CHAPTER 2

Audit of
Receivables
RECEIVABLES

Receivables are financial assets because they represent a contractual right to receive cash or another
financial asset from another entity.
For retailers or manufacturers, receivables are classified into trade receivables and nontrade
receivables.
Trade receivables refer to claims arising from the sale of merchandise or services in the ordinary course
of business operations. The usual types are accounts receivable and notes receivable.
Accounts receivable are open accounts or those not supported by promissory notes. Other names of
accounts receivable are customers' accounts, trade debtors, and trade accounts receivable.
Notes receivable are those supported by formal promises to pay in the form of notes.
Nontrade receivables represent claims arising from sources other than the sale of merchandise or
services in the ordinary course of business.
For banks and other financial institutions, receivables result primarily from loans to customers.
The loans are made to heterogeneous customers and the repayment periods are frequently longer or
over several years.
Trade receivables which are expected to be realized in cash within the normal operating cycle or one
year, whichever is longer, are classified as current assets.
Nontrade receivables which are expected to be realized in cash within one year, the length of the
operating cycle notwithstanding, are classified as current assets.
If collectible beyond one year, nontrade receivables are classified as noncurrent assets. The
classifications are in accordance with PAS 1. Paragraph 66, which states:
"An entity shall classify an asset as current when the entity expects to realize the asset or intends to sell
or consume it in the entity's normal operating cycle, or when the entity expects to realize the asset within
twelve months after the reporting period."
Trade receivables and nontrade receivables which are currently collectible shall be presented as one
line item called "trade and other receivables"

Initial measurement of receivables.

PFRS 9, paragraph 5.1.1 provides when a financial asset is recognized initially, an entity, shall
measure it at fair value plus transaction costs that are directly attributable to the acquisition.
The fair value of a financial asset is usually the transaction price, meaning, the fair value of the
consideration given.
For short-term receivables, the fair value is equal to the face value or original invoice amount.
Cash flows relating to short-term receivables are not discounted because the effect of
discounting is usually
immaterial.
Thus, accounts receivable shall be measured initially at face value.
For long-term receivables that are interest-bearing, the fair value is equal to the face value..
However, for long-term receivables that are noninterest- bearing, the fair value is equal to
the present value of all future cash flows discounted using the prevailing market rate of interest
for similar receivables.
Thus, initially, long-term interest-bearing notes receivable shall be measured at face value
and long-term noninterest- bearing notes receivable shall be measured at present value

Measurement of accounts receivable.

Accounts receivable shall be measured initially at face value or original invoice amount.
However, subsequently the accounts receivable shall be measured at net realizable value,
meaning the amount of cash expected to be collected or the estimated recoverable amount.
The initial amount recognized for accounts receivable shall be reduced by adjustments which
in the ordinary course of business will reduce the amount receivable from the customer.
This is based on the established principle that assets shall not be carried at an amount 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 accounts
Customers' Credit balances
Customers' credit balances are credit balances in accounts receivable resulting from
overpayments, returns and allowances, and advance payments from customers.
These balances are classified as current liabilities and shall not be offset against the debit
balances in other customers' accounts.
However, when the amount is not material, only the net accounts receivable may be presented
in the statement of financial position.

Two methods of accounting for bad debts.

The two methods of accounting for bad debts are the allowance method and direct write-off
method.
The allowance method requires recognition of bad debt loss if the accounts are doubtful of
collection.
The doubtful accounts are recorded by debiting doubtful accounts and crediting allowance
doubtful recounts.
Generally accepted accounting principles require the use of the allowance method because it
conforms with the matching principle.
Moreover, accounts receivable will be properly measured at net realizable value.
The direct write-off method requires recognition of a bad debt loss only when the accounts are worthless
or uncollectible.
Worthless accounts are recorded by debiting bad debts and crediting accounts receivable.
This approach is often used by small businesses because it is simple to apply.
As a matter of fact, the Bureau of Internal Revenue recognizes only this method for income tax
purposes.

