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RECEIVABLES Financing & Discounting INTERMEDIATE ACCOUNTING I CHAPTER 8 & 9
RECEIVABLE FINANCING CHAPTER 8
RECEIVABLE FINANCING • the financial flexibility or capability of an entity to raise money out of its receivables • common forms:
1. 2. 3. 4.
Pledge of accounts receivable Assignment of accounts receivable Factoring of accounts receivable Discounting of notes receivable
PLEDGE
Pledge of Accounts Receivable • When loans are obtained from the bank or any lending institution, the accounts receivable may be pledge as collateral security for the payment of the loan. • Normally, the borrowing entity makes the collections of the pledged accounts but may be required to turn over the collection to the bank in satisfaction for the loan.
Pledge of Accounts Receivable • Accounting for LOAN (Liability) • To Record the LOAN • Debit cash and discount on note payable (if loan is discounted), and Credit note payable • To Record payment of the loan • Debit note payable and credit cash. • With respect to the PLEDGED ACCOUNTS, no entry would be necessary. • It is sufficient that disclosure is made in the notes to financial statement.
Pledge of Accounts Receivable
• On Nov 1, 2019, an entity borrowed P1,000,000 from Philippine National Bank and issued a promissory note for the same. • The term of the loan is one year and discounted at 12%. The entity pledged accounts receivable of P2,000,000 to secure the loan. • If the loan is discounted, in the banking parlance this means that the interest for the term of the loan is deducted in advance.
COMPUTATION FACE VALUE 1,000,000 Less: Interest Deducted in Advance 1,000,000 * 12% NET PROCEEDS
DATE
ACCOUNT TITLE & EXPLANATION
120,000 880,000
DEBIT
2019 Nov 1
Cash Discount on Note Payable Note Payable - bank
880,000 120,000 1,000,000
To record loan from pledged accounts
CREDIT
Pledge of Accounts Receivable
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
20,000 • On December 31, 2019, using the Dec 31 Interest Expense Discount on Note Payable 20,000 straight line method, the discount To record amortization of discount on note payable is amortized as (120,000 * 2/12) interest expense for two months from November 1 to December 31. • Presentation as current liabilities: 2020
NOTE PAYABLE – BANK 1,000,000 Less: Discount on Note Payable 100,000 Carrying Amount 900,000
• Note to financial statement: “The Note Payable to bank matures on November 1, 2020 and is secured by accounts receivable with face value of P2, 000, 000.”
Nov 1
Note Payable - Bank Cash
1,000,000 1,000,000
To record payment of loan Nov 1
Interest Expense Discount on Note Payable
100,000
To record amortization of discount
100,000
Problem 8 – 1 • Pittance Company provided the following information in connection with a bank loan: March 1 Pittance Company borrowed P2,000,000 from bank on a six-month note carrying an interest of 12% per annum. Accounts of P3,000,000 are pledged to secure the loan. April 1Pledged accounts of P1,000,000 are collected minus 2% discount. June 1 The remaining pledged accounts are collected. Sept 1 The bank loan is repaid plus (2,000,000 * 12% * 6/12) interest. REQUIRED: Prepare journal entries to record the transactions.
DATE ACCOUNT TITLE & EXPLANATION Mar 1
Cash Note Payable - Bank
DEBIT
CREDIT
2,000,000 2,000,000
To record borrowing with pledged accounts of P3,000,000 Apr 1
980,000 20,000 1,000,000
Cash Sales discounts Accounts Receivable To record collection
Jun 1
Cash Accounts Receivable
2,000,000 2,000,000
To record collection Sep 1
Note Payable - Bank Interest Expense Cash
2,000,000 120,000 2,120,000
To record payment of loan Problem 8 – 2
ASSIGNMENT
Assignment of Accounts Receivable • In substance, assignment of accounts receivable means that a borrower called the assignor transfers rights in some accounts receivable to a lender called assignee in consideration for a loan. • a more formal type of pledging of accounts receivable. • secured borrowing evidence by a financing agreement and a promissory note both of which the assignor signs.
Pledging VS Assignment • Pledging is general because all accounts receivable serve as security for the loan. • Assignment is specific because specific accounts receivable serve as collateral security for a loan.
Features of Assignment 1. Assignment may be done either on a nonnotification or notification basis. • When accounts are assigned on a nonnotification basis, customers are not informed that their accounts have been assigned. • customers continue to make payments to the assignor, who remits the collections to the assignee. • When accounts are assigned on a notification basis, customers are notified to make their payments directly to the assignee.
Features of assignment 2. Before entering into an assignment, the assignee, usually a bank or a finance entity, analyzes the borrower’s accounts receivable. • The assignee lends only a certain percentage of the face value of the accounts assigned because the assigned accounts may not be fully realized by reason of such factors as sales discount, sales return and allowances and uncollectible accounts. 3. The assignee usually charges interest for the loan that it makes and required a service or financing charge or commission for the assignment agreement.
Illustration – nonnotification basis
April 1 • An entity assigned P700, 000 of accounts receivable to a bank under a nonnotification arrangement. • The bank advances 80% less a service charge of P5, 000. The entity signed a promissory note that provides for interest of 1% per month on the unpaid loan balance. • Apr 5 Issued a credit memo for sales return to a customer whose account was assigned, P20, 000.
DATE ACCOUNT TITLE & EXPLANATION Apr 1
DEBIT
CREDIT
Accounts Receivable - assigned 700,000 Accounts Receivable 700,000 To separate assigned accounts
1
Cash Service Charge Note Payable - Bank
555,000 5,000 560,000
To record receipt from the loan
700,000 * 80%
5
20,000 Sales Return and Allowance 20,000 Accounts Receivable - Assigned To record return
Illustration – nonnotification basis
• Apr 10 Collected P300, 000 of the assigned accounts less 2% discount. • Apr 30 Remitted the total collections to the bank plus interest for one month.
DATE ACCOUNT TITLE & EXPLANATION Apr 10
DEBIT
CREDIT
294,000 Cash 6,000 Sales Discount Accounts Receivable - Assigned 300,000 To record collection within the discount period
30
Note Payable - Bank 294,000 Interest Expense 560,000 * 1% 5,600 Cash 299,600 To record remittance to bank
• May 7 Assigned accounts of P15,000 proved worthless.
May 7
• May 20 Collected P300, 000 of the assigned accounts.
20
Allowance for Doubtful Accounts 15,000 15,000 Accounts Receivable - Assigned To record write-off
Cash 300,000 300,000 Accounts Receivable - Assigned To record collection
Illustration – nonnotification basis
• May 30 Remitted the total amount due the bank to pay off the loan balance plus interest for one month. 560,000 Note Payable - Bank Less: Remittance Apr 30 294,000 266,000 Balance – May 30 Multiply by Interest Rate 1% Interest Expense 2,660
DATE ACCOUNT TITLE & EXPLANATION May 30
Note Payable - Bank Interest Expense Cash
DEBIT
CREDIT
266,000 2,660 268,660
To record remittance to bank 30
65,000 Accounts Receivable 65,000 Accounts Receivable - Assigned To transfer the remaining balance of assigned accounts
COMPUTATION Total Accounts Receivable Assigned LESS: Collection Sales Discount Sales Return Write-Off
REMAINING BALANCE
700,000 594,000 6,000 20,000 15,000 635,000 65,000
PROBLEM 8 - 5 • REQUIRED: Prepare journal entries to record the transactions. • Grateful Company provided the following transactions: • July 1 The entity assigned P500,000 accounts receivable its bank on a nonnotification basis in consideration for a loan. • The bank advanced P400, 000 less a service charge of 2% of the total accounts assigned, and the entity signed a promissory note bearing interest of 1% per month on the unpaid loan balance at the beginning of the month.
DATE ACCOUNT TITLE & EXPLANATION Jul 1
DEBIT
CREDIT
Accounts Receivable - assigned 500,000 Accounts Receivable 500,000 To separate assigned accounts
Jul 1
Cash Service Charge Note Payable - Bank
390,000 10,000 400,000
To record receipt from assignment of accounts
A.R. - assigned Multiply by S.C. Rate Service Charge
500,000 2% 10,000
PROBLEM 8 - 5 • REQUIRED: Prepare journal entries to record the transactions. • August 1 Collected P330,000 on assigned accounts were collected. • The entity remitted this amount to the bank in payment first for interest and the balance to the principal.
DATE ACCOUNT TITLE & EXPLANATION Aug 1
DEBIT
CREDIT
Cash 330,000 330,000 Accounts Receivable - Assigned To record collection
1
Note Payable - Bank Interest Expense Cash
326,000 4,000
To record payment to bank
400,000 N.P. - balance Multiply by Interest Rate 1% Service Charge 4,000
330,000
PROBLEM 8 - 5
DATE ACCOUNT TITLE & EXPLANATION
• REQUIRED: Prepare journal entries to record the transactions. • September 1 Collected the remaining balance of assigned accounts. Total AR - assigned Less: Collected Aug 1 Balance – May 30
500,000 330,000 170,000
• The entity paid off the remaining loan balance.
