Chapter 6: Receivables and Payables

1.1.1 Receivables Definition

Definition

Receivables are the amounts due to the business from individuals, organisations, or
other entities to satisfy a debt or a claim.

1.1.2 Examples of Receivables

 Trade receivables – the main example of a receivable is an amount due from a

customer for a credit sale of goods or services.

Other examples of receivables include:

 Rents due to be received from tenants (e.g. where office or warehouse space is let
out to another party).

 Tax refunds due (i.e. where tax has been overpaid).

 Accrued income - income earned in the period but not yet invoiced (see Chapter 11).

 Other receivables – This includes receivables that cannot be classified under a

specific receivable heading in the financial statements. Examples of other receivables
include:

o Loan repayments receivable from another party

o Interest receivable (from bank deposits)

o Advance payments to suppliers (the advance is refundable until the supplier

delivers the goods or services.)

1.2 Sales on Credit

Credit is offered to customers allow them to purchase goods or services from the business. A
business provides this option to customers to give it an advantage over its competitors.

In practice, most businesses operate by offering credit to customers, even though it may
seem to be a risky strategy.

When customers purchase goods from a business, they will arrange with the business to
settle the account at an agreed time in the future. The credit terms define the agreed time
and any penalties resulting from late payment.

Customers will also be given a credit limit. This is the maximum balance that the customer
can owe.

It is the job of the business's credit controller to monitor customers to ensure that they pay
the amounts owed within the credit terms.

1.2.1 Advantages and Disadvantages of Selling on Credit

Advantages Disadvantages

 Seller increases revenues.

 Buyer obtains and can use

 May increase the cost of the seller (For
purchased item immediately.
example, if a customer does not pay on time,
 Minimises the need to carry the business may have to borrow money
cash or write cheques. from its bank and be charged interest fees).

 Makes expensive items  Legal fees may be incurred for credit

affordable by allowing them to customers who refuse to pay.
be paid for over a period.
 Late payment fees and penalties may be
 Buyer convenience, as the costly to the buyer.
buyer does not have to be
 Administrative costs to the seller and the risk
present at the point of
of irrecoverable ("bad") debts.
purchase (e.g. online
shopping).  It may require security or other guarantees.

1.2.2 Credit Control

Credit control concerns not only “chasing” overdue accounts but establishing the procedures
for granting credit to customers:

 Who gets credit? The initial screening of potential credit customers is essential (For
example, businesses only allow credit facilities if potential customers can provide
credit references)

 Agree on terms of credit and the credit limit in advance.

 Accurate invoicing to avoid disputes which delay their settlement.

 Monitoring customer trade receivables balances, and ensuring customers pay on time.

1.2.3 Credit Limits

Definition

The credit limit is the threshold a business will allow a customer to owe at any time
without having to go back and review their credit file.

It is the maximum amount the business is willing to risk on an account.

The primary purpose of credit limits is to limit risk exposure. There are numerous benefits
of having credit limits.

 Established credit limits free up valuable time for other credit management tasks.

 Speed up the sales process as the amount of credit allowed is established.

 Improve collection activity and efforts.

  Serve as an account monitoring tool (For example, if a limit is regularly reached, it is
time to consider increasing the limit or prompt the customer to pay overdue amounts).

1.3 Aged Receivables (Debt) Analysis

The aged trade receivables analysis is a report of all the trade receivables balances analysed
by customer name with information on each customer's credit limit and cumulative turnover
for the accounting period as well as the age of the outstanding amount, that is:

 amounts that have been outstanding for 30 days or less

 amounts that have been outstanding for more than 30 days but less than 60 days

 amounts that have been outstanding for more than 60 days but less than 90 days

 amounts that have been outstanding for 90 days or more

The trade receivable ageing will be used in conjunction with credit control procedures. For
example, first and second reminders and final notices are prompted as a balance (debt)
owed becomes increasingly overdue. The percentage of total balances falling into each
period can be monitored, and prompt corrective action can be taken if the profile
deteriorates.