Recoveries of accounts previously written off

If a collection is made on account previously written off, the customary procedure is to recharge
the customer's account with the amount collected and possibly with the entire amount
previously charged off if it is now expected that collection will be received in full.
In other words, the recovery is recorded by reversing the entry of writeoff by debiting accounts
receivable and crediting allowance for doubtful accounts.
The collection is then normally recorded by debiting cash and crediting accounts receivable.
Three methods of estimating doubtful accounts
Doubtful accounts are recognized when the loss is probable and the amount can be estimated
reliably.
This approach is parallel to the recognition of a "provision" which is both "probable and
measurable" in accordance with PAS 37.

There are three methods of estimating doubtful accounts, namely:

1. Aging method - This involves an analysis of the accounts whether they are not due or past due.

Past due accounts are further classified in terms of the length of the period they are past due.

The required allowance for doubtful accounts is then determined by multiplying the total of
each classification by the rate of loss experienced by the company for each category.

The major argument for this method is the more accurate and scientific computation of
allowance for doubtful accounts and consequently, the accounts receivable would be fairly
presented at net realizable value. Thus, this method is a statement of financial position
approach.

2. Percent of accounts receivable method - A certain rate is multiplied by the ending accounts
receivable balance in order to get the required allowance balance.
The rate used is usually determined from past experience of the entity.
This procedure has also the advantage of presenting the accounts receivable at estimated net
realizable value.
This method is also a statement of financial position approach because it favors the statement
of financial position.

3. Percent of sales method - The amount of sales for 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.

When this method is used, proper matching is achieved because doubtful accounts are directly
related to sales from which they arise, and are reported in the same year of sale

Thus, this method is an income statement approach because it favors the income statement.

Classify doubtful accounts in the income statement

1. Distribution cost- 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 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.
In the absence of any contrary statement, doubtful accounts shall be classified as administrative
expense.
NOTES RECEIVABLE
Notes receivable are claims supported by formal promises to pay usually in the form of notes.
A 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.
Simply stated, a promissory note is a written contract in which one person, known as the maker,
promises to pay another person, known as the payee, a definite sum of money.
The note may be payable on demand or at a definite future date.
Standing alone, the term "notes receivable" represents only claims arising from sale of
merchandise or service in the ordinary course of business.
Thus, notes received from officers, employees, shareholders and affiliates shall be designated
separately.

Treatment of "dishonored notes".

When a promissory note matures and is not paid, it is said to be dishonored.
Theoretically, dishonored notes shall be removed from the notes receivable account and
transferred to accounts receivable at an amount to include, if any, interest and other charges,
The entry to record dishonored notes is as follows:

Accounts receivable XX
Notes receivable XX
Interest income XX

Such approach is defended on the ground that the overdue 1ote has lost part of its status as a negotiable
instrument and really represents only an ordinary eluim against the maker.

Initial measurement of notes receivable.

Conceptually, notes receivable shall be measured initially at present value.
"T'he present value is the sum of all future cash flows discounted using the prevailing market
rate of interest for similar notes.
The prevailing market rate of interest is actually the effective interest rate.
However, short-term notes receivable are measured at face value.

Cash flows relating to short-term notes receivable are not discounted because the effect of
discounting is usually not material.
The initial measurement of long-term notes will depend on whether the notes are interest-
bearing or noninterest- bearing
 Interest bearing long-term notes are measured at face value which is actually the present value
upon issuance.
Noninterest-bearing long-term notes are measured at present value which is the discounted
value of the future. cash flows using the effective interest rate.

Actually, the term "noninterest-bearing" is a misnomer because all notes implicitly contain
interest.
It is simply a case of the "interest being included in the face amount" rather than being stated
as a separate rate.

Subsequent measurement of notes receivable

Subsequent to initial recognition, long-term notes receivable shall be measured at amortized
cost using the effective interest method.
The "amortized cost" is the amount at which the note receivable is measured initially minus
principal repayment, plus or minus the cumulative amortization of any difference between the
initial carrying amount and the principal maturity amount minus reduction for impairment or
uncollectability.
For long-term noninterest-bearing notes receivable, the amortized cost is the present value plus
amortization of the discount, or the face value minus the unamortized unearned interest income.

