Audit of Receivables PDF

BM2008 AUDIT OF RECEIVABLES INTRODUCTION TO AUDIT OF RECEIVABLES Receivables are debts owed to a company by its customers for goods or services that have been delivered or used but not yet paid for. The audit of receivables and revenue (e.g., s...

BM2008 AUDIT OF RECEIVABLES INTRODUCTION TO AUDIT OF RECEIVABLES Receivables are debts owed to a company by its customers for goods or services that have been delivered or used but not yet paid for. The audit of receivables and revenue (e.g., sales) represents significant audit risk because: 1. Many incidences of financial statement fraud have involved the overstatement of receivables and revenue; 2. Revenue recognition may be based on complex accounting rules; and 3. Receivables and revenue are usually subject to valuation using significant accounting estimates. Companies should establish effective high-level controls over the financial reporting of these accounts, including: a. An audit committee to oversee the reliability of reporting of revenue; b. An internal audit department to monitor compliance with other revenue cycle controls; c. Human resource policies and practices to ensure that competent personnel are involved in determining revenue and receivables estimates; and d. Effective monitoring policies and procedures. Also, a sound accounting system and effective control activities should be established for the revenue cycle. Because of the close relationship between revenue (e.g., sales, sales return, sales discount, sales allowances, etc.) and receivable, the two (2) can be best considered jointly. The determination of the amount of revenue to be recognized for a particular period is integrally related to a number of financial statement accounts, including sales and accounts receivable, adjustment to sales and accounts receivable, service revenue, deferred revenues, and cash. AUDIT OBJECTIVES & PROCEDURES Audit Objectives When auditing accounts receivable and sales, the principal objective for the substantive tests is to determine the following: Assertion Category Audit Objectives Existence or Occurrence All receivables on the statement of financial position are authentic claims of the entity and all sales have really occurred and pertained to the entity. Completeness All authentic claims of the entity for amounts receivable are included in the statement of financial position and all sales have been included in the statement of comprehensive income. Cut-off Sales have been recorded in the proper accounting period. Valuation and Allocation Receivables are carried at their net realizable (collectible) value (i.e., the gross receivables are properly stated with appropriate allowances provided for doubtful accounts, discounts, returns, warranties, and similar items). Accuracy Sales have been accurately recorded in the statement of comprehensive income. Rights and Obligations The entity owns or has a legal right to all the receivables on the statement of financial position at the reporting date. Presentation and Receivables and sales are properly classified, described, and disclosed in the Disclosure & financial statements, including notes, in accordance with PFRS. Classification 04 Handout 1 *Property of STI 🖂 [email protected] Page 1 of 20  BM2008 Assertion Category Audit Objectives Pledged, discounted, or assigned accounts receivable are properly disclosed. Related party receivables and sales are properly disclosed. Audit Procedures for Receivables and Sales The auditor's primary substantive procedures for receivable balance and sales transactions will typically include the following: 1. Reconciliation of Subsidiary-ledger with General Ledger; 2. Confirming receivables and reviewing subsequent cash receipts; 3. Analyzing notes receivable and related interest; 4. Evaluating the adequacy of the allowance for doubtful accounts, including the appropriateness of the methodology used to calculate the allowance; 5. Performing accounts receivable and sales cutoff; 6. Checking the appropriate valuation of accounts receivables denominated in foreign currencies; 7. Investigating any transactions with or related party receivables; 8. Analyzing credit balances and unusual items; 9. Ascertaining whether any receivables have been pledged or assigned; and 10. Performing analytical procedures In accordance with PSA 505 Revised and Redrafted, when using confirmation, the auditor can use either the positive or negative confirmation, or a combination of the two (2) methods to produce a more effective procedure. Positive Confirmation. It is sent to the customer of the client by the auditor requesting a response directly as to whether the stated amount owed is correct or incorrect, or to request the customer to provide specific information, such as their account balance with the entity (referred to as a blank form). This type of confirmation is specifically used when: 1. The information available to corroborate management's assertions is only available outside the entity; 2. The entity's information systems and internal controls