% : 92Chapter 2 ~ Receivables The given case is similar to Case 4, except that the rate stated on the face of the note exceeds the market rate of interest. The computed amortized cost at the date of initial recognition would result in an amount higher than the face of the note, resulting in a premium on notes receivable. The computation of the present value of the note on January 1, 2022 is as follows: Interest Due Total Present Present Principal (Balance Amount Value Value, Jan. Due Date (P) Due of Px 4%) Due Factor 1, 2021 12/31/22 200,000 P84,000 P284,000 0.90909 P258,182 12/31/23 200,000 56,000 256,000 0.82645 211,571 12/31/24 200,000 28,000 228,000 0.75132. 171,301 TOTAL P641,054 Present value of note P641,054 Face value of note 600,000 Premium on notes receivable P_41,054 Present value of the note (Selling Price) P641,054 Carrying amount of the land 400,000 Gain on sale of land 241,054 Amortization Table ‘ Note Effective Nominal Premium Principal Carrying Date Interest_| Interest_| Amortization | Payment |. Value 01/01/22 641,054 12/31/22 | 64,105 | 84,000 19,895 | 200,000 | 421,159 12/31/23 | 42,116 | 56,000 13,884 | 200,000 | 207,275 12/31/24 | 20,725 | 28,000 7,275* | 200,000 = “Adjusted; difference is due to rounding off. Based on the given computations and amortization table, the entries for 2022 through 2024 are as follows: 2022 Jan. 1 Notes Receivable ‘ 600,000 Premium on Notes Receivable 41,054 Land 400,000 Gain on Sale of Land 241,054ter 2 - Recetvables 284,000 200,000 Dec. 31 Cash Notes Receivable 64, 105 t Revenue 2 895 Prombutn on ‘Notes Receivable Dee. 31 Cash 256,000 200,000 . SI , Notes Receivable 42,116 Interest Revenue ; 13,884 Premium on Notes Receivable 2024 000 Dec. 31 Cash 228, 200,000 Notes Receivable 20,728 Interest Revenue ore Premium on Notes Receivable The balances of Notes Receivable and Premium on Notes Receivable on December 31, 2022 are analyzed as follows: Non- Total Current Current Notes Receivable P400,000 200,000 —_ P200,000 Premium on Notes Receivable 21,159 13,884 7,215 Carrying Amount P421,159 P213,884 207,275 , MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION Notes and accounts receivable meet the IFRS 9 Financial Instruments requirements for the financial assets to be classified a8 measured at amortized cost. The two conditions are: (a) the financial asset is held within the enterprises business model, whose objective is to hold assets 10 collect contractual cash flows; and (b) the contractual terms of the financial asset give rise specified dates to cash flows that are ym ecifi s t ents principal and interest (SPI). 2 soe The amortized cost of receivables is ite as... 7 accrued interest and any unamortized prea ena emo fiscount using the effective interest method anne te ee acti minus any re‘ ofinterest receivable, if interest bearing) plus any remaining by Premium on Notes Receivable, or in the case of discount saintctan, remaining balance of Discount on Notes Receivable. An entity shall aie, deduct the receivables it considers impaired and uncollectible Accounts receivable that are granted within the entity’s usual credit terms are not generally discounted to their present value because any amount of the discount or interest is usually immaterial, Impairment of Receivables Almost invariably, some receivables will prove uncollectible such that an amount of accounts or notes receivable must tbe recognized as an expense in profit or loss. ‘This expense ie called impairment loss, more commonly called uncollectible accounts or ba debts. There are two methods of accounting for uncollectible accounts: the direct write-off method and the allowance method. The direct write-off method recognizes impairment loss or bad debt expense by crediting the receivables account directly. The entry to recognize impairment on accounts receivable is Bad Debts Expense (or Uncollectible Accounts Expense or Impairment Loss) 20 Accounts Receivable (or Notes Receivable) voc Some accounts which have been previously written off are unexpectedly recovered or collected. In such a case, the entity shall reinstate the account and record the collection’ as usual. Thus, to record recovery under the direct-write-off method, the entries are Accounts Receivable 300 Bad Debts Recovery (or Recovery of Previous Impairment of Receivable) voc Cash voc xo Accounts Receivable The direct write-off method is the only method allowed for income tax purposes. On the other hand, the allowance ened Tequires using.a valuation account for the receivables. nai eth, recognizes the impairment of receivables by a charge to Bi i Expense or Impairment Loss and a credit to the allowance account. 95Chapter 2 - Receivables impairment iS - ‘Thus, the entry to recognize impairme 2 Bad Debts Expense (or Impairment Lo: ss) oe 1 Allowance for Bad Debts! deducted from account, is The resulting allowance for bad de rized cost. When an enti or notes receivable to arrive at Sait areparcs' the fallow: writes off an account it considers uncollectible, #* P bs wing entry: ' x Allowance for Bad Debts - Accounts Receivable Uncollectible account written off When an entity recovers an account previously ae off, it reinstates the receivable and records the collection as usual. "hus, the entries for the recovery are Accounts Receivable — Allowance for Bad Debts 2 Reinstatement of an account recovered Cash noc Joc Accounts Receivable Collection of an account previously written off Under the allowance method, the write-off of an uncollectible account does not change the net amount of accounts receivable, nor does it affect profit or loss. Simplified Approach and General Approach to Measuring and Recognizing Expected Credit Loss IFRS 9 presents two models for measuring and assessing expected credit loss (ECL): the simplified and general approaches. Simplified Approach IFRS 9 requires a simplified approach for trade receivables of contract assets with no significant financing component (SFC) arising from the IFRS 15 Revenue from Contracts teh Cees Tikewise entities may also choose as their accounting policy the ECL simplified approach for receivables and contract assets with SFC arising from the application of IFRS, 15 and for lease receivables recognized under IFRS 1 A modem terminology for this account i i or simply Loss Allowance. 