LOAN RECEIVABLE
A loan receivable is a financial asset arising from a loan granted by a bank or other financial
institution to a borrower or client.
The term of the loan may be short-term but in most cases, the repayment periods cover several
years.

Initial measurement of loan receivable.

At initial recognition, an entity shall measure a loan receivable at fair value plus transaction
costs that are directly attributable to the acquisition of the financial asset.
The fair value of the loan receivable at initial recognition is normally the transaction price,
meaning, the amount of the loan granted.
Transaction costs that are directly attributable to the loan receivable include origination fees.
Direct origination costs should be included in the initial measurement of the loan receivable.
Subsequent measurement of loan receivable.
PFRS 9, paragraph 4.1.2, provides that if the business model in managing financial asset is to
collect contractual cash flows on specified dates and the contractual cash flows are solely
payments of principal and interest, the financial asset shall| be measured at amortized cost.
Accordingly, a loan receivable is subsequently measured at amortized cost using the effective
interest method.
The "amortized cost" is the amount at which the receivable measured initially minus principal
repayment, Plus or between minus the cumulative amortization of any the initial amount
recognized and the principal maturity amount, minus reduction for impairment or
uncollectibility.
In other words, if the initial amount recognized is lower than the principal amount., the
amortization of the difference is added to the carrying amount.
If the initial amount recognized is higher than the principal amount, the amortization of the
difference is deducted from the carrying amount.

"Origination fees" in relation to a loan receivable.

Lending activities usually precede the actual disbursement of funds and generally include
efforts to identify and attact potential borrowers and to originate a loan.
The fees charged by the bank against the borrower for the creation of the loan are known as
"origination fees".
Origination fees include compensation for activities such as evaluating the borrower's financial
condition, evaluating guarantees, collateral and other security, negotiating the terms of the loan,
preparing and processing documents and closing the loan transaction..

Treatment of origination fees

The origination fees received from borrower are recognized as unearned interest income and
amortized over the term of the loan.
If the origination fees are not chargeable against the borrower, the fees are known as "direct
origination costs".
The direct origination costs are deferred and also amortized over the term of the loan.
Preferably, the direct origination costs are offset directly against any origination fees received.
If the origination fees received exceed the direct origination costs, the difference is unearned
interest income and the amortization will increase interest income.
If the direct origination costs exceed the origination fees received, the difference is charged to
"direct origination costs and the amortization will decrease interest income.
Accordingly, the origination fees received and the direct origination costs are included in the
measurement of the loan receivable.
Impairment of loan.
PAS 39, paragraph 58, provides that an entity shall assess at every end of reporting period
whether there is objective evidence that a financial asset or group of financial assets is impaired.
If such evidence exists, the entity shall determine and recognize the amount of any impairment
loss.
Objective evidence of impairment may result from the following "loss events" occurring after
the initial recognition of the financial asset:
1. Significant financial difficulty of the issuer or obligor.
2. Breach of contract, such as default or delinquency in interest or principal payment.
3. Debt restructuring The lender, for economic or legal reason relating to the borrower's
financial difficulty, grants to the borrower a concession that the lender would not otherwise
consider.
4. Probability that the borrower will enter bankruptcy or other financial reorganization.
5. The disappearance of an active market for the financial asset because of financial difficulty.
6. Observable data indicating that there is a measurable decrease in the estimated future cash
flows from a group of financial assets since the initial recognition of those assets, although
the decrease cannot yet be identified with the individual financial assets in the group.

Measurement of impairment loss on loan. receivable.

PFRS 9, paragraph 5.2.2, provides that if there is evidence that an impairment loss on loan
receivable carried at amortized cost has been incurred, the amount of the loss is measured as
the "difference between the carrying amount of the loan receivable and the present value of
estimated future cash flows discounted at the original effective rate of the loan."
The carrying amount of the loan receivable shall be reduced either directly or through the use
of an allowance account.
The amount of impairment loss shall be recognized in. profit or loss.