1.4 Irrecoverable Debts

Definition

An irrecoverable or bad debt is an account receivable which is expected to remain

uncollectable and should be written off.

Unfortunately, some customers will be unable or unwilling to pay amounts owed. When this
is the case, the debt is termed to be irrecoverable.

Indicators that debt may become irrecoverable include:

 Taking longer to pay than is usual

 Paying in instalments outside normal credit terms

 Regular disputing of invoices (as a delaying tactic)

 Going into receivership (administration)/liquidation

1.4.1 Irrecoverable Debt Write-off

When a business is owed money by a customer that is unable to pay, there is little point in
keeping the balance as receivable in the customer's account.

 If the debt is not an asset, it should not be carried in the statement of financial
position.

 To give a fair presentation in the accounts, irrecoverable debts are written off and
expensed to profit or loss, thereby reducing profit (or increasing a loss).

The journal entry to write off the irrecoverable debt is:

 General ledger account Catego Explanation
ry

DR Irrecoverable debt expenses Expense Irrecoverable debt expenses

account increased

CR Trade receivables account Asset Trade receivables (asset)

decreased

Example 1

A business sells $500 of goods to Mr Maxwell on credit. The journal entry to record the
initial sale is Dr. Trade receivables $500, Cr. Sales/ revenue $500

During the year, Mr Maxwell goes bankrupt before paying the debt. The debt is
considered to be irrecoverable. The journal entry to record the irrecoverable debt is Dr
Irrecoverable debts expense a/c $500, CR Trade receivables $500

1.4.2 Subsequent Recovery of Irrecoverable Debt

An irrecoverable debt written off may subsequently be paid. The journal entry to record an
irrecoverable debt recovery is:

Step 1: Reverse the irrecoverable debt write-off

General ledger account Catego Explanation

ry

DR Trade receivables Asset Trade receivables (asset)

increased

CR Irrecoverable debts expense Expense Irrecoverable debts expense

account 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

General ledger Catego Explanation

 account ry

DR Bank Asset Bank (asset) increased

CR Trade receivables Asset Trade receivables (asset)

decreased

Therefore, the net effect of the above two entries is Dr. Bank, Cr. Irrecoverable debts
expense account.

General ledger account Catego Explanation

ry

DR Trade Receivables Asset Trade Receivables (Asset)

increased

DR Bank Asset Bank (asset) increased

CR Irrecoverable debts expense Expense Irrecoverable debts expense

account decreased

CR Trade Receivables Asset Trade Receivables (Asset)

decreased

Example 2

Continuation from Example 1 previously.

$217 is received in the following year from Mr Maxwell for a debt written off as
irrecoverable. The journal entry to record the irrecoverable debt recovery is:

DR. Cash/Bank $217 and CR Irrecoverable debt expense $217

Note: The amount recovered may not be equal to the amount written off as only part of
the debt may be recovered.

1.5 Allowance for irrecoverable debts

In addition to the irrecoverable debts written off, most businesses make an allowance for
irrecoverable debts on the remaining trade receivables. This involves estimating the
expected credit losses on these trade receivables.
Exam advice

In the FA/FFA exam, the term 'allowance for receivables' may also be used for
'allowance for irrecoverable debts'.

 The allowance is forward-looking and based on the expectation that some customers
will not settle their outstanding balances in full.

 When it is uncertain (though not definite) that a debt will be recovered, the expected
loss is recognised when the risk of non-recovery is first identified.

 The amount of the allowance is offset against gross trade receivables for the purpose
of presentation in the statement of financial position.

 $ $

Current assets

Inventory x

Trade receivables x

Less: Allowance for (x

irrecoverable debts ) x

Cash x

 As long as there is some chance of recovering the debt (and steps are taken to try to
secure payment from the customer), the record of the customer's balance is kept in
the customer’s account.