are unreliable or ineffective (the assessed level of the risk of material misstatement is HIGH); 3. Specific fraud risk factors, such as the risk of management override of internal controls, prevent the auditor from relying on evidence from the entity; and 4. The account balances comprise of a small number of large accounts. Positive confirmation is considered to provide more reliable audit evidence; however, it is costlier compared to negative confirmation. Negative confirmation. It is sent to the customer of the client by auditor requesting a response only if the customer disagrees with the amount stated on the confirmation. This type of confirmation is used in the following circumstances: 1. The auditor has no reason to believe that recipients of negative confirmation requests will disregard such confirmation requests; 2. The receivables comprise a large number of small, homogenous, account balances, transactions or conditions; 3. The auditor has assessed the risk of material misstatement as low and has obtained sufficient appropriate audit evidence regarding the operating effectiveness of controls relevant to the assertion; and 4. Very few or no exceptions expected. 04 Handout 1 *Property of STI 🖂 [email protected] Page 2 of 20  BM2008 Negative confirmation provides audit evidence that is less reliable and less costly compared to positive confirmation. Non-response of the customer may either indicate that the customer agrees with the information in the confirmation request or the customers just ignore the confirmation letter. When customers do not respond to requests, other procedures should be employed, such as examining subsequent cash receipts, shipping documents, sales invoices, bank deposits. Although the main objective of confirmation is to verify the existence of such receivables, confirmation also can be used to detect lapping and improper sales cutoff (such as those customers that show smaller balances). Other Audit Considerations When Using Confirmation 1. The confirmation request should describe that it is not a request for payment, but merely to confirm the account; 2. The confirmation request should be prepared and sent to the customer under the control of the auditor; 3. The auditor may include in the confirmation request the details of the transactions, such as customer's purchase order numbers to improve the response rate; 4. The confirmation request should be mailed in envelopes bearing the CPA firm's return address to ensure that all confirmation requests that are undeliverable by the post office are returned directly to the audit firm; 5. Receipt of reply to confirmation request should be under the control of the auditor; and 6. Retain copies of all confirmations in the working papers. Discrepancies in Customers' Replies The auditor should resolve differences reported by customers. The majority of such reported discrepancies arise because of normal lags and in-transit items (e.g., payments made but not received, goods shipped but not received), disputed sales terms, credits allowed but not reflected in the records, and clerical errors. Alternative Audit Procedures for Non-responses When using positive confirmation requests, the auditor should generally follow up with a second or sometimes third request or through a telephone call to elicit replies. When replies are still not received, the auditor should apply the following alternative procedures (unless the amount of nonresponse is insignificant and there are no unusual characteristics related to the nonresponses): 1. Examination of subsequent cash receipts in payment of receivables, 2. Examination of charges and credits to accounts receivables, and 3. Examination of related shipping documents, purchase orders, or sales invoices for the sales transactions making up the receivable. Management's Refusal to Allow the Auditor to Send a Confirmation Request A refusal by management to allow the auditor to send a confirmation request is a limitation (i.e. scope limitation) on the audit evidence the auditor may wish to obtain. The auditor is therefore required to inquire as to the reasons for the limitation. A common reason advanced is the existence of a legal dispute or ongoing negotiation with the intended confirming party, the resolution of which may be affected by an untimely confirmation request. The auditor is required to seek audit evidence as to the validity and reasonableness of the reasons because of the risk that management may be attempting to deny the auditor access to audit evidence that may reveal fraud or error. 