AUDIT PROGRAM FOR RECEIVABLES

Audit objectives:

To determine that:
1. Receivables represent valid claims against customers and other parties and have
been properly recorded.
2. The related allowance for doubtful accounts, returns and allowances, and discounts
are reasonably adequate.
3. Receivables are properly described.
4. Disclosures with respect to the accounts are adequate.
Audit Procedures:
1. Obtain a list of aged accounts receivable balances from the subsidiary ledger, and:
• Foot and cross-foot the list.
• Check if the list reconciles with the general ledger control account.
• Check if the list reconciles with the general ledger control account.
• Adjust non-trade accounts erroneously included in customers' accounts.
• Investigate and reclassify significant credit balances.
2. Test accuracy of balances appearing in the subsidiary ledger.
3. Confirm accuracy of individual balances by direct communication with customers.
• Investigate exceptions reported by customers and discuss with appropriate
officer for proper disposal.
• Send a second request for positive confirmation requests without any replies
from customers.
• If the second request does not produce a reply from the customer, perform
extended procedures, like:
➢ Reviewing collections after year-end.
➢ Checking supporting documents.
➢ Discussing the account with appropriate officer.
• Discuss with appropriate officer, confirmation requests returned by the post
office and perform extended procedures.
• Prepare a summary of confirmation results.
4. Review correspondence with customers for possible adjustments.
5. Test propriety of cutoff:
• Examine sales recorded and shipments made a week before and after the
end of the reporting period and ascertain whether the sales were recorded in
the proper period.
• Investigate large amounts of sales returned shortly after the end of the
reporting period.
6. Perform analytical procedures, like:
• Gross profit ratio
• Accounts receivable turnover
• Ratio of accounts written off to sales or balance of accounts receivable
• Compare with prior year and industry averages
7. Review individual balances and age of accounts with appropriate officer, and:
• Determine accounts that should be written off.
• Determine adequacy of allowance for doubtful accounts.
8. Obtain analyses of significant other receivables.
9. Ascertain whether some receivables are pledged, factored, discounted, or assigned.
10. Determine propriety of financial statement presentation and adequacy of
disclosures.
11. Obtain receivable representation letter from client.

PROBLEM 2-1
 Analyzing Various Receivable transactors
The December 31, 2022, statement of financial position of the UPAT COMPANY included the
following information:
Accounts receivable P672,700
Less: Allowance for doubtful accounts (42,300) P629,700
Notes receivable* 65,400
Total receivables P695.100
* The company is contingently liable for discounted notes receivable of P114,000.
During the year ending December 31, 2023, the following transactions occurred:
1. Sales on credit P2,623,800
2. Collections of accounts receivable P2,523,000
3. Accounts receivable written off as uncollectible 41,400
4. Notes receivable collected 87,000
5. Customer notes received in payment of accounts receivable 216,000
6. Notes receivable discounted that were paid at maturity 108,000
7. Notes receivable discounted that were defaulted, including
interest of P60 and a P15 fee. This amount is expected to be collected during
2023 6,075
8. Proceeds from customer notes discounted with recourse (principal P135,000,
accrued interest, P600) 135,225
9. Collections on accounts previously written off 1,500
10. Sales returns and allowances (on credit sales) 6,000
11. Increase in allowance for doubtful accounts 39,357
Based on the preceding information, determine the balances of the following
accounts at December 31, 2023.

1. Account receivables
A. P473,718 C. P513,975
B. P509,400 D. P515,475
2. Allowance for doubtful accounts
A. P39,357 C. P40,857
B. P40,800 D. P41,757
3. Notes receivable
A. P59,400 C. P200,400
B. P194,400 D. P329,400
4. Notes receivable discounted
A. P114,00 C. P129,000
B. P120,00 D. P135,000
PROBLEM 2-2

Computer of Accounts Receivable Balance

Shown below is GOROSPE COMPANY’s aging schedule of its accounts receivable on
December 31, 2023

