Trade and Other Receivables

Every time a business sells on credit it creates a debtor — and with debtors comes risk. This study unit covers everything that happens after the sale: encouraging early payment with discounts, charging interest on overdue accounts, writing off bad debts, and managing the allowance for credit losses.

1. Trade debtors and credit transactions

A credit transaction is a sale where the buyer does not pay at the time of the sale. The person or business who owes money to the entity is a trade debtor. The period within which the debtor must pay is the credit term (e.g. 30 days from date of invoice).

Because some debtors inevitably fail to pay, most entities that sell on credit take two steps to protect themselves: they offer discounts to encourage early payment, and they create an allowance for credit losses to anticipate future bad debts.

2. Settlement discount granted

Settlement discount is offered to encourage debtors to pay within the credit term. It is conditional — the debtor only earns the discount by paying on time.

3. Interest charged on overdue accounts

If a debtor does not pay within the credit term, many entities charge interest on the outstanding balance. This interest is income for the seller and increases the debtor’s account.

4. Credit losses — direct write-off

When management determines a specific debt is irrecoverable, it must be written off immediately. The debt becomes a credit loss (expense) and the debtor’s account is cleared.

5. The allowance for credit losses

Because it is impossible to know in advance exactly which debts will go bad, many entities create an allowance for credit losses — a general provision based on the estimated percentage of debtors that will not pay. This is a contra-asset account: it always has a credit balance and is deducted from the Debtors control account on the SFP.

At year-end the allowance is reviewed and adjusted to the required balance. Three situations can arise:

6. Creating the allowance — Trio Traders

At 30 June 20.0, outstanding debtors total R20 000. The financial manager sets the allowance at R800.

7. Increasing the allowance

The following year, Trio Traders has debtors of R30 000 and credit losses of R730 already written off. The allowance must increase from R800 to R1 200.

At year-end the Credit losses account shows the total charge for the year: R730 (actual write-offs) + R400 (allowance increase) = R1 130 — all closed to profit or loss.

8. Decreasing the allowance

The following year, Trio Traders has debtors of R25 000 and R960 in credit losses already written off. The allowance must decrease from R1 200 to R1 000.

9. Writing off when an allowance exists — Method 2

When an actual bad debt is identified and an allowance exists, there are two methods. FAC1502 primarily uses Method 2: write off directly to the Credit losses account (same as without an allowance), then adjust the allowance to the required balance at year-end separately.

10. Recovery of credit losses

Sometimes a debt that was previously written off is unexpectedly recovered. When this happens:

1. Open a Credit losses recovered account (income)
2. Dr Bank / Cr Credit losses recovered

11. Presentation on the Statement of Financial Position

Debtors are classified as current assets — the entity expects to collect them within one year (the normal business cycle). Under IFRS, trade and other receivables are shown net of the allowance.

12. The debtors control account

The debtors control account in the general ledger is a summary account. It is updated monthly from the journal totals. The individual debtor accounts are maintained in the debtors ledger (subsidiary ledger), which is updated daily from the journals.

13. Allowance adjustment calculator

Enter the existing allowance balance and the required new balance to calculate the adjustment entry needed.

14. Worked exercises

Trade receivables questions in the FAC1502 exam style.

15. Quick quiz

Twelve questions covering the full study unit.