Sep 1
DEBIT
CREDIT
Cash 170,000 170,000 Accounts Receivable - Assigned To record collection
1
Note Payable - Bank Interest Expense Cash
74,000 740
To record payment to bank
400,000 Note Payable - Bank 326,000 Less: Remittance Aug 1 74,000 Balance – Sep 1 1% Multiply by Interest Rate 740 Interest Expense
74,740
Illustration – notification basis
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
• July 1 An entity assigned Jul 1 Accounts Receivable - assigned 1,000,000 Accounts Receivable 1,000,000 P1,000,000 of accounts receivable To separate assigned accounts to a bank under a notification arrangement. 760,000 1 Cash 40,000 • The bank loans 80% less 4% service Service Charge Note Payable - Bank 800,000 charge on the gross amount To record receipt from the loan assigned. The entity signed a 1,000,000 * 80% promissory note that provides for 1,000,000 * 4% 1% interest per month on the 31 Note Payable - Bank 588,000 unpaid loan balance. 12,000 Sales Discount Accounts Receivable - Assigned 600,000 • July 31 Received notice from bank To record collection within the discount that P600, 000 of the assigned period and was applied to loan accounts were collected less 2% 31 Interest Expense 8,000 discount. 8,000 Cash • A check was sent to the bank for the To record payment to bank 800,000 * 1% interest due.
Illustration – notification basis
• August 31 Received notice from bank that P300, 000 of the assigned accounts were collected. • Final settlement was made by the bank for the excess collections together with the uncollected assigned accounts of P100, 000.
800,000 Note Payable - Bank Less: Collection applied Jul 31 588,000 212,000 Balance – Aug 31 1% Multiply by Interest Rate 2,120 Interest Expense
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
85,880 212,000 2,120
Aug 31 Cash
Note Payable - Bank Interest Expense Accounts Receivable - Assigned
300,000
To record collection 31
100,000 Accounts Receivable 100,000 Accounts Receivable - Assigned To transfer the remaining balance of assigned accounts
COMPUTATION 1,000,000 Total Accounts Receivable Assigned LESS: Collected July 31 600,000 Collected Aug 31 300,000 900,000 REMAINING BALANCE
100,000
STATEMENT PRESENTATION
• The following accounts were gathered from the ledger of an entity: Accounts receivable-unassigned 4,000,000 accounts receivable-assigned 1,000,000 allowance for doubtful accounts 100,000 note payable-bank (related to assignment) 400,000 DATE
ACCOUNT TITLE & EXPLANATION
Accounts Receivable-unassigned Accounts Receivable-assigned
Gross Accounts Receivable Less: Allowance for Doubtful Accounts
NET REALIZABLE VALUE
DEBIT
CREDIT
4,000,000 1,000,000 5,000,000 100,000 4,900,000
EQUITY IN ASSIGNED ACCOUNTS 1,000,000 Accounts Receivable-assigned Less: Note Payable - Bank
Equity in Assigned Accounts Problem 8 – 4
400,000 600,000
The net realizable value of P4,900,000 will be included in the caption “trade and other receivables” and classified as current asset.
REQUIRED DISCLOSURE on assigned accounts
FACTORING
Factoring • a sale of accounts receivable on a without recourse, notification basis. • In a factoring arrangement, an entity sells its accounts receivable to a bank or finance entity called a factor • a gain or loss is recognized for the difference between the proceeds received and the net carrying amount of the receivables factored. • Factoring differs from an assignment • transfers ownership of its accounts receivable to the factor. • the factor assumes responsibility for uncollectible factored accounts. • In assignment, the assignor retains ownership of the accounts assigned. • the customer whose accounts are factored are notified and required to pay directly to the factor. • The factor has then the responsibility of keeping the receivable records and collecting the accounts.
Factoring • 2 Forms:
• Casual Factoring • If an entity finds itself in a critical cash position, it may be forced to factor some or all of its accounts receivable at a substantial discount to a bank or a finance entity to obtain the much needed cash.
• Factoring as a Continuing Agreement
Casual Factoring • For example, an entity factored P100, 000 of accounts receivable with an allowance for doubtful accounts of P5, 000 for P80, 000. • The entry to record the sale is: Cash 80,000 Allowance for doubtful accounts 5,000 Loss on factoring 15,000 Accounts Receivable 100,000 LOSS ON FACTORING is the difference between the carrying amount of receivables factored and the proceeds received.
Factoring as continuing agreement • where a finance entity purchases all of the accounts receivable of a certain entity. • selling entity requests factor’s credit approval before shipment of merchandise to a customer • If approved, the account is sold immediately to the factor after shipment of the goods. The factor assumes the credit and the collection function. • For compensation, (FACTOR) • the factor charges a commission or factoring fee of 5% to 20% for its services of credit approval, billing, and collecting • Also, assumes uncollectible factored accounts
Factor’s Holdback • Amount withheld by the factor as a protection against customer returns and allowances and other special adjustments. • Receivable from Factor (account) • classified as current asset (TOR) • Final settlement is made after the factored receivables have been fully collected.
ILLUSTRATION
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
• An entity factored accounts 1 Cash 365,000 receivables of P500, 000 with credit Sales Discounts 10,000 Service Charge 25,000 terms of 2/10, n/30 immediately Receivable from Factor 100,000 after shipment of the goods to the Accounts Receivable 500,000 customer. To record sale of accounts • The factor charged a 5% commission based on the gross amount of the COMPUTATION receivables factored. GROSS AMOUNT 500,000 • In addition, the factor withheld 20% LESS: Sales Discounts (500,000*2%) 10,000 COMMISSION (500,000*5%) 25,000 of the amount of the receivables Factor’s holdback (500,000*20%) 100,000 135,000 factored to cover sales return and 365,000 CASH RECEIVED from FACTORING allowances.
ILLUSTRATION • If the customer is subsequently allowed a credit of P50, 000 for damaged merchandise.
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Sales Returns & Allowance 50,000 1,000 Sales Discounts (50,000*2%) Receivable from Factor 49,000
2
To record return
• When all the receivables factored are collected by factor with no further returns and allowances, the final settlement with the factor is recorded.
3
Cash Receivable from Factor
51,000
To record receipt from factor 100,000 – 49,000
51,000
Problem 8 – 8 • Dainty Company sold accounts receivable without recourse with face amount of P6,000,000. The factor charged 15% commission on all accounts receivable factored and withheld 10% of the accounts factored as protection against customer returns and other adjustments. • The entity had previously established an allowance for doubtful accounts of P200,000 for these accounts. • By year-end the entity had collected the factor’s holdback there being no customer returns and other adjustment.
• REQUIRED: Prepare journal entries to record the factoring and the subsequent collection of the factor’s holdback. Problem 8 – 10
DATE
ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Cash 4,500,000 Allowance for Doubtful Accounts 200,000 Receivable From Factor 600,000 Loss on Factoring 700,000 Accounts Receivable 6,000,000 To record factoring
Cash 600,000 Receivable From Factor
600,000
Gross amount 6,000, 000 Less: Commission (15% x 6,000, 000) 900, 000 Factor’s holdback (10% x 6,000, 000) 600,000 1,500, 000 Cash received from factoring 4,500, 000 Net Sale Price (6,000,000 – 900,000) 5,100, 000 Carrying Amount (6,000,000 – 200,000)5,800, 000 LOSS ON FACTORING (700, 000)
Credit Card • A plastic card which enables the holder to obtain credit up to a predetermined limit from the issuer of the card for the purchase of goods and services. • The credit card has enabled retailers and other businesses to continue to sell goods and services where the customers obtain possession of the goods immediately but do not have to pay the goods for about one month. • These issuers are generally responsible for approving the credit of customers and collecting the receivables for a service fee from 1% to 5% of the credit card sales. • If a customer buys goods and uses a credit card, the credit card receipt must be forwarded by the retailer to the card issuer who will then pay the retailer the appropriate amount minus the credit service charge.
• Two entries are necessary, one entry at the time of the sale and another entry when payment is received from the card issuer.
Illustration • Credit card sales to customers using Diners Club amount to P200, 000 for a certain period. The credit card receipts are forwarded to Diners Club and payment is subsequently received from Diners Club minus a 3% service charge. • To record the credit card sales: Accounts receivable-Diners Club 200, 000 Sales 200, 000 • To record the payment from diners Club: Cash 194,000 Credit card service charge (200, 000 x 3%) Accounts receivable- Diners Club 200, 000
6,000
Another illustration: CREDIT CARD • Some credit cards allow the retailer business to deposit the credit card receipts directly to a current account. • The bank accepts the credit card receipts and immediately increases the current account of the retailer for the amount of credit card sales minus the credit card service charge. • This arrangement is in effect a form of factoring of accounts receivable because the credit card sales are treated as cash sales by retailers. • For example, credit card sales amount to P200, 000 with 5% service charge or P10, 000 • The entry to record the credit card sales under this form of arrangement: Cash 190, 000 Credit card service charge 10, 000 Sales 200,000
Problem 8 – 12 • Lucid Company showed the following balance on December 31: Accounts Receivable – unassigned 1,000,000 Accounts Receivable – assigned 300,000 Allowance for doubtful accounts – Jan 1 30,000 Receivable from factor 40,000 Note Payable – bank 240,000 • REQUIRED: 1. Prepare journal entry to record the factoring. 2. Prepare journal entry to record the assignment. 3. Prepare journal entry to adjust allowance for doubtful accounts on December 31. 4. Indicate the classification, presentation and disclosure of the accounts receivable involved in receivable financing.
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
• During the current year, the entity 150,000 found itself in financial distress Jun 30 Cash Service Charge 10,000 and decided to resort to Receivable from Factor 40,000 receivable financing. Accounts Receivable 200,000 To record sale of accounts • On June 30, the entity factored P200,000 of accounts receivable to a finance entity. COMPUTATION • The finance entity charged a GROSS AMOUNT 200,000 (200,000*5%) 10,000 factoring fee of 5% of the LESS: Fee Factor’s holdback (200,000*20%) 40,000 50,000 accounts factored and withheld 150,000 CASH RECEIVED from FACTORING 20% of the amount factored.