04 Handout 1 *Property of STI 🖂 [email protected] Page 3 of 20  BM2008 Exhibit 1: Positive Form of Receivable Confirmation 31-Dec-19 Dear Sir(s): Please confirm directly to our auditors Riego, Mercadejas, Elizalde & Co. P.O. Box 14344, 2600 Cagayan De Oro City The correctness of the balance of your account payable to us as shown below and on the enclosed statement on December 31, 2019, for their use in connection with the examination of our accounts. If the amount is correct, please sign this letter in the space provided below. If not correct, please list on the remarks portion full details of the difference. A return envelope is enclosed for your reply. No postage stamps are required. PLEASE NOTE THE DATE as of which we request confirmation. Transactions with us or payments to us between that date and the date you receive this letter are not to be considered. Thank you for your cooperation. Please fax an advance copy of Very truly yours, your reply at 143-14344. Attention of Mr. Rozen Elizalde, Partner-in-Charge. LT Logan Torrealba Controller Puppy Company THIS IS NOT A REQUEST FOR PAYMENT, BUT MERELY FOR CONFIRMATION OF YOUR ACCOUNT. ****************************************************** ***************** THE FOLLOWING BALANCE DUE FROM US IS CORRECT: Due to: Puppy Company As of: December 31, 2019 Amount: P1,430,440.17 Remarks: None Signature: Brandon Rockwell Position: Manager, Accounts Payable Department 04 Handout 1 *Property of STI 🖂 [email protected] Page 4 of 20  BM2008 Substantive Test of Receivables and Sales Exhibit 2: Accounts Receivable (Sales) Cut-off Accounts Receivable (Sales) Cut-off Client: Vince Hidalgo Reference: AR.01 Period end: 31-Dec-17 Sale Invoice Date in AR Delivery recorded in Customer Number Ledger Date the proper period? Transactions recorded before December 31 DULAWAN ABS14344 12/29/2017 12/28/2017 Yes ALEX ABS14345 12/29/2017 12/28/2017 Yes KALANGEG ABS14346 12/30/2017 12/29/2017 Yes KAPAWEN ABS14347 12/30/2017 1/5/2018 No KILLASE ABS14348 12/30/2017 12/29/2017 Yes KAHAPON ABS14349 12/30/2017 12/29/2017 Yes Transactions recorded after December 31 FLORES ABS14351 1/5/2018 1/4/2018 Yes EUNICE ABS14352 1/5/2018 1/5/2018 Yes GUMILAB ABS14353 1/5/2018 1/5/2018 Yes RAFIE ABS14354 1/6/2018 12/29/2017 No Legend: P traced to bill of lading/delivery receipt and commercial invoice These transactions are in FOB shipping point, wherein, ownership passes to the buyer when the goods leave the seller’s shipping dock, thus the sale of the goods is complete and the seller can recognize the earned revenue. Customer KAPAWEN, must be recorded after December 31 while RAFIE, must be recorded before December 31. TRADE RECEIVABLE AND ALLOWANCES Trade receivables are the total amounts owing to a company for goods or services it has sold, which are reflected in invoices that the company has issued to its clients, but has not yet received payments for. For an invoice amount to be added to trade receivables, full payment must be expected within one (1) year. Expected question(s): 1. What is the balance of accounts receivable at year-end? 2. What is the balance of allowance for doubtful accounts at year-end? 3. What is the amount of bad debt expense for the year? 4. What is the net realizable value of accounts receivable at year-end? 04 Handout 1 *Property of STI 🖂 [email protected] Page 5 of 20  BM2008 1. What is the balance of accounts receivable at year-end? Answer: If the opening balance of accounts receivable is given Accounts Receivable Beginning balance X Gross Sales X Recovery of write X X Collection of accounts off Receivable X Collection of recovery X Write off of accounts receivable X Discounts taken during the period X Sales actually returned X Other forms of payment Ending Balance X Answer: If the unadjusted closing balance of accounts receivable is given Unadjusted balance X Add: Reversal of customer's postdated or NSF check; X Add: Adding back of customer's credit balance that was assumed X "netted"; Less: Unrecorded sales returns by the customers X Less: Recorded sales without transfer of title of title (e.g., FOB X destination) Add: Unrecorded sales with transfer of title of title (e.g., FOB shipping X point) Adjusted balance X 2. What is the balance of allowance for doubtful accounts at year-end? 3. What is the amount of bad debt expense for the year? Answer: USING PERCENTAGE OF AR METHOD First, solve for the allowance for doubtful accounts as follows: Accounts Receivable ending balance (from question number 1) X Multiplied by: Percentage of uncollectibility x% Allowance for doubtful accounts (required allowance or ending X balance) Second, solve for the bad debts expense by squeezing the bad debt expense in the T-account of allowance: Allowance for Doubtful Accounts X Beginning balance Write off of receivable X X Bad debt expense (SQUEEZE) X Recovery of write off X Ending Balance 04 Handout 1 *Property of STI 🖂 [email protected] Page 6 of 20  BM2008 USING PERCENTAGE OF SALES METHOD First, solve for the bad debts expense as follows: Sales X Multiplied by: Percentage of uncollectibility x% Bad debts expense X Second, solve for the allowance by using T-account as follows: Allowance for doubtful accounts X Beginning balance Write off of receivable X X Bad debt expense X Recovery of write off X Ending Balance USING AGING OF AR METHOD First, solve for the allowance for doubtful accounts as follows: Group 1 Group 2 Group 3 Total Accounts Receivable X X X X Multiplied by: Percentage of uncollectibility x% x% x% x% Allowance for doubtful accounts X X X X