TRADE RECEIVABLES LEARNING OUTCOMES
7. TRADE RECEIVABLES LEARNING OUTCOMES
At the end of the topic, the student should be able to:
Debtors Control Account Recovery Allowances for credit Losses
7.1 INTRODUCTION
A sale made without the buyer paying at the time of the sale is known as a credit transaction. The person or business owing money to an entity which originates from a credit sale is known as a trade debtor. A debtor accepts responsibility for paying the debt within a specific period. The period is known as a credit term and is predetermined in accordance with the credit policy of the entity making the sale. Because some debtors do not pay their accounts, many firms create an allowance for credit losses.
7.2 SETTLEMENT DISCOUNT GRANTED
Discount is often offered to debtors in order to encourage a quick settlement of their debts within the stated credit term. The credit term will be shown on the credit invoice, for example,
30 days from the date of sale.
A client purchased R2 850 worth of goods on credit on 1 March 2009. The client has one month (the credit term) in which to settle the debt. If the client pays before 31 March 2009, a discount of 2% will be granted. If the client settles the account before 31 March 2009 it means that the amount payable is R2 793, calculated as follows:
R2 850 - (2 850 x 2/100) = R (2 850 - 57) =R2 793
If VAT at 14% is included in the R2 850, the VAT collected on behalf of the SA Revenue Service (SARS) (recorded at the date of sale) will amount to R350 and will be recorded in the VAT Output account.
Settlement discount granted will be written off at the end of the financial period and subtracted from sales in the statement of comprehensive income.
7.3 INTEREST CHARGED
Many entities charge interest on the outstanding debt if an account is not paid within the credit term. Suppose the entity which sold the goods in the above example has a policy of charging 18% interest per annum on accounts that are not paid within the stated credit terms. If the client does not pay the account of R550 before 31 March 2009, but only pays it at the end of April, he will be charged 18% per annum interest (for 1 month) on R550 and will have to pay R558, 25 calculated as follows:
R550 + R (550 x 18/100 x1/12) = R (550 + 8, 25) = R558, 25
The interest increases the outstanding balance on the individual debtor's account as well as the balance in the debtors control account.
7.4. CREDIT LOSSES
When a credit transaction occurs there is always a possibility that the debt might not be paid. These debts which are never paid are known as credit losses or irrecoverable debts. Because there is always the possibility that some debts will not be paid, most entities have a policy of creating an allowance for credit losses.
Writing off of credit losses
When management decides that a specific debt will not be recovered, the amount must be written off as a credit loss. When credit losses are written off the debtor's personal account and the debtors control account are affected. The amount of the credit loss will be debited to the credit losses account (a nominal account) and credited to the debtor's personal account and the debtors control account (a statement of financial position account).
7.5. ALLOWANCE FOR CREDIT LOSSES
It is customary for entities selling goods on credit to create an allowance for credit losses. This allowance is based on the estimated credit losses. The policy of prudence is applied when there is uncertainty about whether income or a current asset will be realised (i.e. whether the entity will receive its money). The prospect of not realizing all debts is typical of this type of uncertainty. When an allowance for credit losses is created, there are certain accounting procedures that have to be followed.
The business can use its experience of losses from credits losses to estimate the amount of allowances to make on debtors. For instance, if it loses 5% of its debts continuously, it can take the business decision to make an allowance for credit losses 5% of total debtors each year .Since trade debtors fluctuate, the allowance will be increased or decreased in order to maintain the 5% allowances for credit losses It is important to differentiate between credit losses and allowances for credit losses.
7.6. RECORDING ALLOWANCES FOR CREDIT LOSSES
When an allowance for credit losses is made, the profit and loss account is debited and the allowance for credit losses account is credited. In the statement of financial position, the allowance for credit losses is shown as a deduction from total debtors.
Creation of the allowance
Once the amount of the possible credit losses has been determined according to one of the methods the amount is recorded as follows by means of an adjustment journal entry
Dr Credit losses Cr Allowances for credit losses
When closing the books at the end of the period the debit balance on the credit losses account is transferred to the profit and loss account as a loss.