ILLUSTRATION • During the current year, the entity found itself in financial distress and decided to resort to receivable financing. • On December 31, the entity assigned P300,000 of accounts receivable to a bank under a nonnotification basis. • The bank advanced 80% less a service fee of 5% of the accounts assigned. The entity signed a promissory note for the loan.
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
Cash Service Charge Receivable from Factor Accounts Receivable
150,000 10,000 40,000
Jun 30
CREDIT
200,000
To record sale of accounts Dec 31
Accounts Receivable - assigned 300,000 Accounts Receivable 300,000 To separate assigned accounts
31
Cash 225,000 Service Charge 300,000 * 5% 15,000 Note Payable - Bank 240,000 To record receipt from the loan
300,000 * 80%
ILLUSTRATION
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
• During the current year, the entity Dec 31 Doubtful Accounts Expense 35,000 35,000 Allowance for Doubtful Accounts found itself in financial distress To record doubtful accounts and decided to resort to for the year receivable financing. • On December 31, it is estimated Accounts Receivable-unassigned 1,000,000 300,000 that 5% of the outstanding Accounts Receivable-assigned 1,300,000 accounts receivable may proved Gross Accounts Receivable 5% Multiply by Rate uncollectible. 65,000 Required Allowance Less: Allowance – Jan 1
DOUBTFUL ACCOUNTS EXPENSE
30,000 35,000
Indicate the classification, presentation and disclosure of the accounts receivable involved in receivable financing. • The net realizable value of the accounts receivable is included in trade and other receivables and classified as current asset. Accounts receivable – unassigned 1,000,000
•
Accounts receivable – assigned 300,000 Gross Accounts Receivable 1,300,000 Less: Allowance for doubtful accounts 65,000 Net realizable value 1,235,000
The receivable from factor of P40,000 is included in trade and other receivables and classified as current asset. • The note payable – bank of P240,000 is classified as current liability presented separately or included in trade and other payables. • Disclosure of the equity in assigned accounts Accounts receivable – assigned 300,000 Note payable – bank (240,000) Equity in assigned accounts 60,000
Discounting of Note Receivable
Discounting of Note Receivable • In a promissory note, the original parties are the maker and payee. • The maker is the one liable and the payee is the one entitled to payment on the date of maturity. • When a note is negotiable the payee may obtain cash before maturity date by discounting the note at a bank or other financing company. • To discount the note, the payee must endorse it. Thus, legally the payee becomes an endorser and the bank becomes endorsee.
ENDORSEMENT • The transfer of right to a negotiable instrument by simply signing at the back of the instrument. • Endorsement may be with recourse which means that the endorser shall pay the endorsee if the maker dishonours the note. • contingent (accounting) or secondary (Legal) liability of the endorser. • Endorsement may be without recourse which means that the endorser avoids future liability even if the maker refuses to pay the endorsee on the date of maturity. • In the absence of any evidence to the contrary, endorsement is assumed to be with recourse.
Terms related to discounting of note • Net proceeds refer to the discounted value of the note received by the endorser from the endorsee. Net proceeds = Maturity Value - Discount • Maturity value is the amount due on the note at the date of maturity. Maturity Value = Principal + interest • Maturity date is the date on which the note should be paid.
Terms related to discounting of note • Principal (Face Value) is the amount appearing on the face of the note. • Interest is the amount of interest for the full term of the note. Interest = Principal x rate x time. • Interest rate is the rate appearing on the face of the note. • Time is the period within which interest shall accrue. • For discounting purposes, it is the period from date of note to maturity date. (entire period of the note)
Terms related to discounting of note • Discount is the amount of interest deducted by bank in advance. Discount = maturity value * discount rate * discount period • Discount rate is the rate used by the bank in computing the discount. • If no discount rate is given, the interest rate is assumed • Discount period is the period of time from date of discounting to maturity date. Discount period = term of the note - expired portion up to the date of discounting • The discount period is the unexpired term of the note.
COMPUTATION
DISCOUNTING WITHOUT RECOURSE
• A P1,000,000, 180-day, 12% note dated July 1 was received from a customer and discounted without recourse on August 30 at 15% discount rate. • JOURNAL ENTRY
PRINCIPAL Add: INTEREST * 12% * 180/360 MATURITY VALUE Less: DISCOUNT * 15% * 120/360 NET PROCEEDS Less: CARRYING AMOUNT of NR
1,000,000 60,000 1,060,000 53,000 1,017,000
1,020,000 GAIN / (LOSS) on NR DISCOUNTING ( 13,000) 1,000,000 + (60,000 * 60/180)
Jul 1 Cash 1,017,000 Loss on NR discounting 13,000 Note Receivable 1,000,000 Interest Income 20,000 To record discounting without recourse
Accounting for note receivable discounting • The accounting for note receivable discounting depends on whether the discounting is with or without recourse. • If the discounting is without recourse, the sale of the note receivable is absolute and therefore there is no contingent liability. • The note receivable account is credited directly because the sale of the note receivable is without recourse or absolute. • The interest income is credited for the actual interest earned on the date of discounting. Problem 9 – 1
DISCOUNTING WITH RECOURSE
COMPUTATION
PRINCIPAL Add: INTEREST * 12% * 6/12 MATURITY VALUE Less: DISCOUNT * 15% * 5/12 NET PROCEEDS Less: CARRYING AMOUNT of NR
2,400,000 144,000
• A P2,400,000, 6-month, 2,544,000 12% note dated February 1 159,000 of the current year is received from a customer 2,385,000 by an entity and discounted by First Bank on 2,400,000 + (144,000 * 1/6) 2,424,000 March 1 at 15%. GAIN / (LOSS) on NR DISCOUNTING ( 39,000)
Accounting for note receivable discounting • If the discounting is with recourse, the transaction is accounted for as either of the following: 1. Conditional sale of note receivable recognizing a contingent liability 2. Secured borrowing
CONDITIONAL SALE The note receivable is not derecognized, instead a “note receivable discounted” account is recorded. (contra account) DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
SECURED BORROWING the note receivable is not derecognized, instead an accounting liability is recorded at an amount equal to the face amount of the note. DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Mar 1 Cash Mar 1 Cash 2,385,000 2,385,000 Loss on NR discounting 39,000 Interest Expense 39,000 Liability for Note Note Receivable - Discounted 2,400,000 Interest Income 24,000 2,400,000 Receivable - Discounted To record discounting with Interest Income 24,000 recourse as conditional sale
The note receivable discounted is deducted from the total note receivable when preparing the statement of financial position with disclosure of the contingent liability.
To record discounting with recourse as secured borrowing
no gain or loss on discounting if the note discounting is accounted for as secured borrowing. (interest expense) no objection if the interest expense is “netted” against the interest income
SECURED BORROWING
CONDITIONAL SALE
Note is paid on maturity DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Aug 1 Liability for Note Rec. Aug 1 Note Receivable – Disc. 2,400,000 2,400,000 2,400,000 Discounted Note Receivable 2,400,000 To record payment of the Note Receivable maker of the discounted note
To record payment of the maker of the discounted note
The note is dishonored by the maker on 1, and the Note is dishonored byAugust maker entity pays the First Bank the maturity value of the note, P2,544,000 plus protest fee and other bank charges of Aug 1 Accounts Receivable 2,550,000 P6,000. 2,550,000 Aug 1 Accounts Receivable 2,550,000 Cash To record payment to bank for 2,550,000 Cash To record payment to bank for dishonored note
Aug 1 Note Receivable – Disc. 2,400,000 2,400,000 Note Receivable To cancel contingent liability
dishonored note
Aug 1 Liability for Note Rec. 2,400,000 Discounted 2,400,000 Note Receivable To derecognize liability
Conditional Sale or Secured Borrowing • PFRS 9, paragraph 3.2.3, provides that an entity shall derecognize a financial asset when either one of the following criteria is met: a. The contractual rights to the cash flows of the financial asset have expired. b. The financial asset has been transferred and the transfer qualifies for derecognition based on the extent of transfer of risk and rewards ownership.
Problem 9 – 2 • Morale Company provided the following transactions: March 14 Sale of merchandise, P2,050,000 to a customer, FOB Destination 2/10, n/30. April 7 Receipt of a 60-day 12% note dated April 5 from the customer. The face of the note was the amount of the invoice minus freight charge of P50,000 paid by the customer in connection with March 14 sale. April 20 The note of the customer was discounted with the bank at 15%. June 4 Receipt of notification from bank that the customer dishonored the note. Accordingly, the entity paid the bank the amount due including protest fee and other charges of P10,000. July 4 receipt of cash from the customer for the full amount of indebtedness plus interest on the original face value.
• REQUIRED: Prepare journal entries to record the transactions assuming any discounting of note receivable is accounted for as a conditional sale with recognition of a contingent liability.
Problem 9-2
• March 14 Sale of merchandise, P2,050,000 to a customer, FOB Destination 2/10, n/30. • April 7 Receipt of a 60-day 12% note dated April 5 from the customer. The face of the note was the amount of the invoice minus freight charge of P50,000 paid by the customer in connection with March 14 sale.