's Allowance for Expected Credit Los* 96Chapter 2 - Receivables 16 Leases. Under the simplified approach, an entity measures its expected credit loss without applying the three stages under the general approach. The simplified approach requires an entity to measure impairment loss based on lifetime expected credit loss of financial assets. It seems that IFRS 9 considers the collection period of the trade receivables to be generally within twelve months or shorter; hence, there may be no need for the more complicated stages 1, 2, and 3 under the general approach. To illustrate, assume that on April 1, 2022, ABC Manufacturing wrote off an account of its customer, Mr. X, in the amount of P25,000, which has been overdue for several years. Subsequently, on July 5, 2022, ABC recovered and collected the account of Mr. X. Journal entries for the write-off and subsequent recovery of the account are as follows: 2022 Apr. 1 Allowance for Expected Credit Loss 25,000 Accounts Receivable - Mr. X 25,000 Write off an uncollectible account July 5 Accounts Receivable - Mr. X 25,000 Allowance for Expected Credit Loss 25,000 Reinstatement of the account of Mr. X previously written off 5 Cash 25,000 Accounts Receivable - Mr. X 25,000 Collection of an account recovered At year-end, the entity must estimate the amount of accounts receivable that may prove uncollectible and prepare the following adjusting entry: Impairment Loss ~ Accounts Receivable aoc Allowance for Expected Credit Loss 300 Lifetime expected credit loss on AR Sometimes, the allowance for expected credit Joss may result in a debit balance before the year-end adjustment. This debit balance may indicate that there have been excessive write-offs during the period, and the company's previous estimate may not be adequate. In such a case, the company has to review the basis of estimating its expected credit loss and should bring its uncollectible accounts to the appropriate balance at year-end based on the most reasonable estimate. An error in making such previous estimates is not considered an accounting error, and changing the basis for estimating the expected credit loss is not 97Chapter 2 - Recetvables ted as a ch; Both are treat ange allowance account to its policy. : sidered an adjustment ;, considered a change in accounting PowcY. ¢ g Beal in accounting estimates, and bringi i appropriate balance at year-end would be co the current year’s impairment loss. ; A debit balance in the allowance account pare edteinen jous est should not conclude that the company's Dee patio ad tnay. leg jie inadequate. The accounts written off Se tthe entry for the writes from the current year’s sales. It is merely that the SUUry Of 2s wit ot ic bac recedes the year-end entry to provide for end of the year, the entity should bring the allowance account to g credit balance that reasonably brings the accounts receivable to its recoverable amount. General Approach The general approach to ECL applies to all other financial assets within the scope of IFRS 9. The new IFRS 9 Financial Instruments provides a significant change in the measurement of impairment losses on an entity's financial assets. IFRS 9 adopts a model that requires an entity to recognize expected credit losses at all times and-to update its estimate of expected credit losses at each reporting date to reflect the changes in the credit risk of financial instruments. IFRS 9 requires an entity to measure its expected credit losses not nécessarily based on a loss event but on reasonable and supportable information available without undue cost and effort, including past experiences, present conditions, and future expectations. The IFRS 9 moves from the incurred loss model (under IAS 39) to the more prudent “expected credit loss” model. The IFRS 9 model requires three stages in impairment measurement and recognition: (a) Stage 1 Recognize in profit or loss, through an allowance account, an impairment loss based on 12-month expected credit losses for receivables that are not credit impaired and with no significant increase in eredit riski (b) Stage 2‘hapter 2 - Receivables * significant financial difficulty of the borrower; a8 ican of contract, such as default or Selene * grant by the holder (the entity holding the financial asset) of concession to the issuer that the former would not otherwise grant under normal circumstances; * the’ probability that the borrower will enter bankruptcy proceedings or financial reorganization; and hs * > the disappearance of an active market for securities that were previously traded. In stage 3, the entity shall measure the impairment loss on individual receivables as the excess of the receivable’s carrying amount (net of the loss allowance or allowance for uncollectible accounts) over the present value of the estimated future cash flows discounted at the historical or original effective interest rate. Illustration of Accounting for ECL under General Approach Case A - Stage 1, 12-month credit risk (no significant credit risk) On January 1, 2022, ABC Company lent P500,000 to XYZ Company, collectible after 5 years but interest at 9% is due every December 31. ABC collected the interest’on December 31, 2022. Based on the credit information available for XYZ Company on December 31, 2022, ABC determined that there is 2% probability of default for the next 12 months and expected to collect only 95% of the loan principal. On December 31, 2022 (after collecting the interest) Carrying amount of the loan P500,000 Probability of collection 95% Future cash flows P475,000 Present value factor (at 9% effective rate) For 4 more periods 7084 Present value of future cash flows P336,490 Carrying amount of the loan P500,000 Present value of future cash flows 336,490 Expected credit loss - P163,510 Probability of default for the next 12 month 2% 12-month ECL P32,702 In addition to the entries for the loan and interest, ABC shall prepare the following as.an adjusting entry on December 31, 2022. 100