Second, solve for the bad debt expense by squeezing the bad debt expense in the T-account of allowance: Allowance for doubtful accounts X Beginning balance Write off of receivable X X Bad debt expense (SQUEEZE) X Recovery of write off X Ending balance 4. What is the net realizable value of accounts receivable? Answer: Accounts receivable balance at year end (question 1) X Less: Allowance for doubtful accounts (question 2) (X) Allowance for sales discount (X) Allowance for sales returns (X) Net realizable value (NRV) of accounts receivable X If the percentage of uncollectibility is not given in the problem, it can be computed as follows: Total amount of write off - total amount of = % of uncollectibility recovery Total amount of credit sales Illustrative Problem 1: You are examining the financial statements of RIEGO CORPORATION for the year ended December 31, 20x1. During the audit of the accounts receivable and other related accounts, certain information was obtained. The December 31, 20x1 debit balance in the Accounts Receivable control account is P197,000. The only entries in the Bad Debts Expense account were: a credit for P324 on December 31, 20x1, because Soleil Company remitted in full for the accounts charged off October 31, 20x1, and a debit on December 31 for the amount of the credit to the Allowance for Doubtful Accounts. 04 Handout 1 *Property of STI 🖂 [email protected] Page 7 of 20  BM2008 The Allowance for Doubtful Accounts schedule is presented below: Debit Credit Balance January 1, 20x1 P 3,658 October 21, 20x1, Uncollectible; Soleil Co., - P324; Radleigh Co., - P 820; Hades Co., - P564 P 1,508 2,150 December 31, 20x1, 5% of P197,000 P 9,850 12,000 An aging schedule of the accounts receivable as of December 31, 20x1, and the decision are shown in the table below: Amount to which the Allowance Age Net Debit Balance is to be adjusted after adjustment and corrections have been made 0 – 1 month P93,240 1 percent 1 – 3 months 76,820 2 percent 3 – 6 months 22,180 3 percent Definitely uncollectible, P1,000; P2,000 is over 6 months 6,000 considered 50% uncollectible; the remainder is estimated to be 80% collectible. There is a credit balance in one (1) account receivable (0-1 month) of P2,000; it represents an advance on a sales contract. Also, there is a credit balance in one of the 1-3 months accounts receivable of P500 for which merchandise will be accepted by the customer. The ledger accounts have not been closed as of December 31, 20x1. The Accounts Receivable control account is not in agreement with the subsidiary ledger. The difference cannot be located, and the auditor decides to adjust the control to the sum of the subsidiaries after corrections are made. Required: 1. The adjusted balance of accounts receivable of RIEGO CORPORATION at December 31, 20x1. 2. The adjusted write-off of accounts receivable balance of RIEGO CORPORATION at December 31, 20x1. 3. The adjusted allowance of bad debts account of RIEGO CORPORATION at December 31, 20x1. 4. The bad debts expense per book of RIEGO CORPORATION on December 31, 20x1. 5. The adjusted bad debts expense of RIEGO CORPORATION at December 31, 20x1. 6. The entry to adjust the account of Soleil Company. 7. The entry to reconcile the accounts receivable control ledger to subsidiary ledger. 8. The net realizable value of accounts receivable of RIEGO CORPORATION at December 31, 20x1. NOTES RECEIVABLE Notes receivable is a balance sheet item, that records the value of promissory notes that a business is owed and should receive payment for. A written promissory note gives the holder, or bearer, the right to receive the amount outlined in the legal agreement. Promissory notes are a written promise to pay cash to another party on or before a specified future date. If the note receivable is due within a year, then it is treated as a current asset on the balance sheet. If it is not due until a date that is more than one year in the future, then it is treated as a non-current asset on the balance sheet. 04 Handout 1 *Property of STI 🖂 [email protected] Page 8 of 20  BM2008 Expected question(s): 5. What is the initial measurement of notes receivable (fair value at the date received)? 6. What is the gain or loss on sale of property, plant, and equipment? 7. What is the amount of revenue or sales where the consideration received is in the form of notes? 8. What is the subsequent measurement of notes receivable (carrying amount at year-end)? 9. What is the interest income for the year? 10. What is the interest receivable as of year-end? 11. What is the current portion of the notes receivable? 12. What is the non-current portion of the notes receivable? 