DATE ACCOUNT TITLE & EXPLANATION Mar 14
DEBIT
CREDIT
Accounts Receivable 2,050,000 Freight Out 50,000 2,050,000 Sales 50,000 Allowance for freight charge To record sales 2/10, n/30
Apr 7
2,000,000 Note Receivable Allowance for Freight Charge 50,000 Accounts Receivable 2,050,000 To record receipt of note
Problem 9-2
• April 20 The note of the customer was discounted with the bank at 15%. COMPUTATION
PRINCIPAL 2,000,000 Add: INTEREST * 12% * 60/360 40,000 MATURITY VALUE 2,040,000 Less: DISCOUNT * 15% * 45/360 38,250 NET PROCEEDS 2,001,750 Less: CARRYING AMOUNT of NR
2,000,000 + (40,000 * 15/60) 2,010,000 GAIN / (LOSS) on NR DISCOUNTING ( 8,250)
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Apr 20 Cash
2,001,750 Loss on NR discounting 8,250 2,000,000 Note Receivable - Discounted Interest Income 10,000 To record discounting with recourse as conditional sale
SECURED BORROWING 2,001,750 Cash Interest Expense 8,250 Liability for N.R. - Discounted 2,000,000 10,000 Interest Income
OR
2,001,750 Cash Liability for N.R. - Discounted 2,000,000 1,750 Interest Income
Problem 9-2
• June 4 Receipt of notification from bank that the customer dishonored the note. Accordingly, the entity paid the bank the amount due including protest fee and other charges of P10,000. • July 4 receipt of cash from the customer for the full amount of indebtedness plus interest on the original face value.
DATE ACCOUNT TITLE & EXPLANATION Jun 4
DEBIT
CREDIT
Note Receivable - discounted 2,000,000 Note Receivable 2,000,000 To cancel contingent liability
4
Accounts Receivable Cash
2,050,000 2,050,000
To record payment for dishonored note
2,040,000 (maturity value) + 10,000 (protest fee) Jul 4
Cash Accounts Receivable Interest Income
2,070,000 2,050,000 20,000
To record collection
2,000,000 * 12% * 1/12
• Problem 9-7 (IAA) • Chameleon Company • Required: • Prepare journal entries to record the transactions on the assumption: • 1. The discounting of note receivable is accounted for as a secured borrowing. • 2. The discounting of note receivable is accounted for as conditional sale with recognition of contingent liability.
• June 1 Received from Aye Company a P5,000,000, 12% 90-day note for merchandise sold. • July 1 Received from the Bee Company a P6,000,000, 10% 60days note in full payment of an account.
Jun 1
SECURED BORROWING 5,000,000 Notes Receivable 5,000,000 Sales To record sales to Aye Company (12% 90-day)
Jul 1
6,000,000 Notes Receivable 6,000,000 Accounts Receivale To record Bee Company note (10% 60-day)
• June 1 Received from Aye Company a P5,000,000, 12% 90-day note for merchandise sold. • July 1 Received from the Bee Company a P6,000,000, 10% 60days note in full payment of an account. Jun 1
CONDITIONAL SALE 5,000,000 Notes Receivable 5,000,000 Sales To record sales to Aye Company (12% 90-day)
Jul 1
Notes Receivable 65,000,000 Accounts Receivale 65,000,000 To record Bee Company note (10% 60-day)
• July 1 Discounted the Aye Company note at the bank at 12%. (SECURED BORROWING) Cash 5, 047,000 Interest Expense 3 ,000 Liability for Note Receivable - discounted 5, 000, 000 Interest income 50, 000 Principal 5,000, 000 Add: interest (5,000,000 x 12% x 90/360) 150, 000 Maturity value: 5,150, 000 Less: discount (5,150, 000 x 12% x 60/360) 103, 000 Net proceeds 5, 047, 000 Carrying amount of note receivable 5,000,000 + (150,000 * 30/90) 5, 050, 000 Loss on note receivable discounting (3,000) ( interest expense )
• July 1 Discounted the Aye Company note at the bank at 12%. (CONDITIONAL SALE) Cash 5, 047,000 Loss on Note Receivable discounting 3 ,000 Note Receivable - discounted 5, 000, 000 Interest income 50, 000 Principal 5,000, 000 Add: interest (5,000,000 x 12% x 90/360) 150, 000 Maturity value: 5,150, 000 Less: discount (5,150, 000 x 12% x 60/360) 103, 000 Net proceeds 5, 047, 000 Carrying amount of note receivable 5,000,000 + (150,000 * 30/90) 5, 050, 000 Loss on note receivable discounting (3,000) ( interest expense )
• July 16 Discounted the Bee Company note at the bank at 12%. (SECURED BORROWING) Cash 6,008,500 Interest Expense 16,500 Liability for note receivable discounted 6,000,000 Interest income 25,000 Principal 6,000, 000 Add: interest (6,000,000 x 10% x 60/360) 100, 000 Maturity value: 6,100, 000 Less: discount (6,100, 000 x 12% x 45/360) 91, 500 Net proceeds 6, 008, 500 Carrying amount of note receivable 6,000,000 + (100,000 * 15/60) 6, 025, 000 Loss on note receivable discounting (16,500) ( interest expense )
• July 16 Discounted the Bee Company note at the bank at 12%. (CONDITIONAL SALE) Cash 6,008,500 Loss on Note Receivable Discounting 16,500 Note Receivable - Discounted 6,000,000 Interest income 25,000 Principal 6,000, 000 Add: interest (6,000,000 x 10% x 60/360) 100, 000 Maturity value: 6,100, 000 Less: discount (6,100, 000 x 12% x 45/360) 91, 500 Net proceeds 6, 008, 500 Carrying amount of note receivable 6,000,000 + (100,000 * 15/60) 6, 025, 000 Loss on note receivable discounting (16,500) ( interest expense )
• August 30 The bank notified Chameleon Company that the Bee Company note was paid. CONDITIONAL SALE Note Receivable – Discounted 6,000,000 Note Receivable 6,000,000 SECURED BORROWING Liability for Note Receivable Discounted 6,000,000 Note Receivable 6,000,000
• August 30 The bank notified Chameleon Company that Aye Company defaulted on the note and charged the amount of principal, interest and a fee of P20,000 against Chameleon’s bank account. (SECURED BORROWING) Accounts Receivable Cash
5,170,000 5,170,000
(5,150,000 + 20,000)
Liability for Note Receivable – Discounted 5,000,000 Note Receivable 5,000,000
• August 30 The bank notified Chameleon Company that Aye Company defaulted on the note and charged the amount of principal, interest and a fee of P20,000 against Chameleon’s bank account. (CONDITIONAL SALE) Accounts Receivable Cash
5,170,000 5,170,000
(5,150,000 + 20,000)
Note Receivable – Discounted 5,000,000 Note Receivable 5,000,000
• December 30 Received full payment from Aye Company for the dishonored note plus 12% annual interest on the total amount due for four months. Cash 5,376,800 Accounts Receivable 5,170,000 Interest Income 206,800 Amount Due 5,170, 000 Add: interest (5,170,000 x 12% x 4/12) Total 5,376, 800
206, 800
Conditional Sale or Secured Borrowing • PFRS 9, paragraph 3.2.6, provides the following guidelines for derecognition based on transfer of risks and rewards: 1. if the entity has transferred substantially all risks and rewards, the financial asset shall be derecognized. 2. If the entity has retained substantially all risks and rewards, the financial asset shall not be derecognized. 3. If the entity has neither transferred nor retained substantially all risks and rewards, derecognition depends on whether the entity has retained control of the asset. a. If the entity has lost control of the asset, the financial asset is derecognized in its entirety. b. If the entity has retained control over the asset, the financial asset is not derecognized.
Evaluation • Unquestionably, the contractual rights to the cash flows of the note receivable discounted with recourse have not yet expired. Thus, this first criterion does not apply. • The discounting of note with recourse does not also fall squarely within a single guideline in the second criterion of “transfer of risks and rewards of ownership”. • The discounting transaction is a combination of the guidelines in the second criterion as follows: a. The entity has substantially transferred all “rewards”. b. The entity has retained substantially all “risks”. c. The entity has lost control of the note receivable.
Conclusion • Much debate on this accounting issue can go on among academicians and theoreticians until a clear cut interpretation of the standard is made up by the Financial Reporting Standards Council. • Premises considered, it is believed that the discounting of note receivable with recourse is to be accounted for as a conditional sale with recognition of a contingent liability. • The main justification is that upon discounting or endorsement of the note receivable, whether with or without recourse, the transferor or endorser has lost control over the note receivable. • Accordingly, the transferee has complete control over the note receivable because the transferee has the practical ability to sell the asset in its entirety to a third party without attaching any restrictions to the transfer.
END…
Discounting own note • In the previous discussion, the maker of note discounted is a customer. • In other words, the party discounting is the payee and a mere endorser and therefore only a person secondarily liable. There is then a contingent liability on the note discounted. • Where the note discounted is made by the party discounting, a primary liability, not a contingent liability, exists. • In effect, the party discounting is entering into a contract of loan with the endorsee.
Discounting own note • For example, an entity discounted at the bank its own note of P500, 000 at 12% for one year on September 1, 2016. Principal 500, 000 Less: discount (500, 000X 12%) 60, 000 Net Proceeds 440, 000 • The entry to record the discounting is: Cash 440, 000 Discount on note payable 60, 000 Note Payable-bank 500, 000
Discounting own note • On December 31, 2016, using the straight line method, the discount on note payable is amortized as interest expense for four months from September 1 to December 31 as follows: Interest Expense (60, 000 x 4/12) 20, 000 Discount on note payable 20, 000 • In the December 31, 2016 statement of financial position, the note payable minus the discount on note payable is presented as current liability as follows: Note payable-bank500, 000 Discount on note payable ( 40, 000) Carrying amount 460, 000
RECEIVABLE FINANCING CHAPTER 8
RECEIVABLE FINANCING • the financial flexibility or capability of an entity to raise money out of its receivables • common forms:
1. 2. 3. 4.