1.5.1 Journal entries for Allowances for Irrecoverable Debts

The steps needed to account for the allowance for irrecoverable debts:

1. Calculate the closing allowance for irrecoverable debts at the year-end

2. Calculate the difference between the closing allowance and the opening allowance
(brought forward from the previous accounting period)

3. The difference is posted as a journal entry to the allowance for irrecoverable debts
ledger. The corresponding account is the irrecoverable debts expense account.

If the closing allowance is more than the opening allowance, the journal entry to record the
adjustment is:
 General ledger account Catego Explanation
ry

DR Irrecoverable debts expense Expense Bad debt (expense) increased

CR Allowance for irrecoverable Asset Trade receivables (asset)

debts decreased

Since it has been identified that the closing allowance is more than the opening allowance,
the difference is posted as an irrecoverable debts expense in the statement of profit or loss
(in the same way as an irrecoverable debt written off).

If the closing allowance calculated is less than the opening allowance, the journal entry to
record the adjustment is:

General ledger account Catego Explanation

ry

DR Allowance for irrecoverable Asset Trade receivables (asset)

debts increased

CR Irrecoverable debt expense Expense Irrecoverable debts expense

account decreased

Since the closing allowance is less than the opening allowance, the difference is posted to
decrease the irrecoverable debt expense. The reduced expense will be shown in the
statement of profit or loss.

(Note – while the allowance for irrecoverable debts is described as an asset account, it is a
negative asset, as it reduces the value of trade receivables in the statement of financial
position.)

Example 3

On 31 December 20X5, Aztec made an allowance for irrecoverable debts of $100.

During the year ended 31 December 20X6, $50 of trade receivables was written off as
irrecoverable debts.

Required:

Write up the journal entries, the irrecoverable debts expense a/c and the allowance for
irrecoverable debts a/c assuming that the allowance for irrecoverable debts needed at
31 December 20X6 is:

(i) $180

(ii) $80
Example 3

Solution:

(i) Allowance for irrecoverable debts is $180

DR Irrecoverable debts expense $5

account 0

CR Trade receivables $5
0

Being the write off of trade receivables during the year.

The allowance for irrecoverable debts has increased from $100 at 31 December 20X5 to
$180 at 31 December 20X6, an increase of $80. The journal entries used to record this
are:

DR Irrecoverable debts expense $8

account 0

CR Allowance for irrecoverable $8

debts 0

D
R Irrecoverable debts expense account CR

Debt written off $50

Increase in Transfer to Statement of Profit $13

allowance $80 or loss 0

$13 $13
0 0

DR Allowance for Irrecoverable Debts (Asset) CR

31-Dec- $10
X5 Balance b/d 0

31-Dec- Balance 31-Dec- Irrecoverable debts expense

X6 c/d 180 X5 account $80
Example 3

$18 $18
0 0

01-Jan-
X7 Balance b/d 180

(ii) Allowance for irrecoverable debts is $80

DR Irrecoverable debts expense $5

account 0

CR Trade receivables $5
0

Being the write off of trade receivables during the year.

The allowance for irrecoverable debts has fallen from $100 at 31 December 20X5 to
$80 at 31 December 20X6, a decrease of $20. The journal entries used to record this
are:

DR Allowance for irrecoverable $2

debts 0

CR Irrecoverable debts expense $2

account 0

D
R Irrecoverable debts expense account CR

Debt written $5 $2
off 0 Decrease in allowance 0

Transfer to Statement of Profit $3

or loss 0

$5 $5
0 0

DR Allowance for Irrecoverable Debts (Asset) CR

 Example 3

31 Dec Irrecoverable debts expense 31-Dec- Balance $10

X6 account $20 X5 b/d 0

31 Dec
X6 Balance c/d $80

$10 $10
0 0

01-Jan- Balance $
X7 b/d 80

1.6 Calculating the Allowance

Under IFRS 9, Financial Instruments, an allowance for credit losses must be calculated for
every receivable from the moment of its origination (i.e. the date that the sale is made).
Calculating the allowance involves the use of expected values. This is beyond the scope of
the FA/FFA exam, so you would be told what the allowance should be at the start and end of
each year, if needed.