5. What is the initial measurement (fair value) of the notes receivable at the date received? Answer: METHOD 1 (If the fair value of the consideration given up is available) Fair value of the consideration given up (i.e., inventory, service or PPE) X Less: Down payment (X) Fair value of the notes receivable X METHOD 2 (If the fair value of the consideration given up is NOT available) Type of note Fair value at the date of recognition 1. Interest Bearing Face Amount 2. Non-Interest Bearing Present value of Principal Present value of Principal 3. Interest Bearing with Unrealistic Nominal + Present value of Nominal Interest 6. What is the gain or loss on the sale of property, plant, and equipment? Answer: Fair value of the notes receivable (question 5) X Add: Down payment, if any X Total consideration received X Less: Carrying amount of property, plant and equipment sold (X) Gain or (loss) on sale of property, plant and equipment X Cost of property, plant and equipment sold X Less: Accumulated depreciation X Carrying amount of the property, plant and equipment sold X 7. What is the revenue or sales when the consideration received is in a form of notes receivable? Answer: Fair value of the notes receivable (question 5) X Add: Down payment, if any X Revenue or sales X 8. What is the subsequent measurement of notes receivable (carrying amount at year end)? Answer: Type of note Carrying amount at year-end 1. Interest Bearing Face Amount 04 Handout 1 *Property of STI 🖂 [email protected] Page 9 of 20  BM2008 Type of note Carrying amount at year-end Initial measurement (question 5) X Times: 1 + Effective rate x% 2. Non-Interest Bearing Less: Principal payment, if any (X) Carrying amount at year end X Initial measurement (question 5) X 3. Interest Bearing with Times: 1 + Effective rate x% Unrealistic Nominal Less: Nominal interest (Face x NR) (X) Rate (NR) Principal payment, if any (X) Carrying amount at year-end X 9. What is the amount of interest income for the year? Answer: Type of note Carrying amount at year-end Face Amount X 1. Interest Times: Nominal Rate x% Bearing Interest Income X Carrying amount at beginning of the year X 2. Non-Interest Times: Effective Rate x% Bearing Interest Income X 3. Interest Carrying amount at beginning of the year X Bearing with Times: Effective Rate x% Unrealistic Interest Income X Nominal 10. What is the amount of interest receivable as of the year-end? Type of note Carrying amount at year-end Face Amount X 1. Interest Bearing Times: Nominal Rate x% Interest Income X 2. Non-Interest Bearing None Face Amount X 3. Interest Bearing with Unrealistic Times: Nominal Rate x% Nominal Interest Income X 11. What is the current portion of the notes receivable? 12. What is the non-current portion of the note receivable? Answer: If the note is a term note (principal is payable one time), the whole notes receivable will be classified as current if the principal is payable within one year. If the principal will be paid beyond one year, the whole notes receivable will be classified as a non-current asset. If the note is a serial note, it is both current and non-current and can be computed as follows: Type Current portion Non-current portion Payment of face and interest w/ one year X Carrying amount of NR at year-end X Interest Less: Nominal interest for one year (X) Less: Current portion of NR (X) Bearing X Current portion of notes receivable X Non-current portion of NR 04 Handout 1 *Property of STI 🖂 [email protected] Page 10 of 20  BM2008 Type Current portion Non-current portion Carrying amount of NR at year-end X Carrying amount of NR at year-end X Non- Less: Non-current portion of NR X Times: 1+Effective rate x% Interest Current portion of NR X Less: Principal payment next year X Bearing Non-current portion of NR X Interest Carrying amount of NR at year-end X Carrying amount of NR at year-end X Bearing Less: Non-current portion of NR X Times: 1+Effective rate x% with Current portion of NR X Less: Nominal interest (X) Unrealistic Less: Principal payment next year (X) Nominal Non-current portion of NR X Illustrative Problem 2 On January 1, 20x4, GINTO COMPANY sells its equipment with a carrying value of P160,000. The company receives a non-interest-bearing note due in 3 years with a face amount of P200,000. There is no established market value for the equipment. The prevailing interest rate for a note of this type is 12%. The following are the present value factors of 1 at 12%: Present value of 1 for 3 periods 0.71178 The present value of an ordinary annuity of 1 for 3 periods 2.40183 Questions: 1. The gain or loss on the sale of equipment is: a. P 40,000 b. P 122 c. P 0 d. (P 17,644) 2. The discount on notes receivable is: a. P 57,644 b. P 40,000 c. P 39,878 d. P 0 3. The entry to record the sale of equipment is: a. Notes receivable 200,000 c. Notes receivable 200,000 i. Equipment 200,000 Loss on sale 17,644 Equipment 160,000 Discount on NR 57,644 b. Notes receivable 200,000 d. Notes receivable 200,000 Equipment 160,000 Equipment 160,000 Gain on sale 40,000 Gain on sale 122 Discount on NR 39,878 4. The discount amortization at the end of the second year using the effective-interest amortization is: a. P 17,083 b. P 19,133 c. P 21,428 d. P 36,216 5. The entry to record the discount amortization is: a. Discount on NR c. Interest income Interest income Discount on NR b. Discount on NR d. Interest expense Interest expense Discount on NR Illustrative Problem 3: On