Pledge of accounts receivable Assignment of accounts receivable Factoring of accounts receivable Discounting of notes receivable
PLEDGE
Pledge of Accounts Receivable • When loans are obtained from the bank or any lending institution, the accounts receivable may be pledge as collateral security for the payment of the loan. • Normally, the borrowing entity makes the collections of the pledged accounts but may be required to turn over the collection to the bank in satisfaction for the loan.
Pledge of Accounts Receivable • Accounting for LOAN (Liability) • To Record the LOAN • Debit cash and discount on note payable (if loan is discounted), and Credit note payable • To Record payment of the loan • Debit note payable and credit cash. • With respect to the PLEDGED ACCOUNTS, no entry would be necessary. • It is sufficient that disclosure is made in the notes to financial statement.
Pledge of Accounts Receivable
• On Nov 1, 2019, an entity borrowed P1,000,000 from Philippine National Bank and issued a promissory note for the same. • The term of the loan is one year and discounted at 12%. The entity pledged accounts receivable of P2,000,000 to secure the loan. • If the loan is discounted, in the banking parlance this means that the interest for the term of the loan is deducted in advance.
COMPUTATION FACE VALUE 1,000,000 Less: Interest Deducted in Advance 1,000,000 * 12% NET PROCEEDS
DATE
ACCOUNT TITLE & EXPLANATION
120,000 880,000
DEBIT
2019 Nov 1
Cash Discount on Note Payable Note Payable - bank
880,000 120,000 1,000,000
To record loan from pledged accounts
CREDIT
Pledge of Accounts Receivable
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
20,000 • On December 31, 2019, using the Dec 31 Interest Expense Discount on Note Payable 20,000 straight line method, the discount To record amortization of discount on note payable is amortized as (120,000 * 2/12) interest expense for two months from November 1 to December 31. • Presentation as current liabilities: 2020
NOTE PAYABLE – BANK 1,000,000 Less: Discount on Note Payable 100,000 Carrying Amount 900,000
• Note to financial statement: “The Note Payable to bank matures on November 1, 2020 and is secured by accounts receivable with face value of P2, 000, 000.”
Nov 1
Note Payable - Bank Cash
1,000,000 1,000,000
To record payment of loan Nov 1
Interest Expense Discount on Note Payable
100,000
To record amortization of discount
100,000
Problem 8 – 1 • Pittance Company provided the following information in connection with a bank loan: March 1 Pittance Company borrowed P2,000,000 from bank on a six-month note carrying an interest of 12% per annum. Accounts of P3,000,000 are pledged to secure the loan. April 1Pledged accounts of P1,000,000 are collected minus 2% discount. June 1 The remaining pledged accounts are collected. Sept 1 The bank loan is repaid plus (2,000,000 * 12% * 6/12) interest. REQUIRED: Prepare journal entries to record the transactions.
DATE ACCOUNT TITLE & EXPLANATION Mar 1
Cash Note Payable - Bank
DEBIT
CREDIT
2,000,000 2,000,000
To record borrowing with pledged accounts of P3,000,000 Apr 1
980,000 20,000 1,000,000
Cash Sales discounts Accounts Receivable To record collection
Jun 1
Cash Accounts Receivable
2,000,000 2,000,000
To record collection Sep 1
Note Payable - Bank Interest Expense Cash
2,000,000 120,000 2,120,000
To record payment of loan Problem 8 – 2
ASSIGNMENT
Assignment of Accounts Receivable • In substance, assignment of accounts receivable means that a borrower called the assignor transfers rights in some accounts receivable to a lender called assignee in consideration for a loan. • a more formal type of pledging of accounts receivable. • secured borrowing evidence by a financing agreement and a promissory note both of which the assignor signs.
Pledging VS Assignment • Pledging is general because all accounts receivable serve as security for the loan. • Assignment is specific because specific accounts receivable serve as collateral security for a loan.
Features of Assignment 1. Assignment may be done either on a nonnotification or notification basis. • When accounts are assigned on a nonnotification basis, customers are not informed that their accounts have been assigned. • customers continue to make payments to the assignor, who remits the collections to the assignee. • When accounts are assigned on a notification basis, customers are notified to make their payments directly to the assignee.
Features of assignment 2. Before entering into an assignment, the assignee, usually a bank or a finance entity, analyzes the borrower’s accounts receivable. • The assignee lends only a certain percentage of the face value of the accounts assigned because the assigned accounts may not be fully realized by reason of such factors as sales discount, sales return and allowances and uncollectible accounts. 3. The assignee usually charges interest for the loan that it makes and required a service or financing charge or commission for the assignment agreement.
Illustration – nonnotification basis
April 1 • An entity assigned P700, 000 of accounts receivable to a bank under a nonnotification arrangement. • The bank advances 80% less a service charge of P5, 000. The entity signed a promissory note that provides for interest of 1% per month on the unpaid loan balance. • Apr 5 Issued a credit memo for sales return to a customer whose account was assigned, P20, 000.
DATE ACCOUNT TITLE & EXPLANATION Apr 1
DEBIT
CREDIT
Accounts Receivable - assigned 700,000 Accounts Receivable 700,000 To separate assigned accounts
1
Cash Service Charge Note Payable - Bank
555,000 5,000 560,000
To record receipt from the loan
700,000 * 80%
5
20,000 Sales Return and Allowance 20,000 Accounts Receivable - Assigned To record return
Illustration – nonnotification basis
• Apr 10 Collected P300, 000 of the assigned accounts less 2% discount. • Apr 30 Remitted the total collections to the bank plus interest for one month.
DATE ACCOUNT TITLE & EXPLANATION Apr 10
DEBIT
CREDIT
294,000 Cash 6,000 Sales Discount Accounts Receivable - Assigned 300,000 To record collection within the discount period
30
Note Payable - Bank 294,000 Interest Expense 560,000 * 1% 5,600 Cash 299,600 To record remittance to bank
• May 7 Assigned accounts of P15,000 proved worthless.
May 7
• May 20 Collected P300, 000 of the assigned accounts.
20
Allowance for Doubtful Accounts 15,000 15,000 Accounts Receivable - Assigned To record write-off
Cash 300,000 300,000 Accounts Receivable - Assigned To record collection
Illustration – nonnotification basis
• May 30 Remitted the total amount due the bank to pay off the loan balance plus interest for one month. 560,000 Note Payable - Bank Less: Remittance Apr 30 294,000 266,000 Balance – May 30 Multiply by Interest Rate 1% Interest Expense 2,660
DATE ACCOUNT TITLE & EXPLANATION May 30
Note Payable - Bank Interest Expense Cash
DEBIT
CREDIT
266,000 2,660 268,660
To record remittance to bank 30
65,000 Accounts Receivable 65,000 Accounts Receivable - Assigned To transfer the remaining balance of assigned accounts
COMPUTATION Total Accounts Receivable Assigned LESS: Collection Sales Discount Sales Return Write-Off
REMAINING BALANCE
700,000 594,000 6,000 20,000 15,000 635,000 65,000
PROBLEM 8 - 5 • REQUIRED: Prepare journal entries to record the transactions. • Grateful Company provided the following transactions: • July 1 The entity assigned P500,000 accounts receivable its bank on a nonnotification basis in consideration for a loan. • The bank advanced P400, 000 less a service charge of 2% of the total accounts assigned, and the entity signed a promissory note bearing interest of 1% per month on the unpaid loan balance at the beginning of the month.
DATE ACCOUNT TITLE & EXPLANATION Jul 1
DEBIT
CREDIT
Accounts Receivable - assigned 500,000 Accounts Receivable 500,000 To separate assigned accounts
Jul 1
Cash Service Charge Note Payable - Bank
390,000 10,000 400,000
To record receipt from assignment of accounts
A.R. - assigned Multiply by S.C. Rate Service Charge
500,000 2% 10,000
PROBLEM 8 - 5 • REQUIRED: Prepare journal entries to record the transactions. • August 1 Collected P330,000 on assigned accounts were collected. • The entity remitted this amount to the bank in payment first for interest and the balance to the principal.
DATE ACCOUNT TITLE & EXPLANATION Aug 1
DEBIT
CREDIT
Cash 330,000 330,000 Accounts Receivable - Assigned To record collection
1
Note Payable - Bank Interest Expense Cash
326,000 4,000
To record payment to bank
400,000 N.P. - balance Multiply by Interest Rate 1% Service Charge 4,000
330,000
PROBLEM 8 - 5
DATE ACCOUNT TITLE & EXPLANATION
• REQUIRED: Prepare journal entries to record the transactions. • September 1 Collected the remaining balance of assigned accounts. Total AR - assigned Less: Collected Aug 1 Balance – May 30
500,000 330,000 170,000
• The entity paid off the remaining loan balance.
