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Financial Accounting Section D: Recording Transactions and Events Designed to give you knowledge and application of: D1. Sales and purchases D3. Inventory D4. Tangible non-current assets D5. Depreciation D7. Accruals & payments D8. Receivables & payments D9. Provisions & contingencies 2 Study Guide D8: Receivables and Payables Learning outcomes Examples of receivables and payables. The benefit and costs of offering credit facilities to customers. The bookkeeping entries to record and write off a bad debt. Identify the impact of bad debts on the income statement and on the SOFP. Prepare the bookkeeping entries to create and adjust an allowance for receivables. Illustrate how to include movements in the allowance for receivables in the income statement and how the closing balance of the allowance should appear in the SOFP. Account for contras between trade receivables and payables. Prepare ,reconcile and understand the purpose of supplier statements. Classify items as current or non-current liabilities in the SOFP. 3 Trade Receivables SALES CREDIT CASH Journal entry Amount is received immediately Credit sale Dr Cr Trade receivables Sales Being credit sales recorded X X Amount received from customer Dr Cash X Cr Trade receivables X Being cash received for the credit sales recorded 4 Amount is receivable & shown in Trade Receivable Account Trade Payables Purchases CREDIT CASH Amount is payable & shown in Trade payable Account Amount paid immediately Journal entry Credit purchase Dr Purchases X Cr Trade payables X Being credit purchases recorded When the payment is made Dr Trade payables X Cr Cash X Being cash paid for the outstanding payables 5 Bad Debt Bad debt: A debt that has become irrecoverable or ‘bad’. Reasons for bad debt: Dishonesty, insolvency, death of the debtor Journal entry Dr Bad debts expense X Cr Trade receivable X Being removing the receivable amount and transferring it to expenses In the personal ledger these balances will be removed from the ledger. Impact of Bad debt on SOCI (income statement) and SOFP SOCI (income statement) SOFP Trade receivables from Assets is reduced, lower profit Net profit is reduced as there is extra Cost. 6 Bad Debt Example (Refer Example on page 298) Donald Co. showed a Trade Receivable at the end of the year 31 December 20X6 .Trade Receivables had the following amounts Receivable from Debtors Rogers $15,000 Ronnie $12,000 Ambush $6,000 Ian $27,000 Financial losses Suffered , paid only $10,0000 Paid all his dues Died, Paid only $4500 Paid all his dues BAD DEBT $5,000 No Bad Debt BAD DEBT $1,500 No Bad Debt 7 Bad Debt When bad debts are written off following entry is made: Dr Bad debts 6,500 Cr Trade receivables 6,500 Being amount receivable from Ambush and Rogers written off partly Trade receivable account Date 31/12/20X6 $ Balance b/d Total Date 60,000 $ 31/12/20X6 Bad debts 6,500 31/12/20X6 Balance c/f 53,500 Total 60,000 60,000 Bad debts account Date 31/12/20X6 $ Date Trade receivable 6,500 Total 6,500 8 31/12/20X6 $ Transferred to SOCI 6,500 Total 6,500 Bad Debt Presentation in the financial statements SOCI SOFP $ Income $ $ X Non-current assets Less: Expenses Bad debts Total X Current assets 6,500 X Trade receivable 60,000 Less: Bad debts 6,500 Total 9 53,500 Bad Debt Sometimes it happens that Bad Debt which was written off earlier is recovered later .Amount is not credited in receivables as it is not there in receivables. It is treated as unexpected income in SOCI. Example Superb Ltd has the following transactions during the year ended 31/12/20X7: Credit sales during the year $50,000 Amount received from receivables $55,000 Mack and Jack are two customers owing $2,500 and $5,000 respectively. These amounts have been outstanding for five years. The accounts are now settled with a payment 90% of the amount outstanding and 10% is considered irrecoverable. The opening balance of receivables was $8,000. We will see how these transactions can be recorded in the books of Superb Ltd and the impact of bad debts on its SOCI (income statement). Superb Ltd Trade Receivables $ Opening balance b/d Sales $ 8,000 50,000 Cash Bad debts ($250 + $500) W1 Closing balance c/f 58,000 10 55,000 750 2,250 58,000 Bad Debt recovered W1 Bad debts = 10% of $2,500 and 10% of $5,000 = $250 and $500 = $750. $750 should be debited to the SOCI (income statement) as bad debts written off. As a result, profit will reduce by $750. Nature of general allowance for receivables Management estimates the percentage of debts which become bad. In doing this, management relies heavily on historical accounting data. Due to the concept of prudence, the company recognises this percentage as a cost in the income statement. This ensures that the profits and the assets of an entity are not overstated. An allowance for receivables also known as a provision for bad debts allows the entity to recognise the cost, without touching individual receivable accounts. Example The historical records of Best Ltd show that, on an average, Tom does not pay 5% of the total debts he owes to the Best Ltd. Tom owes 500,000 to Best Ltd in the current year. In this case, a provision of $25,000 ($500,000 x 5%) for bad debts will be shown as an expense in the SOCI (income statement) and deducted from the total receivables in the SOFP. Although the $25,000 is shown as a cost; the individual accounts of the receivables are not touched. A separate allowance account is created. 