2. The Allowance for Receivables Flashcards
What does IFRS 9, Financial Instruments require receivables to be tested for?
What is the expectation in the exam?
A trade receivable is a type of financial asset. IFRS 9, Financial Instruments, requires assets to be tested for impairment. For complex financial assets this can be a challenging process but in Accounting you only need to be aware of the simplified approach that applies to trade receivables.
IFRS 9 requires a company to look forward and estimate expected future losses on the trade receivables balance (IFRS 9: para. 5.5.1).
In the exam you are required to calculate an allowance for receivables, you will be provided with the probability of non-payment and should use this to calculate the required allowance for receivables.
How does the the UK GAAP differ from IFRS 9, in terms of the accounting treatment for receivables and impairment?
Under UK GAAP, in FRS 102, trade receivables (trade debtors) should be tested for impairment at the end of each reporting period. If there is objective evidence of impairment, such as a debtor becoming bankrupt or entering into administration, any impairment loss should be recognised in profit or loss immediately.
This is a backwards looking test based on known evidence at year-end date. There are no forward-looking criteria under FRS 102.
What does determining the allowance for receivables require of the accountant?
In practice, determining the allowance for receivables will require significant judgement on behalf of the accountant in order to determine the probability of non-payment.
This will involve detailed analysis of the aged receivables listing and determining the probability of non-payment based on industry averages, past trends, known payment issues for specific receivables as well as consideration of changes in the wider economy.
Define allowance for receivables.
The allowance for receivables is the amount in relation to the probability of the non-recovery of debts that reduces the receivables asset to its prudent valuation in the statement of financial position.
The allowance is a separate account which is offset against trade receivables, which are shown at the net amount.
What are expected credit losses in relation to receivables.
An allowance for receivables is a provision for the expected credit losses relating to trade receivables. Expected credit losses refers to the amount of trade receivables which may not be collected in future and arises due to the risk that credit customers will default on their debts.
The allowance for receivables is less certain than an irrecoverable debt write off and an accountant must use judgement to determine the expected future losses relating to trade receivables.
Why is making an allowance for receivables important?
What is the dual impact on profits?
How is it contrary to the general aim of the business?
By making an allowance for receivables, the business will be more likely to avoid reporting profits which subsequently fail to materialise because some receivables turn out to be irrecoverable.
Creating an allowance for receivables has the dual impact of reducing the carrying amount of a business’s assets and increasing its expenses, thus reducing profits.
Businesses generally want to report a high asset value and strong profits and therefore the creation of an allowance is contrary to this general aim.
Because of the level of subjectivity and estimates involved in determining the amount of the allowance, there is increased scope for creative accounting, which would generally seek to understate the amount of allowance required.
What is the journal entry when an allowance for receivables is first made?
When an allowance for receivables is first made, it is charged as an expense (irrecoverable debts expense) in the statement of profit or loss. The other side of the double entry is a credit to a separate account in the statement of financial position, the allowance for receivables. The double entry is
Debit - Irrecoverable debts expense (statement of profit or loss - administrative expense)
Credit (Allowance for receivables (statement of financial position)
What is the treatment for:
An increase in allowance for receivables
A decrease in allowance for receivables
When an allowance for receivables already exists but is subsequently increased, the amount of the increase in allowance is debited to irrecoverable debts expense and credited to the allowance for receivables.
When an allowance for receivables already exists but is subsequently reduced, the amount of the decrease in allowance is credited to irrecoverable debts expense and debited to the allowance for receivables.
How is the allowance for receivables presented in the statement of financial position?
The allowance for receivables is not presented as a separate account in the statement of financial position. Instead, it is net off against trade receivables.
How is the increase/decrease in allowance for receivables calculated. (3)
The amount of allowance for receivables in the statement of profit or loss is calculated by:
1. Preparing a T-account for the allowance for receivables;
2. Carrying down the figure that we require at the end of each reporting period’s statement of financial position; and
3. Treating the balancing figure in the reporting period as the charge or credit required in the statement of profit or loss for that reporting period.