Sep 1
DEBIT
CREDIT
Cash 170,000 170,000 Accounts Receivable - Assigned To record collection
1
Note Payable - Bank Interest Expense Cash
74,000 740
To record payment to bank
400,000 Note Payable - Bank 326,000 Less: Remittance Aug 1 74,000 Balance – Sep 1 1% Multiply by Interest Rate 740 Interest Expense
74,740
Illustration – notification basis
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
• July 1 An entity assigned Jul 1 Accounts Receivable - assigned 1,000,000 Accounts Receivable 1,000,000 P1,000,000 of accounts receivable To separate assigned accounts to a bank under a notification arrangement. 760,000 1 Cash 40,000 • The bank loans 80% less 4% service Service Charge Note Payable - Bank 800,000 charge on the gross amount To record receipt from the loan assigned. The entity signed a 1,000,000 * 80% promissory note that provides for 1,000,000 * 4% 1% interest per month on the 31 Note Payable - Bank 588,000 unpaid loan balance. 12,000 Sales Discount Accounts Receivable - Assigned 600,000 • July 31 Received notice from bank To record collection within the discount that P600, 000 of the assigned period and was applied to loan accounts were collected less 2% 31 Interest Expense 8,000 discount. 8,000 Cash • A check was sent to the bank for the To record payment to bank 800,000 * 1% interest due.
Illustration – notification basis
• August 31 Received notice from bank that P300, 000 of the assigned accounts were collected. • Final settlement was made by the bank for the excess collections together with the uncollected assigned accounts of P100, 000.
800,000 Note Payable - Bank Less: Collection applied Jul 31 588,000 212,000 Balance – Aug 31 1% Multiply by Interest Rate 2,120 Interest Expense
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
85,880 212,000 2,120
Aug 31 Cash
Note Payable - Bank Interest Expense Accounts Receivable - Assigned
300,000
To record collection 31
100,000 Accounts Receivable 100,000 Accounts Receivable - Assigned To transfer the remaining balance of assigned accounts
COMPUTATION 1,000,000 Total Accounts Receivable Assigned LESS: Collected July 31 600,000 Collected Aug 31 300,000 900,000 REMAINING BALANCE
100,000
STATEMENT PRESENTATION
• The following accounts were gathered from the ledger of an entity: Accounts receivable-unassigned 4,000,000 accounts receivable-assigned 1,000,000 allowance for doubtful accounts 100,000 note payable-bank (related to assignment) 400,000 DATE
ACCOUNT TITLE & EXPLANATION
Accounts Receivable-unassigned Accounts Receivable-assigned
Gross Accounts Receivable Less: Allowance for Doubtful Accounts
NET REALIZABLE VALUE
DEBIT
CREDIT
4,000,000 1,000,000 5,000,000 100,000 4,900,000
EQUITY IN ASSIGNED ACCOUNTS 1,000,000 Accounts Receivable-assigned Less: Note Payable - Bank
Equity in Assigned Accounts Problem 8 – 4
400,000 600,000
The net realizable value of P4,900,000 will be included in the caption “trade and other receivables” and classified as current asset.
REQUIRED DISCLOSURE on assigned accounts
FACTORING
Factoring • a sale of accounts receivable on a without recourse, notification basis. • In a factoring arrangement, an entity sells its accounts receivable to a bank or finance entity called a factor • a gain or loss is recognized for the difference between the proceeds received and the net carrying amount of the receivables factored. • Factoring differs from an assignment • transfers ownership of its accounts receivable to the factor. • the factor assumes responsibility for uncollectible factored accounts. • In assignment, the assignor retains ownership of the accounts assigned. • the customer whose accounts are factored are notified and required to pay directly to the factor. • The factor has then the responsibility of keeping the receivable records and collecting the accounts.
Factoring • 2 Forms:
• Casual Factoring • If an entity finds itself in a critical cash position, it may be forced to factor some or all of its accounts receivable at a substantial discount to a bank or a finance entity to obtain the much needed cash.
• Factoring as a Continuing Agreement
Casual Factoring • For example, an entity factored P100, 000 of accounts receivable with an allowance for doubtful accounts of P5, 000 for P80, 000. • The entry to record the sale is: Cash 80,000 Allowance for doubtful accounts 5,000 Loss on factoring 15,000 Accounts Receivable 100,000 LOSS ON FACTORING is the difference between the carrying amount of receivables factored and the proceeds received.
Factoring as continuing agreement • where a finance entity purchases all of the accounts receivable of a certain entity. • selling entity requests factor’s credit approval before shipment of merchandise to a customer • If approved, the account is sold immediately to the factor after shipment of the goods. The factor assumes the credit and the collection function. • For compensation, (FACTOR) • the factor charges a commission or factoring fee of 5% to 20% for its services of credit approval, billing, and collecting • Also, assumes uncollectible factored accounts
Factor’s Holdback • Amount withheld by the factor as a protection against customer returns and allowances and other special adjustments. • Receivable from Factor (account) • classified as current asset (TOR) • Final settlement is made after the factored receivables have been fully collected.
ILLUSTRATION
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
• An entity factored accounts 1 Cash 365,000 receivables of P500, 000 with credit Sales Discounts 10,000 Service Charge 25,000 terms of 2/10, n/30 immediately Receivable from Factor 100,000 after shipment of the goods to the Accounts Receivable 500,000 customer. To record sale of accounts • The factor charged a 5% commission based on the gross amount of the COMPUTATION receivables factored. GROSS AMOUNT 500,000 • In addition, the factor withheld 20% LESS: Sales Discounts (500,000*2%) 10,000 COMMISSION (500,000*5%) 25,000 of the amount of the receivables Factor’s holdback (500,000*20%) 100,000 135,000 factored to cover sales return and 365,000 CASH RECEIVED from FACTORING allowances.
ILLUSTRATION • If the customer is subsequently allowed a credit of P50, 000 for damaged merchandise.
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Sales Returns & Allowance 50,000 1,000 Sales Discounts (50,000*2%) Receivable from Factor 49,000
2
To record return
• When all the receivables factored are collected by factor with no further returns and allowances, the final settlement with the factor is recorded.
3
Cash Receivable from Factor
51,000
To record receipt from factor 100,000 – 49,000
51,000
Problem 8 – 8 • Dainty Company sold accounts receivable without recourse with face amount of P6,000,000. The factor charged 15% commission on all accounts receivable factored and withheld 10% of the accounts factored as protection against customer returns and other adjustments. • The entity had previously established an allowance for doubtful accounts of P200,000 for these accounts. • By year-end the entity had collected the factor’s holdback there being no customer returns and other adjustment.
• REQUIRED: Prepare journal entries to record the factoring and the subsequent collection of the factor’s holdback. Problem 8 – 10
DATE
ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Cash 4,500,000 Allowance for Doubtful Accounts 200,000 Receivable From Factor 600,000 Loss on Factoring 700,000 Accounts Receivable 6,000,000 To record factoring
Cash 600,000 Receivable From Factor
600,000
Gross amount 6,000, 000 Less: Commission (15% x 6,000, 000) 900, 000 Factor’s holdback (10% x 6,000, 000) 600,000 1,500, 000 Cash received from factoring 4,500, 000 Net Sale Price (6,000,000 – 900,000) 5,100, 000 Carrying Amount (6,000,000 – 200,000)5,800, 000 LOSS ON FACTORING (700, 000)
Credit Card • A plastic card which enables the holder to obtain credit up to a predetermined limit from the issuer of the card for the purchase of goods and services. • The credit card has enabled retailers and other businesses to continue to sell goods and services where the customers obtain possession of the goods immediately but do not have to pay the goods for about one month. • These issuers are generally responsible for approving the credit of customers and collecting the receivables for a service fee from 1% to 5% of the credit card sales. • If a customer buys goods and uses a credit card, the credit card receipt must be forwarded by the retailer to the card issuer who will then pay the retailer the appropriate amount minus the credit service charge.
• Two entries are necessary, one entry at the time of the sale and another entry when payment is received from the card issuer.
Illustration • Credit card sales to customers using Diners Club amount to P200, 000 for a certain period. The credit card receipts are forwarded to Diners Club and payment is subsequently received from Diners Club minus a 3% service charge. • To record the credit card sales: Accounts receivable-Diners Club 200, 000 Sales 200, 000 • To record the payment from diners Club: Cash 194,000 Credit card service charge (200, 000 x 3%) Accounts receivable- Diners Club 200, 000
6,000
Another illustration: CREDIT CARD • Some credit cards allow the retailer business to deposit the credit card receipts directly to a current account. • The bank accepts the credit card receipts and immediately increases the current account of the retailer for the amount of credit card sales minus the credit card service charge. • This arrangement is in effect a form of factoring of accounts receivable because the credit card sales are treated as cash sales by retailers. • For example, credit card sales amount to P200, 000 with 5% service charge or P10, 000 • The entry to record the credit card sales under this form of arrangement: Cash 190, 000 Credit card service charge 10, 000 Sales 200,000
Problem 8 – 12 • Lucid Company showed the following balance on December 31: Accounts Receivable – unassigned 1,000,000 Accounts Receivable – assigned 300,000 Allowance for doubtful accounts – Jan 1 30,000 Receivable from factor 40,000 Note Payable – bank 240,000 • REQUIRED: 1. Prepare journal entry to record the factoring. 2. Prepare journal entry to record the assignment. 3. Prepare journal entry to adjust allowance for doubtful accounts on December 31. 4. Indicate the classification, presentation and disclosure of the accounts receivable involved in receivable financing.
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
• During the current year, the entity 150,000 found itself in financial distress Jun 30 Cash Service Charge 10,000 and decided to resort to Receivable from Factor 40,000 receivable financing. Accounts Receivable 200,000 To record sale of accounts • On June 30, the entity factored P200,000 of accounts receivable to a finance entity. COMPUTATION • The finance entity charged a GROSS AMOUNT 200,000 (200,000*5%) 10,000 factoring fee of 5% of the LESS: Fee Factor’s holdback (200,000*20%) 40,000 50,000 accounts factored and withheld 150,000 CASH RECEIVED from FACTORING 20% of the amount factored.