Balance Days Past Due

Customers Due Current 1-30 31-60 Over 60
AA Co. P23,000 P 0 P 0 P23,000 P 0
BB Inc. 105,000 62,000 20,000 13,000 10,000
CC Corp. 87,500 23,000 14,500 10,000 40,000
DD, Inc. 93,500 53,000 20,500 10,000 10,000
EE Transport 40,000 0 0 0 40,000
FF, Inc. 31,000 15,000 16,000 0 0
GG Co. 1,000 1,000 0 0 0
HH Corp. 64,000 20,000 18,000 16,000 10,000
II Company 60,000 60,000 0 0 0
Totals P505,000 P234,000 P89,000 P72,000 P110,000

The accounts receivable balance per general ledger is P505,000 on December 31, 2023

The following are audit comments for possible adjustment:

AA Co.
Merchandise found defective; returned by the customer on November 10 for credit, but the
credit memo was issued by Gorospe only on January 2, 2024.

BB, Corp.
Account is good but usually pays late.

CC Corp.
Merchandise worth P40,000 destroyed in transit on June 4, 2023. The carrier was billed on
July 1. (See EE Transport and II Company)

DD, Inc.
customer billed twice in error for P10,000. Balance is collectible.

EE Transport
Collected in full on January 15, 2024.

FF, Inc.
Paid in full on December 29, 2023, but not recorded. Collections were deposited January 3,
2024.

GG Co.
Received account confirmation from customer for P11,000. Investigation revealed an
erroneous credit for P10,000. (See HH Corp.)
HH Corp.
Neglected to post P10,000 credit to customer's account.
II Company
Customer wants to know the reason for receipt of P40,000 credit memo as its account
payable balance is P100,000.

REQUIRED:

Based on the foregoing information, what should be the adjusted balance of the Accounts
receivable - trade at December 31, 2023?

PROBLEM 2-3
Sales Cutoff Test
DAFFODIL AUTO PARTS sells new parts to auto dealers. Company policy requires that a prenumbered
shipping document be issued for each sale. At the time of pickup or shipment, the shipping clerk writes
the date on the shipping document. The last shipment made in the year ended December 31, 2023, was
recorded on document 3167. Shipments are billed in the order that the billing clerk receives the shipping
documents.

For late December 2023 and early January 2024, shipping documents are billed on sales invoices as
follows:

Shipping Sales
Document No. Invoice No.
3163 5332
3164 3526
3165 5327
3166 5330
3167 5331
3168 5328
3169 5329
3170 5333
3171 5335
3172 5334
The December 2023, and January 2024 sales Journals have the following information included:

SALES JOURNAL – DECEMBER 2023

Day of Sales Amount

Month Invoice of Sale
30 5326 P72,611
30 5329 191,430
31 5327 41,983
31 5328 62,022
31 5330 4,774
SALES JOURNAL – JANUARY 2024

Day of Sales Amount

Month Invoice of Sale
1 5332 P264,313
1 5331 10,639
1 5333 485,206
2 5335 125,050
2 5334 64,658
1. What is the net overstatement (understatement) of Daffodil’s sales for the year ended
December 31, 2023?
A. P21,318 C. (P253,452)
B. P253,452 D. (P21,318)
2. What adjusting entry is necessary to correct Daffodil’s financial statement for the year ended
December 31, 2023?
A. Account receivable 21,318
Sales 21,318
B. Accounts receivable 253,452
Sales 253,452
C. Sales 21,318
Accounts receivable 21,318
D. Sales 253,452
Account receivable 253,452
3. Cutoff tests designed to detect credit sales made before the end of the year that have been
recorded in the subsequent year provide assurance about management’s assertion of
A. Rights and obligations
B. Completeness
C. Existence
D. Valuation and allocation
4. Tracing shipping documents to prenumbered sales invoices provides evidence that.
A. No duplicate shipments or billings occurred
B. Shipments to customers were properly invoiced
C. All goods ordered by customers were shipped
D. All prenumbered sales invoices were accounted for
5. An auditor most likely would review an entity's periodic accounting for the numerical
sequence of shipping documents and invoices to support management's financial statement
assertion of
A. Existence
B. Rights and obligations
C. Valuation and allocation
D. Completeness

PROBLEM 2-4
Accounts Receivable and Related Accounts
Presented below are unrelated situation. Answer the questions relating to each situation.