Example 4

Zan runs a business selling engine parts to the motor industry. Chandni owns a motor
manufacturing business and owes Zan $56,000. Chandni has been disputing the
amount owed for two months. Zan believes Chandni will not pay, so she wants to make
an allowance of 100% against this trade receivable.

Zan has also looked at her aged trade receivables balance and has noted that the
amount relating to other customers who have not paid in the last four months totals
$45,000. She would like to make an allowance equivalent to 3% against these trade
receivables.

This is Zan’s first year in operation. Her financial year-end is 31 st December X2.

Allowance required

$56,000 + ($45,000 x 3%) = $57,350

Since there was no opening allowance, the closing allowance has increased by $57,350.
Example 4

The journal entry for recording this is:

DR Irrecoverable debts expense $57,35

account 0

CR Allowance for irrecoverable $57,35

debts 0

The allowance for irrecoverable debts should be as follows:

DR Allowance for irrecoverable debts CR

31-Dec-
X2 Balance b/d $0

31-Dec- Balance $57,3 31-Dec- Increase in $57,3

X2 c/d 50 X2 allowance 50

$57,3 $57,3
50 50

01-Jan- $57,3
X3 Balance b/d 50

Next Year:

In the following year ending 31st December 20X3, Zan calculated her total closing
allowance for irrecoverable debts as $45,660. What is the year-end adjustment to
record the allowance?

The closing allowance ($45,660) is compared to the opening allowance ($57,350). Since
the current closing allowance is less than the opening balance by $11,690 ($57,350 −
$45,660), the journal entry to record the entry is:

DR Allowance for irrecoverable $11,69

debts 0

CR Irrecoverable debts expense $11,69

account 0

Zan’s Allowance for irrecoverable debts will be as follows on 31st December 20X3:
 Example 4

Allowance for Irrecoverable Debts

DR (Asset) CR

31-Dec- Decrease in $11,6 01-Jan- Balance $57,3

X3 Allowance 90 X3 b/d 50

31-Dec- $45,6
X3 Balance c/d 60

$57,3 $57,3
50 50

01-Jan- Balance $45,6

X4 b/d 60

The closing balance of the allowance for irrecoverable debts (balance c/d) is $45,660.
The amount will be carried forward as the opening allowance in the following year.

1.6.1 Writing off debts where an allowance has already been made

When a debt, against which an allowance has already been made is eventually written off,
the accounting entry is the same as for writing off any irrecoverable expense:

General ledger Catego Explanation

account ry

DR Irrecoverable debt Expense Bad debt (expense) increased

CR Trade receivables Asset Trade receivables (asset)

decreased

You may be concerned that this would lead to the cost of the bad debt being double counted:
first when the allowance is made, and secondly when the debt is written off. However, that is
not the case. When the debt is finally written off, it will also be taken out of the allowance for
irrecoverable debts. A reduction in the allowance leads to a credit to the irrecoverable debts
expense account, which cancels out the expense recognised when the debt is written off.

2.1 Introduction to Payables

2.1.1 Payables Definition

 Definition

Payables are the amounts owed for the cost of purchases or other obligations entered
but not yet paid.

2.1.2 Examples of Payables

 Trade Payables – the main example of a payable is an amount due to a trade supplier
for the credit purchase of goods or services in the ordinary course of business.

Examples of other payables include:

 Bank Overdraft – An overdraft exists where the balance of cash held at the bank is
negative. This sum is repayable to the bank on demand.

 Sales Tax Liability – The amounts owed to the tax authority for sales tax collected on
sales to customers.

 Income Tax Liability – This is the income tax due from profits the business makes.

 Accruals – These are expenses of the business that have been incurred during the
accounting period and an invoice has not yet been received, such as electricity and
rent.