January 2, 20x4, a tract of land that originally cost P800,000 was sold by REINA CORPORATION. The company received a P1,200,000 note as payment. It bears interest rate of 4% and is payable in 3 annual installments of P400,000 plus interest on the outstanding balance. The prevailing rate of interest for a note of this type is 10%. The present value table shows the following present value factors of 1 at 10%: Present value factor of 1 for 3 periods 0.75132 04 Handout 1 *Property of STI 🖂 [email protected] Page 11 of 20  BM2008 Present value factor of 1 for 2 periods 0.82645 Present value factor of 1 for 1 period 0.90909 Present value of an ordinary annuity of 1 for 3 periods 2.48685 Questions: 1. The gain on sale of land on January 2, 20x4 is: a. P 194,740 b. P 276,847 c. P 290,740 d. P 400,000 2. The interest income on the note receivable for the year ended December 31, 20x4 using effective interest method is: a. P 120,000 b. P 109,074 c. P 107,685 d. P 99,474 3. How much cash will REINA CORPORATION received from notes receivable? a. P 1,076,847 b. P 1,200,000 c. P 1,296,000 d. P 1,476,847 LOANS RECEIVABLE (LR) Expected question(s): 13. What is the initial measurement of loans receivable (fair value at the date received)? 14. What is the subsequent measurement of loans receivable (carrying amount as of year-end)? 15. What is the interest income for the year before impairment? 16. What is the impairment loss for the year? 17. What is the carrying amount of the loans receivable subsequent to the date of impairment? 18. What is the interest income for the year after impairment? 13. What is the initial measurement (fair value) of the notes receivable at the date received? Answer: METHOD 1 Face amount of loans receivable X Add: Origination cost (direct only) X Less: Origination fee (X) Initial measurement of LR X METHOD 2 Present value factor X Principal amount X Add: Present value factor X Nominal interest X Initial measurement of LR X 14. What is the subsequent measurement of LR (carrying amount as of year-end)? Answer: Type of note Carrying amount at year-end 1. Interest Bearing Face Amount Initial measurement (question 13) X Times: 1 + Effective rate x% 2. Interest Bearing with Unrealistic Nominal Less: Nominal interest (Face x NR) (X) Less: Principal payment, if any (X) Carrying amount at year-end X 04 Handout 1 *Property of STI 🖂 [email protected] Page 12 of 20  BM2008 15. What is the interest income for the year? Answer: Type of note Carrying amount at year-end Face Amount X Times: Nominal Rate x% 1. Interest Bearing Interest Income X Carrying amount at beginning of the year X 2. Interest Bearing with Unrealistic Times: Effective Rate x% Nominal Interest Income X 16. What is the impairment loss of the notes for the year? Answer: Carrying amount of the LR at the date of impairment (question 14) X Add: Interest receivable, if any* X Total receivable subject to impairment X Less: Measurement of new receivable PVF X New principal X PVF X New nominal interest, if any X (X) Impairment loss X *(if stated "did not accrue" no interest receivable to be added) 17. What is the carrying amount of LR subsequent to impairment? Answer: Measurement of new receivable (question 16) X Times: 1 + Original effective rate x% Less: Nominal interest, if any (X) Less: Principal payment, if any (X) Carrying amount of LR at year end X 18. What is the interest income subsequent to impairment? Answer: Measurement of new receivable (question 16) X Times: Original effective interest rate X Interest income subsequent to impairment X RECEIVABLE FINANCING Assignment of Accounts Receivable. Assignment of accounts receivable is an agreement between a lending company and a borrowing company in which the later assigns its accounts receivable to the former in return for a loan. Factoring. Factoring is a financial transaction in which a company sells its accounts receivable to a financing company that specializes in buying receivables (called a factor) at a discount. 04 Handout 1 *Property of STI 🖂 [email protected] Page 13 of 20  BM2008 Discounting of Notes Receivable. A holder of a note can readily convert it to cash by discounting it at a bank, either with or without recourse. The bank accepts the note and gives the holder cash equal to its maturity value less a discount computed by a discount rate to the maturity value. The bank gets its money back plus the discount when the note is paid by its maker at maturity. If the note is not paid at maturity, the bank can collect from the original holder if it was discounted with recourse. If the arrangement is without recourse, the bank must find another remedy. 1. Discounting without recourse – The holder/endorser is not held liable in case the maker fails to pay. Discounting with recourse – The holder/endorser is held liable in case the maker fails to pay. The discounting is accounted either (a) conditional sale; or (b) secured borrowing. Expected question(s): Assignment 19. What is the balance of accounts receivable - assigned? 20. What is the balance of loans payable? 