Chapter 8: Receivables Flashcards
A customer buys goods from a business on credit. This generates sales for the business, which results in a receivable balance.
Since the customer only pays in the future, there is a debit balance in the Receivables ledger account at the point of sale. It is shown as a current asset in the Statement of Financial Position, as the debt is expected to be settled within the next 12 months
- The business records the credit sale by debiting the Receivables account and crediting the Sales account with the amount the customer owes
- When the customer pays the balance owed, the business will debit the Bank account and credit the Receivables account by the amount paid to the business
When a business is owed money, this gives rise to a Receivable balance. Receivable balances are split into Trade Receivables and Other Receivables.
- TRADE RECEIVABLES - a business may sell goods to its customers on credit. the amount the credit customer owes to the business is the Trade Receivables balance.
- OTHER RECEIVABLES - Other Receivables arise from situations where a business is owed money but not from regular trading - for example, loans provided to employees or advances paid to directors.
Payables
A supplier sells goods to a business on credit - the business purchase results in a payable balance.
Since the business only pays the amount owing to the credit supplier in the future, there is a credit balance in the Payables ledger account at the point of purchase.
This is a current liability in the Statement of Financial Position, as the business expects to make payment within a year
- A business records the credit purchase of goods or non-current assets by debiting the Purchase Expenses account or Non-Current Asset account and crediting the Payables account by the amount owed to the supplier.
- When the business pays the amount owed, it will debit the Payables account and credit the Bank account with the amount paid by the business.
When a business owes money, this gives rise to a Payable balance. Payable balances are split into Trade Payables and Other Payables.
- TRADE PAYABLES - A business may purchase goods from its suppliers on credit. The amount owed to the credit suppliers is the Trade Payables balance
- OTHER PAYABLES - arise when a business owes money, not due to regular trading. For example, amounts owed to the tax authority
Trade Receivables and Trade Payables Contra
A business may have transactions with another entity as a customer and a supplier. In this case, a CONTRA entry can be made to reduce the amount outstanding in the business’s Trade Receivables and Trade Payables ledger.
The double entry to book the contra adjustment is as follows:
Dr Trade Payables, Payables (Liability) decreased
Cr, Trade Receivables, Receivables (asset) decreased
Once the contra entry takes place, only the difference is reflected in the Trade Receivables or Trade Payables account
(see example)
What is an Irrecoverable Debt
- is a debt from a customer that is not expected to be recovered
It is money that the business will not receive to settle a receivable balance.
When a credit sale is made, receivables are recognised in the ledger accounts as amounts owed to the business. Irrecoverable debts arise when customers are unable or refuse to pay their debt due to bankruptcy or other financial difficulties.
A business needs to account for three aspects of irrecoverable debt:
-> Irrecoverable debt write off
The balance owed by the customer who cannot pay is an irrecoverable debt. The accounting treatment for irrecoverable debt is to write off the balance from the receivable ledger accounts.
-> Irrecoverable debt subsequent recovery
Suppose the customer subsequently makes payment in part or full of the balances written off. In that case, the accounting treatment is to record the cash receipt and reverse the irrecoverable debt write-off.
-> Allowances for irrecoverable debt
If there are doubts about a credit customer’s ability to make payment for balances owed, an allowance for receivables is recorded.
Irrecoverable Debt Write Off
Irrecoverable debts are balances owed by customers that are not collectable due to the following:
- Credit customers facing financial difficulties
- Credit customer declared bankrupt
- Dishonesty or fraud by the customer
- Credit customers from foreign countries are prevented from making payments due to local government restrictions
Accounting for Irrecoverable Debt Write Off
Once the irrecoverable debt amount is established, the amount is written off to the Statement of Profit or Loss as an expense.
The irrecoverable debt written off affects two ledger accounts:
- Irrecoverable Debt Account (Dr, irrecoverable debt (Expense) increased
- Receivables account (Cr, receivables (Asset) decreased
Receivables are credited (reduced) to reflect that the amount owed to the business is uncollectable. The loss of receipt is charged off to the Statement of Profit or Loss as an expense by debiting the Irrecoverable Debt account.
Irrecoverable Debt Recovery
An irrecoverable debt written off as an expense may be recovered in part or whole.
The payment made by the credit customer is accounted for by reversing the original irrecoverable debt write-off and posting the receipt of payment.
In such cases, the business should question whether it was too hasty in writing the receivable off in the first place and review its writing-off procedures generally.
Accounting for Irrecoverable Debt Recovery
Balances written off may be subsequently recovered. There are two steps to account for this recovery:
- Reverse the irrecoverable debt write-off
- Record receipt by credit customer
Step 1: Reverse the irrecoverable debt write-off
Reversing the irrecoverable debt adjustment affects two ledger accounts:
- Receivables (Dr, receivables (asset) increased
- Irrecoverable Debt (Cr, irrecoverable debt (expense) decreased
Since the balance owed has been paid, the amount is not irrecoverable. Therefore, an adjustment to reverse the earlier write-off is made.
Step 2: Record the receipt
The receipt made by the credit customer affects two ledger accounts:
- Bank (Dr, Bank (asset) increased
- Receivables (Cr, receivables (asset) decreased
Allowance for Receivables
Allowance for Receivables is recorded when a business is unsure whether debts will be paid. The business can adjust for these balances when uncertain by reducing the receivables balance. This Adjustment is known as the allowance for Receivables.
At the end of each year, businesses will review all customer accounts in the receivables ledger and identify if an allowance needs to be made for the balance owed that may not be settled.
The outcome of the review includes:
- The business identifies customers where there is evidence that they WILL NOT PAY. eg. the customer is filing for bankruptcy. These customer balances should be written off as irrecoverable debts
- the business identifies customers with evidence to suggest they MIGHT NOT PAY. for example, a customer has a balance outstanding of more than 180 days.
An allowance for receivables is set for these account balances. This allowance for receivables is a form of SPECIFIC ALLOWANCE. - The business may take an allowance for receivables based on an ESTIMATED PERCENTAGE of debts that are expected to be irrecoverable. For example, the history of a business shows that 4% of debts become irrecoverable. This estimate is based on past knowledge and experience and is calculated as a percentage of the total receivable amount. This allowance for receivables is a form of GENERAL ALLOWANCE.
Presentation in Financial Statements
The allowance for receivables is recorded in a separate ledger account in the general ledger. This allowance is reflected as a credit entry in the Allowance for Receivable account in the Statement of Financial Position and is deducted from the Trade Receivables balance.
After deducting the allowance for receivables, the Trade Receivables account reflects the amount the business expects to collect from customers.
Current Assets:
Trade Receivables X
Less: Allowance for Receivables (X)
———————————————-
x