11 Nature of General Allowance for Receivables Journal entry 1. In the year in which allowance is created Dr Bad and doubtful debts expense (SOCI) Cr Allowance for receivables (SOFP) Being an allowance made against doubtful debts X X 2. In the Subsequent years Allowance at the end of year will change as sales will change .It will be calculated on the basis of new sales. It is compared with the existing opening balance of allowance. Refer example on page 300 12 Nature of General Allowance for Receivables If required new allowance > Existing opening balance then the allowance has to be increased with the amount of difference. Journal entry Dr Bad and doubtful debts expense X Cr Allowance for receivables X Being an increase in allowance for receivables accounted for. If required new allowance < Existing opening balance then the allowance has to be decreased with the amount of difference Journal entry Dr Allowance for receivables X Cr Bad and doubtful debts expense X Being a decrease in allowance for receivables accounted for. 13 Presentation in the Income Statement and the SOFP Bad debts recognised as expenses Increase in allowance recognised as expenses SOCI (Income statement) Decrease in allowance is credited back to income statement If decrease in allowance > bad debts, then excess is disclosed as other income. Closing balance of allowance reduced from trade receivables SOFP 14 When Bad Debts and Allowance for receivable are calculated Sequence of calculation of debts Adjust the amount of contra transactions if any. Deduct the amount of bad debts from the receivables (if they are not already reduced) Then deduct any specific allowances and Then calculate the allowance based on the remaining ‘good’ receivables TTT (Time to Test) Following are the details of Jacob Inc. Opening balance in trade receivable as at 1 January 20X6 is $70,000 Allowance for receivable account as at 31 December 20X6 is $2000. Credit sales during the year are $200,000 Cash received from debtors during the the year is $160,000 Allowance at the rate of 4 % is to be maintained on closing balance of accounts receivable. Bad debts during the year are $1500 One of the customers is also supplier for Jacobs Inc. Amount payable to him is $3,000 and amount receivable from him is $4000. Required: Prepare the Trade receivable account in the books of Jacob Inc. 15 Answer Trade Receivable Account as at 31 December 20X7. Date $ Balance b/d Sales Total Date 70,000 200,000 270,000 $ Cash received account 160,000 Bad debts account 1,500 Accounts payable 3,000 Balance c/d 105,500 Total 270,000 Disclosed in SOFP Disclosed in Disclosed in SOCI as expense Allowance required for year 31 December 20X7 is 4% of 105,500 is $4,220 SOCI as Less: Balance in the allowance account ($2,000) expense Increase in allowance account $2,220 16 Contras between Trade Receivables and Trade Payables Meaning Offsetting (canceling) the amount due to a party in the receivable ledger with the amount due from the same party in the payables ledger Procedure for contra adjustments : Find out lower amount of two payments Pass the following journal entry: Dr Trade payables control account (in the nominal ledger) Cr Trade receivables control account (in the nominal ledger) Being accounts adjusted for contra entries Refer example on page 306 17 X X Prepare, reconcile and understand the supplier statements To ensure all the transactions are recorded correctly it is useful to obtain supplier statement and compare with our record. Comparison may show certain entries do not match, the reason could be Errors Omissions Differing opinions on: Invoice Payments Rejections Rates and discounts 18 Proforma for Reconciliation Reconciliation: is explanation of the difference between any two balances General proforma for reconciliation: Balance payable to ________ according to our records: (All items that cause the amount shown by supplier as receivable to be higher than amount shown by us as payable will be added) Add: Items where our credit entries are < compared to debit entries in supplier’s statement Purchases not recorded by us Purchases recorded at a lower amount by us Any other amounts debited by supplier to us, but not credited by us, partially or fully. Add: Items where our debit entries are > compared to the credit entries in supplier’s statement. Discounts received recorded only by us Discounts received recorded at a higher amount by us (difference in amount) Purchase returns recorded only by us Purchase returns recorded at a higher amount by us (difference in amount) Any other amounts debited by us but not credited by the supplier partially or fully 19 Proforma for Reconciliation continued (All the items that cause the amount shown by the supplier as receivable to be lower than the amount shown by us as payable will be deducted) Less: Items where our credit entries are > compared to the debits recorded by the supplier Purchases recorded only by us or recorded at a higher amount by us. Less: Items where our debit entries are < compared to the credit recorded by the supplier Discounts recorded at a lower amount or not recorded by us. Purchase returns recorded at a lower amount or not recorded by us Balance according to the supplier’s records. 20 Classify items as Current or Non-current Liabilities in the Statement of Financial Position Current liabilities Liabilities that are to be paid within 12 months from the date of reporting period or form a part of operating cycle Example Trade payables: includes bills of exchange payable Bank overdraft: payable on demand Current tax payable Accrued expenses: expenses already incurred by entity but not yet paid, for which bills are not yet received e.g. electricity, rent etc Non-current liabilities Liabilities that are payable after more than 12 months Example Fixed duration loans taken from a bank, repayable after more than a year Debentures: are securities issued by a limited company, repayable after specified term. Holders of debentures are lenders of money to company. 21 RECAP Can you explain and identify examples of receivables and payables ? Can you prepare the bookkeeping entries record and to write off a bad debt ? Can you Identify the impact of bad debts on the income statement and on the SOFP ? Can you prepare the bookkeeping entries to create and adjust an allowance for receivables ? Can you illustrate how to include movements in the allowance for receivables in the income statement and how the closing balance of the allowance should appear in the SOFP ? Can you account for contras between trade receivables and payables ? Can you prepare ,reconcile and understand the purpose of supplier statements ? Can you classify items as current or non-current liabilities in the SOFP ? 22 [[email protected]]