21. What is the equity to be disclosed in the notes to the financial statement? Factoring 22. What is the net proceeds from factoring of receivable? 23. What is the cost of factoring? Discounting 24. What is the net proceeds from discounting of notes receivable? 25. What is the gain or loss from discounting of notes receivable? 26. What is the journal entry for discounting of notes receivable? 19. What is the balance of accounts receivable - assigned? Answer: Accounts receivable - Assigned Balance X Recovery of write-off X X Collection of accounts receivable X Collection of recovery X Write off of accounts receivable X Discounts taken during the period X Sales actually returned Ending balance X 20. What is the balance of loans payable? Answer: Amount of loan X Less: Cash remittance allocated to the loan (X) Balance of loan payable at year-end X Cash collection from accounts receivable – assigned X Less: Payment for interest expense (X) x Cash remittance allocated to the loan X 04 Handout 1 *Property of STI 🖂 [email protected] Page 14 of 20  BM2008 21. What is the equity of the accounts receivable - assigned to be disclosed in the notes to FS? Answer: Accounts receivable - assigned balance at year-end X Less: Loans payable balance at year end (X) Equity X 22. What is the net proceeds from factoring? Answer: Selling price of accounts receivable X Less: Assessment fee, Service fee, Commission fee (X) Factor's holdback (X) Less: Interest charge (Interest X Number of days X 365 days) (X) Net proceeds from factoring X 23. What is the cost of factoring? Answer: Assessment fee, Service fee, Commission fee X Add: Interest charge (Interest X Number of days X 365 days) X Add: Fair value of recourse obligation (only if with recourse) X Total cost of factoring X 24. What are the net proceeds from discounting NR? Step 1: Compute the total interest over the term of note Face amount of the note X Times: Nominal interest x% Times: Term of the note / 12 months X/12 Total interest over the term X Step 2: Compute the maturity value Face amount of the note X Add: Total interest over the term (step 1) X Maturity value X Step 3: Compute the discount charge Maturity value (step 2) X Times: Discount rate x% Times: Remaining term / 12 months X/12 Discount charge X Step 4: Compute the net proceeds Maturity value (step 2) X Less: Discount charge by the bank (step 3) (X) Net proceeds from discounting X 25. What is the net gain or loss from discounting of NR? Answer: Step 1: Compute the interest receivable earned Face amount of the note X Times: Nominal rate x% Times: Months holding the NR/ 12 months X Interest receivable sold X 04 Handout 1 *Property of STI 🖂 [email protected] Page 15 of 20  BM2008 Step 2: Compute the total receivable sold Face amount of the note X Add: Interest receivable sold (step 1) X Total receivable sold X Step 3: Compute the gain or loss on discounting of NR Total receivable sold (step 2) X Less: Net proceeds (question 31) (X) Gain or loss from discounting X 26. What is the journal entry for discounting of NR? Answer: Type of discounting Journal Entry 1. Without recourse Dr. Cash (net proceeds, question 24) X Dr. Loss from discounting (question 25) X Cr. Notes receivable (face amount) X Cr. Interest receivable (question 24, step 1) X 2. With recourse - Dr. Cash (net proceeds, question 24) X Conditional sale Dr. Loss from discounting (question 25) X Cr. Notes receivable discounted (face amount) X Cr. Interest receivable (question 24, step 1) X Contingent liability will be disclosed in the notes to FS. 3. With recourse - Dr. Cash (net proceeds, question 24) X Secured Borrowing Dr. Interest expense (loss from discounting, question 25) X Cr. Loans payable (face amount) X Cr. Interest receivable (question 24, step 1) X Illustrative Problem 4: On September 1, ME COMPANY assigns specific receivables totaling P750,000 to MEMA Bank as collateral on a P625,000, 12% note. ME COMPANY will continue to collect the assigned accounts receivable. Mema Bank also assesses a 2% service charge on the total accounts receivable assigned. ME COMPANY is to make monthly payments to Mema Bank with cash collected on assigned accounts receivable. Collections of assigned accounts during September totaled P260,000 less cash discounts of P3,500. Questions: 1. What were the proceeds from the assignment of ME COMPANY’s accounts receivable on September 1? 2. What amount is owed to Mema Bank by ME COMPANY for September collections plus accrued interest on the note to September 30? Illustrative Problem 5: CONG FINANCE CORPORATION purchases the accounts receivable of other companies on a without recourse, notification basis. At the time the receivables are factored, 15% of the amount factored is charged to the client as commission and recognized as revenue in CONG’S books. Also, 10% of the receivables factored is withheld by Cong as protection against sales returns or other adjustments. This amount credited by Cong to the client Retainer account. At the end of each month, payments are made by Cong to its clients so that the balance in the Client Retainer account is equal to 10% of unpaid factored receivables. Based on Cong’s bad debt loss experience, an allowance for bad debts of 5% of all factored receivables is to be established, Cong makes adjusting entries at the end of each month. 