 Other Payables – Examples of other payables are:

o Deferred income (income received for a future period).

o Loans and interest thereon (may include penalty payments).

o Amounts due to group companies.

o Salaries and wages earned by but not yet paid to employees.

o Dividends declared by a company but not yet paid to shareholders.

2.1.3 The Payables Ledger

In a computerised system, the payables ledger (sometimes referred to as the Payments

module) contains all the individual supplier accounts (which are not part of the general
ledger), where details of all transactions with that supplier are recorded so that individual
supplier balances can be monitored. The individual account balances will be reconciled with
statements received from suppliers to ensure accuracy and reliability. Supplier statement
reconciliations are discussed later in this chapter. When a transaction is entered in an
individual supplier’s account, journal entries are automatically posted to the general ledger
accounts to record purchases and payables.

The balance on the trade payables ledger account in the general ledger is the same as the
total of all balances on the trade supplier accounts in the payables ledger.

2.2 Receivables and Payables Contra

Payables are most commonly settled in cash via bank transfers. In some cases, amounts due
to suppliers also may be settled through contra-entry, where the supplier is also a
customer.

In this case, the parties agree that amounts may be offset. Therefore, only the net amounts
are settled in cash. The journal entry to book the contra adjustment via the journal is as
follows:

General ledger Catego Explanation

account ry

DR Trade payables Liability Trade payables (liability)

decreased

CR Trade receivables Assets Trade receivables (asset)

decreased

Once the contra entry takes place, only the difference is reflected in the trade receivables or
trade payables account.

Exam advice

The amount of offset must be the lower amount.

Example 5

Company A owes $1,000 to company B, and company B owes $1,200 to company A.

The two parties agree to offset their accounts.

Company A’s ledger

The journal entry in Company A’s ledger accounts is:

DR Trade payables $1,00

0

CR Trade $1,00
receivables 0

Company A’s receivable balance is $1,200, and its payable balance is $1,000.

After the contra entry, Company A’s receivable balance is $200, and its payable balance
is zero. Company B only owes Company A $200.

Company B’s ledger

The journal entry in Company B’s ledger accounts is:

 Example 5

DR Trade payables $1,00

0

CR Trade $1,00
receivables 0

Company B’s receivable balance is $1,000, and its payable balance is $1,200.

After the contra entry, Company B’s receivable balance is zero, and its payables
balance is $200. Company A no longer owes Company B any amount.

2.3 Supplier Statements

A supplier of goods or services will send customers a monthly statement (similar to a credit
card statement) showing what is owed. A supplier statement is one of the financial
documents discussed in Chapter 4.

The supplier issues the statement of accounts (supplier statement) at each month’s
end. The statement of account shows the outstanding balance at the month’s end. It
includes the opening balance plus the invoices raised by the supplier during the month, less
any credit notes and payments received by the supplier.

Example 5

Sweety Sweets runs a confectionery shop and purchases chocolate bars from Puja
Chocolate Supplies. At the end of each month, Puja Chocolate Supplies sends Sweety
Sweets a statement outlining the invoices still needing to be settled.

The statement sent by the supplier would look as follows:

Example 5

The supplier statement of account highlights several items:

 Supplier’s details– The supplier’s name, address, phone, fax and sales tax
registration number are shown in the statement.

 Customer’s details– The customer‘s name and address are displayed.

 Received Stamp – The business will stamp the statement to show the date the
statement was received.

 Transaction list – The statement will highlight all the invoices, credit notes and
payments between the business and the supplier.
 Example 5

 Debits and Credits – Since the statement is from the supplier’s perspective,
debits are the amount the business owes to the supplier (opening balance and
invoices). In contrast, credits are the amounts that reduce the outstanding
balance (credit notes and payments).

 Total Amount Due – The statement highlights the total amount owed from the
business at the end of the month.

 Credit Terms – The credit limit and payment terms are highlighted in the
statement.

2.4 Supplier Statement Reconciliation

Definition

A supplier statement reconciliation is a reconciliation between the supplier’s

balance in the individual payables ledger account and the supplier statement.