ILLUSTRATION • During the current year, the entity found itself in financial distress and decided to resort to receivable financing. • On December 31, the entity assigned P300,000 of accounts receivable to a bank under a nonnotification basis. • The bank advanced 80% less a service fee of 5% of the accounts assigned. The entity signed a promissory note for the loan.
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
Cash Service Charge Receivable from Factor Accounts Receivable
150,000 10,000 40,000
Jun 30
CREDIT
200,000
To record sale of accounts Dec 31
Accounts Receivable - assigned 300,000 Accounts Receivable 300,000 To separate assigned accounts
31
Cash 225,000 Service Charge 300,000 * 5% 15,000 Note Payable - Bank 240,000 To record receipt from the loan
300,000 * 80%
ILLUSTRATION
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
• During the current year, the entity Dec 31 Doubtful Accounts Expense 35,000 35,000 Allowance for Doubtful Accounts found itself in financial distress To record doubtful accounts and decided to resort to for the year receivable financing. • On December 31, it is estimated Accounts Receivable-unassigned 1,000,000 300,000 that 5% of the outstanding Accounts Receivable-assigned 1,300,000 accounts receivable may proved Gross Accounts Receivable 5% Multiply by Rate uncollectible. 65,000 Required Allowance Less: Allowance – Jan 1
DOUBTFUL ACCOUNTS EXPENSE
30,000 35,000
Indicate the classification, presentation and disclosure of the accounts receivable involved in receivable financing. • The net realizable value of the accounts receivable is included in trade and other receivables and classified as current asset. Accounts receivable – unassigned 1,000,000
•
Accounts receivable – assigned 300,000 Gross Accounts Receivable 1,300,000 Less: Allowance for doubtful accounts 65,000 Net realizable value 1,235,000
The receivable from factor of P40,000 is included in trade and other receivables and classified as current asset. • The note payable – bank of P240,000 is classified as current liability presented separately or included in trade and other payables. • Disclosure of the equity in assigned accounts Accounts receivable – assigned 300,000 Note payable – bank (240,000) Equity in assigned accounts 60,000
Discounting of Note Receivable
Discounting of Note Receivable • In a promissory note, the original parties are the maker and payee. • The maker is the one liable and the payee is the one entitled to payment on the date of maturity. • When a note is negotiable the payee may obtain cash before maturity date by discounting the note at a bank or other financing company. • To discount the note, the payee must endorse it. Thus, legally the payee becomes an endorser and the bank becomes endorsee.
ENDORSEMENT • The transfer of right to a negotiable instrument by simply signing at the back of the instrument. • Endorsement may be with recourse which means that the endorser shall pay the endorsee if the maker dishonours the note. • contingent (accounting) or secondary (Legal) liability of the endorser. • Endorsement may be without recourse which means that the endorser avoids future liability even if the maker refuses to pay the endorsee on the date of maturity. • In the absence of any evidence to the contrary, endorsement is assumed to be with recourse.
Terms related to discounting of note • Net proceeds refer to the discounted value of the note received by the endorser from the endorsee. Net proceeds = Maturity Value - Discount • Maturity value is the amount due on the note at the date of maturity. Maturity Value = Principal + interest • Maturity date is the date on which the note should be paid.
Terms related to discounting of note • Principal (Face Value) is the amount appearing on the face of the note. • Interest is the amount of interest for the full term of the note. Interest = Principal x rate x time. • Interest rate is the rate appearing on the face of the note. • Time is the period within which interest shall accrue. • For discounting purposes, it is the period from date of note to maturity date. (entire period of the note)
Terms related to discounting of note • Discount is the amount of interest deducted by bank in advance. Discount = maturity value * discount rate * discount period • Discount rate is the rate used by the bank in computing the discount. • If no discount rate is given, the interest rate is assumed • Discount period is the period of time from date of discounting to maturity date. Discount period = term of the note - expired portion up to the date of discounting • The discount period is the unexpired term of the note.
COMPUTATION
DISCOUNTING WITHOUT RECOURSE
• A P1,000,000, 180-day, 12% note dated July 1 was received from a customer and discounted without recourse on August 30 at 15% discount rate. • JOURNAL ENTRY
PRINCIPAL Add: INTEREST * 12% * 180/360 MATURITY VALUE Less: DISCOUNT * 15% * 120/360 NET PROCEEDS Less: CARRYING AMOUNT of NR
1,000,000 60,000 1,060,000 53,000 1,017,000
1,020,000 GAIN / (LOSS) on NR DISCOUNTING ( 13,000) 1,000,000 + (60,000 * 60/180)
Jul 1 Cash 1,017,000 Loss on NR discounting 13,000 Note Receivable 1,000,000 Interest Income 20,000 To record discounting without recourse
Accounting for note receivable discounting • The accounting for note receivable discounting depends on whether the discounting is with or without recourse. • If the discounting is without recourse, the sale of the note receivable is absolute and therefore there is no contingent liability. • The note receivable account is credited directly because the sale of the note receivable is without recourse or absolute. • The interest income is credited for the actual interest earned on the date of discounting. Problem 9 – 1
DISCOUNTING WITH RECOURSE
COMPUTATION
PRINCIPAL Add: INTEREST * 12% * 6/12 MATURITY VALUE Less: DISCOUNT * 15% * 5/12 NET PROCEEDS Less: CARRYING AMOUNT of NR
2,400,000 144,000
• A P2,400,000, 6-month, 2,544,000 12% note dated February 1 159,000 of the current year is received from a customer 2,385,000 by an entity and discounted by First Bank on 2,400,000 + (144,000 * 1/6) 2,424,000 March 1 at 15%. GAIN / (LOSS) on NR DISCOUNTING ( 39,000)
Accounting for note receivable discounting • If the discounting is with recourse, the transaction is accounted for as either of the following: 1. Conditional sale of note receivable recognizing a contingent liability 2. Secured borrowing
CONDITIONAL SALE The note receivable is not derecognized, instead a “note receivable discounted” account is recorded. (contra account) DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
SECURED BORROWING the note receivable is not derecognized, instead an accounting liability is recorded at an amount equal to the face amount of the note. DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Mar 1 Cash Mar 1 Cash 2,385,000 2,385,000 Loss on NR discounting 39,000 Interest Expense 39,000 Liability for Note Note Receivable - Discounted 2,400,000 Interest Income 24,000 2,400,000 Receivable - Discounted To record discounting with Interest Income 24,000 recourse as conditional sale
The note receivable discounted is deducted from the total note receivable when preparing the statement of financial position with disclosure of the contingent liability.
To record discounting with recourse as secured borrowing
no gain or loss on discounting if the note discounting is accounted for as secured borrowing. (interest expense) no objection if the interest expense is “netted” against the interest income
SECURED BORROWING
CONDITIONAL SALE
Note is paid on maturity DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Aug 1 Liability for Note Rec. Aug 1 Note Receivable – Disc. 2,400,000 2,400,000 2,400,000 Discounted Note Receivable 2,400,000 To record payment of the Note Receivable maker of the discounted note
To record payment of the maker of the discounted note
The note is dishonored by the maker on 1, and the Note is dishonored byAugust maker entity pays the First Bank the maturity value of the note, P2,544,000 plus protest fee and other bank charges of Aug 1 Accounts Receivable 2,550,000 P6,000. 2,550,000 Aug 1 Accounts Receivable 2,550,000 Cash To record payment to bank for 2,550,000 Cash To record payment to bank for dishonored note
Aug 1 Note Receivable – Disc. 2,400,000 2,400,000 Note Receivable To cancel contingent liability
dishonored note
Aug 1 Liability for Note Rec. 2,400,000 Discounted 2,400,000 Note Receivable To derecognize liability
Conditional Sale or Secured Borrowing • PFRS 9, paragraph 3.2.3, provides that an entity shall derecognize a financial asset when either one of the following criteria is met: a. The contractual rights to the cash flows of the financial asset have expired. b. The financial asset has been transferred and the transfer qualifies for derecognition based on the extent of transfer of risk and rewards ownership.
Problem 9 – 2 • Morale Company provided the following transactions: March 14 Sale of merchandise, P2,050,000 to a customer, FOB Destination 2/10, n/30. April 7 Receipt of a 60-day 12% note dated April 5 from the customer. The face of the note was the amount of the invoice minus freight charge of P50,000 paid by the customer in connection with March 14 sale. April 20 The note of the customer was discounted with the bank at 15%. June 4 Receipt of notification from bank that the customer dishonored the note. Accordingly, the entity paid the bank the amount due including protest fee and other charges of P10,000. July 4 receipt of cash from the customer for the full amount of indebtedness plus interest on the original face value.
• REQUIRED: Prepare journal entries to record the transactions assuming any discounting of note receivable is accounted for as a conditional sale with recognition of a contingent liability.
Problem 9-2
• March 14 Sale of merchandise, P2,050,000 to a customer, FOB Destination 2/10, n/30. • April 7 Receipt of a 60-day 12% note dated April 5 from the customer. The face of the note was the amount of the invoice minus freight charge of P50,000 paid by the customer in connection with March 14 sale.