04 Handout 1 *Property of STI 🖂 [email protected] Page 16 of 20  BM2008 On January 3, 20x1, Viy Company factored its accounts receivable totaling P1,000,000. By January 31, P800,000 on these receivables had been collected by Cong. Questions: 1. The commission earned of Cong Finance Corporation from Viy Company’s accounts receivable factored is: a. P 150,000 b. P 120,000 c. P 135,000 d. P 90,000 2. The proceeds received by Viy Company on the accounts factored is: a. P 810,000 b. P 780,000 c. P 765,000 d. P 750,000 3. How much is the Client Retainer account of Cong Finance Corporation at January 31, 20x1 is: a. P 0 b. P 20,000 c. P 60,000 d. P 80,000 4. How much is the bad debts expense of Cong Finance Corporation at January 31, 20x1 is: a. P 50,000 b. P 40,000 c. P 20,000 d. P 0 SOLUTION GUIDE: Suggested Solution: Illustrative Problem 1: Per PER SUBSIDIARY LEDGERS Control Acct. 0-1 mo. 1-3 mos. 3-6 mos. Over 6 mos. Total Bal. before adjustments P 197,000 P 93,240 P 76,820 P 22,180 P 6,000 P 198,240 Adjustments: Add (Deduct) (2) Correction to 10.31.02 entry to write-off uncollectible accts. (200) (3) Write-off of acct. considered definitely uncollectible ( 1,000) (1,000) (1,000) (4) Reclassification of credit balances 2,500 2,000 500 2,500 P 198,300 P 95,240 P 77,320 P 22,180 P 5,000 P 199,740 (5) To adjust the control acct. to agree with SL 1,440 Adjusted balance P 199,740 Audit adjustments as of 12.31.x1 (1) Bad Debts expense 324 Allowance for doubtful accounts 324 (2) Allowance for doubtful accounts 200 Accounts Receivable 200 (3) Allowance for doubtful accounts 1,000 Accounts Receivable 1,000 (4) Accounts Receivable 2,500 Customer’s Accounts with Credit Balances 2,500 (5) Accounts Receivable 1,440 Miscellaneous Revenue 1,440 (6) Allowance for Doubtful Accounts 6,359.80 Bad Debts Expense 6,359.80 04 Handout 1 *Property of STI 🖂 [email protected] Page 17 of 20  BM2008 Required allowance on 12.31.x1 0-1 mo. P 95,240 x 1% P 952.40 1-3 mos. 77,320 x 2 % 1,546.40 3-6 mos. 22,180 x 3% 665.40 Over 6 mos. 3,000 x 20% 600.00 2,000 x 50% 1,000.00 P 4,764.20 Beg. balance 3,658.00 + Provision per audit (squeezed figure) 3,490.20 - Write-off 2,384.00 Ending balance 4,764.20 Provision per book 9,850.00 Provision per audit 3,490.20 Adjustment 6,359.80 Answer: 1. P 199,740 2. P 2,384.00 3. P 4,764.20 4. P 9,850.00 5. P 3,490.20 6. Bad debts Expense 324 Allowance for Bad Debts 324 7. Accounts receivable 1,440 Miscellaneous income 1,440 8. P 194,975.80 Illustrative Problem 2: 1. D Sales price – present value of note (P200,000 x 0.71178) 142,356 Book value of equipment 160,000 Loss on sale of equipment (17,644) 2. A Face value of note 200,000 Present value of note 142,356 Discount on notes receivable 57,644 3. C Notes receivable 200,000 Loss on sale of equipment 17,644 Equipment 160,000 Discount on notes receivable 57,644 4. B Present value of note, 1/1/20x1 142,356 Add: Interest earned in 20x1 (142,356 x 12%) 17,083 Present value of note, 1/1/20x2 159,439 Add: interest earned in 20x2 04 Handout 1 *Property of STI 🖂 [email protected] Page 18 of 20  BM2008 (159,439 x 12%) 19,133 Present value of note, 1/1/20x3 178,572 5. A Illustrative Problem 3: Amount of cash to be received: Interest Principal Total 20x1 48,000 * 400,000 448,000 20x2 32,000 ** 400,000 432,000 20x3 16,000 *** 400,000 416,000 Total 1,296,000 * 1,200,000 x 4% ** 800,000 x 4% *** 400,000 x 4% Cash received PV Factor Present Value 20x1 448,000 0.90909 407,272 20x2 432,000 0.82645 357,026 20x3 416,000 0.75132 312,549 Total 1,076,847 Present value of note 1,076,847 Cost of land 800,000 Gain on sale 276,847 Interest income for 20x1 – P1,076,847 x 10% = P107,685 Answer: 1. B 2. C 3. C Illustrative Problem 4: (1) A P625,000 – (2% x P750,000) P610,000 (2) B P260,000 – P3,500 + (P625,000 x 12% x 1/12) P262,750 Illustrative Problem 5: CONG FINANCE CORPORATION’S BOOKS Jan. 3 Accounts receivable factored 1,000,000 Commission income (P1 M x 15%) 150,000 Client Retainer (P1 M x 10%) 100,000 Cash 750,000 31 Cash 800,000 Accounts receivable factored 800,000 31 Client Retainer 80,000 Cash (100,000 – [10% x 200,000]) 80,000 31 Bad debts expense 50,000 Allowance for bad debts (P1 M x 5%) 50,000 04 Handout 1 *Property of STI 🖂 [email protected] Page 19 of 20  BM2008 VIY COMPANY’S BOOKS Jan. 3 Cash 750,000 Receivable from factor 100,000 Commission 150,000 Accounts receivable 1,000,000 31 Cash 80,000 Receivable from factor 80,000 Answer: 1. A 2. D 3. B 4. A References: Asuncion, D. J., Ngina, M. A., & Escala, R. F. (2018). Applied Auditing Book 1 of 2. Baguio: Real Excellence Publishing. Cayetano, J. B. (n.d.). Nueva Ecija Training and Review Center. Auditing Problems, Lecture Notes. StuDocu. (n.d.). Retrieved from https://www.studocu.com/ph. 04 Handout 1 *Property of STI 🖂 [email protected] Page 20 of 20