General Journal
Credit losses
Allowances for credit losses
20 000 Creation for allowance for credit losses at 5% of outstanding debtors of R400000
Closing Entries
Profit and Loss Account
Credit losses
20 000 Transfer of the estimated loss with regard to credit losses
General Ledger
Debtors Control
19.6Feb Balance b/d 400
Allowances for credit losses
19.6 Credit losses 20
Feb 28 000
Credit Losses
19.6 Allowances for credit losses 19.6 Credit losses 20 000 Feb
Presentation in the balance sheet
Current Assets
Debtors 400 000 Less: Allowances for credit losses
Increasing the allowances for credit losses
Two alternative methods may be used when recording the increase in the allowances for credit losses. Only the net increase (i.e. the difference between the balance on the existing allowance and the allowance is recorded. This method is illustrated below: Assume the outstanding trade debtors has increased to R500 000.
Journal
Credit losses
Allowances for credit losses 5000 Increase in the allowances to 5% of the outstanding debtors 5% of R 500 000 = R25000 Existing provision =R20000 Amount needed R 5000
Debtors control account
19.7 Balance b/d 500000 FEB 28
Allowances for credit losses
19.6 Balance b/d
20000 Mar 1
FEB 28 Credit losses
Credit losses
19.7 Profit and Loss Feb credit losses
19.7 Allowance for
Feb 28 account
Decreasing the allowances for credit losses
A decrease in allowances for credit losses can result in a credit entry (gain) in the profit and loss account
Example: TRIAL BALANCE AS AT 28 FEBRUARY 2008
Cr Debtors Control
Dr
25 000 Allowances for credit losses (01.03.09)
Adjustments:
The fi s poli is to set aside % of de to s ala es as allo a es fo edit losses.
CALCULATIONS
5% OF R450
De to s ala e : 500
Existing allowances for credit losses: 25 000 Decrease in allowance 2 500
Recorded in the journal
Dr
Cr
Allowances for credit losses
Credit losses 2500 Decrease in allowances for credit losses
DEBTORS CONTROL
2008 Feb 28 Balance b/d
ALLOWANCES FOR CREDIT LOSSES
Feb Credit losses
2 March Balance b/d
Balance c/d
25 2008 Balance b/d
Mar 1
CREDIT LOSSES
Allowance
Feb Profit / loss
Feb 28 for credit 2 500
28 losses
PROFIT & LOSS
2008 Feb 28 Credit losses
ANNEXURE TO BALANCE SHEET (STATEMENT OF FINANCIAL POSITION) Trade debtors
Less: allowances for credit losses
You are required to have an understanding of the following from TOPIC 13.5 to
13.7 of Accounting an Introduction 6 th edition: Writing off actual credit losses
Recovery of credit losses Value added tax (VAT) and credit losses
Naturally, you need to know who owes you money. Your method of keeping track of receivables is important to the accuracy of your billings, your collections, credit losses, and financial statements.
7.7. RECOVERY OF CREDIT LOSSES WRITTEN OFF
When money is recovered that was previously written off as irrecoverable (a credit loss), it must be recorded and disclosed separately. An account, credit losses recovered, will be opened for this purpose. The money recovered will be debited against the bank account and the credit losses recovered account will
be credited. Credit losses recovered are seen as an income and are added to other operating income in the statement of comprehensive income. This is to cancel the expense written off previously.
7.8. DEBTORS CONTROL ACCOUNT
Many entities sell their goods on credit. If only one or two credit transactions were involved an account for the debtor can be opened in the general ledger and the specific debtor will be debited and the sales account credited with the amount of the transaction. But, if an entity mainly, or to a great extent, sells on credit, a sales journal can be used for all the credit sales transactions. A separate ledger is then kept in which an account for every debtor is listed.
Posti g f o the jou als to the de to s ledge takes pla e o a dail asis.
To obtain a complete record of all the transactions, a control account is kept in the general ledger. The debtors control account contains a summary of all the entries made in the individual debtors' accounts. Posting to the debtors' control account takes place once a month when the totals of all the subsidiary journals are finalised.
The procedure can be summarised as follows: Individual entries in the Posted to
Personal accounts of debtors sales journal
de it side i the de to s ledger on the day the
transaction took place. Total of the debtors Posted to
Debtors control account (debit control column in the
side) on the last day of the sales journal
month.
Individual entries in the Posted to Personal accounts of debtors sales returns journal
(credit side) in the de to s ledger on the day the transaction took place.
Total of the debtors Posted to Debtors control account (credit control column in the
side) on the last day of the sales returns journal
month.
Individual entries in the Posted to Personal accounts of debtors cash receipts journal
edit side i the de to s ledger on the day the transaction took place.
Total of the debtors Posted to Debtors control account (credit control column in the
side) on the last day of the cash receipts journal
month.
TOPIC 8