DATE ACCOUNT TITLE & EXPLANATION Mar 14
DEBIT
CREDIT
Accounts Receivable 2,050,000 Freight Out 50,000 2,050,000 Sales 50,000 Allowance for freight charge To record sales 2/10, n/30
Apr 7
2,000,000 Note Receivable Allowance for Freight Charge 50,000 Accounts Receivable 2,050,000 To record receipt of note
Problem 9-2
• April 20 The note of the customer was discounted with the bank at 15%. COMPUTATION
PRINCIPAL 2,000,000 Add: INTEREST * 12% * 60/360 40,000 MATURITY VALUE 2,040,000 Less: DISCOUNT * 15% * 45/360 38,250 NET PROCEEDS 2,001,750 Less: CARRYING AMOUNT of NR
2,000,000 + (40,000 * 15/60) 2,010,000 GAIN / (LOSS) on NR DISCOUNTING ( 8,250)
DATE ACCOUNT TITLE & EXPLANATION
DEBIT
CREDIT
Apr 20 Cash
2,001,750 Loss on NR discounting 8,250 2,000,000 Note Receivable - Discounted Interest Income 10,000 To record discounting with recourse as conditional sale
SECURED BORROWING 2,001,750 Cash Interest Expense 8,250 Liability for N.R. - Discounted 2,000,000 10,000 Interest Income
OR
2,001,750 Cash Liability for N.R. - Discounted 2,000,000 1,750 Interest Income
Problem 9-2
• June 4 Receipt of notification from bank that the customer dishonored the note. Accordingly, the entity paid the bank the amount due including protest fee and other charges of P10,000. • July 4 receipt of cash from the customer for the full amount of indebtedness plus interest on the original face value.
DATE ACCOUNT TITLE & EXPLANATION Jun 4
DEBIT
CREDIT
Note Receivable - discounted 2,000,000 Note Receivable 2,000,000 To cancel contingent liability
4
Accounts Receivable Cash
2,050,000 2,050,000
To record payment for dishonored note
2,040,000 (maturity value) + 10,000 (protest fee) Jul 4
Cash Accounts Receivable Interest Income
2,070,000 2,050,000 20,000
To record collection
2,000,000 * 12% * 1/12
• Problem 9-7 (IAA) • Chameleon Company • Required: • Prepare journal entries to record the transactions on the assumption: • 1. The discounting of note receivable is accounted for as a secured borrowing. • 2. The discounting of note receivable is accounted for as conditional sale with recognition of contingent liability.
• June 1 Received from Aye Company a P5,000,000, 12% 90-day note for merchandise sold. • July 1 Received from the Bee Company a P6,000,000, 10% 60days note in full payment of an account.
Jun 1
SECURED BORROWING 5,000,000 Notes Receivable 5,000,000 Sales To record sales to Aye Company (12% 90-day)
Jul 1
6,000,000 Notes Receivable 6,000,000 Accounts Receivale To record Bee Company note (10% 60-day)
• June 1 Received from Aye Company a P5,000,000, 12% 90-day note for merchandise sold. • July 1 Received from the Bee Company a P6,000,000, 10% 60days note in full payment of an account. Jun 1
CONDITIONAL SALE 5,000,000 Notes Receivable 5,000,000 Sales To record sales to Aye Company (12% 90-day)
Jul 1
Notes Receivable 65,000,000 Accounts Receivale 65,000,000 To record Bee Company note (10% 60-day)
• July 1 Discounted the Aye Company note at the bank at 12%. (SECURED BORROWING) Cash 5, 047,000 Interest Expense 3 ,000 Liability for Note Receivable - discounted 5, 000, 000 Interest income 50, 000 Principal 5,000, 000 Add: interest (5,000,000 x 12% x 90/360) 150, 000 Maturity value: 5,150, 000 Less: discount (5,150, 000 x 12% x 60/360) 103, 000 Net proceeds 5, 047, 000 Carrying amount of note receivable 5,000,000 + (150,000 * 30/90) 5, 050, 000 Loss on note receivable discounting (3,000) ( interest expense )
• July 1 Discounted the Aye Company note at the bank at 12%. (CONDITIONAL SALE) Cash 5, 047,000 Loss on Note Receivable discounting 3 ,000 Note Receivable - discounted 5, 000, 000 Interest income 50, 000 Principal 5,000, 000 Add: interest (5,000,000 x 12% x 90/360) 150, 000 Maturity value: 5,150, 000 Less: discount (5,150, 000 x 12% x 60/360) 103, 000 Net proceeds 5, 047, 000 Carrying amount of note receivable 5,000,000 + (150,000 * 30/90) 5, 050, 000 Loss on note receivable discounting (3,000) ( interest expense )
• July 16 Discounted the Bee Company note at the bank at 12%. (SECURED BORROWING) Cash 6,008,500 Interest Expense 16,500 Liability for note receivable discounted 6,000,000 Interest income 25,000 Principal 6,000, 000 Add: interest (6,000,000 x 10% x 60/360) 100, 000 Maturity value: 6,100, 000 Less: discount (6,100, 000 x 12% x 45/360) 91, 500 Net proceeds 6, 008, 500 Carrying amount of note receivable 6,000,000 + (100,000 * 15/60) 6, 025, 000 Loss on note receivable discounting (16,500) ( interest expense )
• July 16 Discounted the Bee Company note at the bank at 12%. (CONDITIONAL SALE) Cash 6,008,500 Loss on Note Receivable Discounting 16,500 Note Receivable - Discounted 6,000,000 Interest income 25,000 Principal 6,000, 000 Add: interest (6,000,000 x 10% x 60/360) 100, 000 Maturity value: 6,100, 000 Less: discount (6,100, 000 x 12% x 45/360) 91, 500 Net proceeds 6, 008, 500 Carrying amount of note receivable 6,000,000 + (100,000 * 15/60) 6, 025, 000 Loss on note receivable discounting (16,500) ( interest expense )
• August 30 The bank notified Chameleon Company that the Bee Company note was paid. CONDITIONAL SALE Note Receivable – Discounted 6,000,000 Note Receivable 6,000,000 SECURED BORROWING Liability for Note Receivable Discounted 6,000,000 Note Receivable 6,000,000
• August 30 The bank notified Chameleon Company that Aye Company defaulted on the note and charged the amount of principal, interest and a fee of P20,000 against Chameleon’s bank account. (SECURED BORROWING) Accounts Receivable Cash
5,170,000 5,170,000
(5,150,000 + 20,000)
Liability for Note Receivable – Discounted 5,000,000 Note Receivable 5,000,000
• August 30 The bank notified Chameleon Company that Aye Company defaulted on the note and charged the amount of principal, interest and a fee of P20,000 against Chameleon’s bank account. (CONDITIONAL SALE) Accounts Receivable Cash
5,170,000 5,170,000
(5,150,000 + 20,000)
Note Receivable – Discounted 5,000,000 Note Receivable 5,000,000
• December 30 Received full payment from Aye Company for the dishonored note plus 12% annual interest on the total amount due for four months. Cash 5,376,800 Accounts Receivable 5,170,000 Interest Income 206,800 Amount Due 5,170, 000 Add: interest (5,170,000 x 12% x 4/12) Total 5,376, 800
206, 800
Conditional Sale or Secured Borrowing • PFRS 9, paragraph 3.2.6, provides the following guidelines for derecognition based on transfer of risks and rewards: 1. if the entity has transferred substantially all risks and rewards, the financial asset shall be derecognized. 2. If the entity has retained substantially all risks and rewards, the financial asset shall not be derecognized. 3. If the entity has neither transferred nor retained substantially all risks and rewards, derecognition depends on whether the entity has retained control of the asset. a. If the entity has lost control of the asset, the financial asset is derecognized in its entirety. b. If the entity has retained control over the asset, the financial asset is not derecognized.
Evaluation • Unquestionably, the contractual rights to the cash flows of the note receivable discounted with recourse have not yet expired. Thus, this first criterion does not apply. • The discounting of note with recourse does not also fall squarely within a single guideline in the second criterion of “transfer of risks and rewards of ownership”. • The discounting transaction is a combination of the guidelines in the second criterion as follows: a. The entity has substantially transferred all “rewards”. b. The entity has retained substantially all “risks”. c. The entity has lost control of the note receivable.
Conclusion • Much debate on this accounting issue can go on among academicians and theoreticians until a clear cut interpretation of the standard is made up by the Financial Reporting Standards Council. • Premises considered, it is believed that the discounting of note receivable with recourse is to be accounted for as a conditional sale with recognition of a contingent liability. • The main justification is that upon discounting or endorsement of the note receivable, whether with or without recourse, the transferor or endorser has lost control over the note receivable. • Accordingly, the transferee has complete control over the note receivable because the transferee has the practical ability to sell the asset in its entirety to a third party without attaching any restrictions to the transfer.
END…
Discounting own note • In the previous discussion, the maker of note discounted is a customer. • In other words, the party discounting is the payee and a mere endorser and therefore only a person secondarily liable. There is then a contingent liability on the note discounted. • Where the note discounted is made by the party discounting, a primary liability, not a contingent liability, exists. • In effect, the party discounting is entering into a contract of loan with the endorsee.
Discounting own note • For example, an entity discounted at the bank its own note of P500, 000 at 12% for one year on September 1, 2016. Principal 500, 000 Less: discount (500, 000X 12%) 60, 000 Net Proceeds 440, 000 • The entry to record the discounting is: Cash 440, 000 Discount on note payable 60, 000 Note Payable-bank 500, 000
Discounting own note • On December 31, 2016, using the straight line method, the discount on note payable is amortized as interest expense for four months from September 1 to December 31 as follows: Interest Expense (60, 000 x 4/12) 20, 000 Discount on note payable 20, 000 • In the December 31, 2016 statement of financial position, the note payable minus the discount on note payable is presented as current liability as follows: Note payable-bank500, 000 Discount on note payable ( 40, 000) Carrying amount 460, 000
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