1. The following information is formation is from GUMAMELA CORP.’s first year of operations:
1. Merchandise purchased P450,000
 2. Ending merchandise inventory 123,000
3. Collections from customers 150,000
4. All sales are on account and goods sell at 30% above cost.

What is the accounts receivable balance at the end of the company's first year of operations?

2. BANABA CO. reported the following information at the end of its first year of operations,
December 31, 2023:

Doubtful accounts expense for 2023 P271,000

Uncollectible accounts written off during 2023 35,400
Net realizable value of accounts receivable 895,000

What is the accounts receivable balance at December 31, 2023?

3. MAHOGANY COMPANY's analysis and aging of its accounts receivable at December 31, 2023,
disclosed the following:

Accounts receivable P460,000

Accounts estimated to be uncollectible (per aging) 95,000
Allowance for doubtful accounts (per books) 103,000

What is the net realizable value of Mahogany's receivables at December 31, 2023?

4. The following amounts are shown on the 2023 and 2022 financial statements of SAN
FRANCISCO CO.:

2023 2022
Accounts receivable ? P 470,000
Allowance for doubtful accounts 20,000 10,000
Net sales 2,600.000 2,400.000
Cost of goods sold 1,900.000 1,752.000

San Fransico Co’s accounts receivable turnover for 2023 is 6.5 times.

What is the accounts receivable balance at December 31, 2023?

PROBLEM 2-5
Estimating Doubtful Accounts
LAGUNDI COMPANY applies the allowance method to value its accounts receivable. The company
estimates its uncollectible accounts based on past experience, which indicates that 1.5% of net
credit sales will be uncollectible. Its total sales for the year ended December 31, 2023, amounted to
P4,000,000 including cash sales of P400,000. After a thorough evaluation of the accounts receivable
from Nolog Company amounting to P20,000, Lagundi has decided to write off this account before
year-end adjustments are made.

Shown below are Lagundis account balances at December 31, 2023, before any adjustments and the
P20,000 write off.
 Sales P4,000,000
Accounts receivable 1,500,000
Sales discounts 250,000
Allowance for credit loss 33,000
Sales returns and allowances 350,000
Expected credit loss 0

Lagundi has decided to value its accounts receivable using the statement of financial position
approach as suggested by its external auditors. Presented below is the aging of the accounts
receivable subsidiary ledger accounts at December 31, 2023.

Less than 61-90 91-120 Over

Account Balance 60 days days days 120 days
Antiporda P100,000 P100,000
Balbkwa 256,000 180,000 P 76,000
Curdapla 654,000 500,000 154,000
Dagul 50,000 P50,000
Empoy 420,000
Total P1,480,000 P780,000 P230,000 P420,000 P50,000
% collectible 99% 95% 85% 60%
1. The entry to write off Lagundi's accounts receivable from Nolog of P20,000 will
A. Decrease total assets and net income for 2023
B. Increase total assets and decrease net income for 2023
C. Have no effect on total assets and net income for 2023
D. Have no effect on total assets and increase net income for 2023
2. Lagundi's doubtful accounts expense for 2023 based on net credit sales is
A. P60,000 C. P45,000
B. P12,000 D. P56,250
3. The final entry to adjust the allowance for doubtful accounts is
A. Doubtful accounts expense 44,300
Allowance for doubtful accounts 44,300
B. Doubtful accounts expense 45,000
Allowance for doubtful accounts 45,000
C. Doubtful accounts expense 24,300
Allowance for doubtful accounts 24,300
D. Allowance for doubtful accounts 24,300
Doubtful accounts expense 24,300
4. What is the net realizable value of Lagundi's accounts receivable on December 31, 2023?
A. P1,435,000 C. P1,397,700
B. P1,435,000 D. P1,377,700
5. Which of the following most likely would give the most assurance concerning the valuation
and allocation assertions of accounts receivable?
A. Vouching amounts in the subsidiary ledger to details on shipping documents.
B. Comparing receivable turnover ratios with industry statistics for reasonableness.
C. Inquiring about receivables pledged under loan agreements.
D. Assessing the allowance for doubtful accounts for reasonableness.