The individual payables ledger account represents the balance outstanding to a supplier. It is
the value of supplier (purchase) invoices received, less credit notes and payments to the
supplier.

The supplier account and the supplier statement balance should match as both show the
amount owed from a business to the supplier. However, these balances may differ due
to timing differences or entry errors.

Differences may arise due to timing differences, such as:

 Supplier has recorded invoices or credit notes that a business has not received

 Payments were made to the supplier after the Supplier Statement was generated

 Payments made but not yet received by the supplier

Differences may also occur due to the business or supplier making erroneous entries, such
as:

 omitted recording invoices, credit notes, or payments made

 making transposition errors when entering information from the supplier (purchase)
invoice (For example, $56 is entered into the system as $65)

 allocating the supplier (purchase) invoice against the wrong supplier

 not updating the accounting records for settlement discounts taken

 recording document information twice (duplicate entry)

Reconciliation between these two balances is needed to verify between internal information
(supplier account) and an external source (supplier statement).

Although supplier statements, as external documents, are a reliable source of information,

errors may still appear. These errors should be communicated to the supplier quickly and
professionally to ensure the business sustains no monetary losses and maintains a good
relationship between the parties.

2.4.1 Reconciliation

A business will want to ensure that its liabilities are wholly and accurately recorded and that
it does not overpay. Therefore, it will reconcile the supplier's statement periodically and
adjust (accounting entries) for any errors.

Example 6

Sweety Sweets (Sweety) receives a statement of account from Puja Chocolate Supplies
(Puja), which shows an outstanding balance of $588.42 at the end of the month.

However, the individual payables ledger account for Puja in Sweety’s system shows an
outstanding balance owed to Puja of $873.55.

The transactions that agree are highlighted, and any missing transactions are noted.

Upon investigating, Sweety noticed the reasons for the difference:

1. Credit Note 258, worth $258.13, was not recorded in Puja’s individual payables
ledger account but reflected in the supplier statement.
Example 6

2. The supplier statement incorrectly recorded Invoice 19892 as $458.13 instead of

$485.13, with a difference of $27.

The missing credit note is recorded in Puja’s account and automatically updated to the
general ledger accounts with the journal entry: DR Trade Payables $258.13, CR
Purchases $258.13.

The revised balance on Puja’s account is $615.42 ($873.55 − $258.13) and is the
correct trade payable balance to be reported in the Statement of Financial Position.

A Supplier Statement Reconciliation is prepared:

Reconciliation of Puja Chocolate Supplies Payables

Balance per individual payables ledger account 615.42

Adjustments – to Payables Ledger

Add: Invoice -

Less: Credit Note -

Less: Payment made -

Corrected balance per Payables Ledger

Adjustments – to Supplier Statement

Less: Invoice -

Add: Credit Note -

Add: Payment made -

Less: Invoice 19892 error (27)

Balances per Supplier Statement 588.42

Several reasons the supplier statement balance did not agree with the individual
payables ledger account are summarised in the table below.

Type of Difference Reason for occurrence Action Plan

Payments made by Sweety made payment to This timing difference between

Sweety but not Puja, which has not been Sweety’s and Puja’s records will
received by received or recorded yet. resolve itself when Puja receives
Puja(payments in
Example 6

transit) the cash in the following month.

Omitted invoices Invoices have been sent Sweety records are incorrect,
by Puja but not recorded/ and the ledger should be
received by Sweety. adjusted.

Omitted credit notes Credit notes have been Sweety records are incorrect,
issued by Puja but have and the ledger should be
not been recorded by adjusted.
Sweety yet.

Other input errors Sweety or Puja may input If Sweety made the error, the
the invoice, credit note or error is corrected in the ledger.
payment amount
If Puja made the error, include
incorrectly in the
the error in the reconciliation
accounting system.
under adjustments to the
supplier statement and inform
the supplier promptly