More on sales and receivables

1 Introduction

This chapter looks in a little more detail at sales transactions and the receivables ledger

2 Recap of the receivables ledger system

Entries in the receivables ledger arise from two main sources:

• The sales day book (SDB), where new credit sales are first recorded.
  

• The cash book(CB) where receipts from credit customers are first recorded (in the receivables ledger column, on the debit side)
  

Additionally there will be occasional postings made from:

• The journal (eg the offset of debts to an account in the payables ledger)
  

The entries made from the sales day book will be:

• Dr   Receivables control account with the total of the SDB gross amount column
  

• Cr   Sales Account with the total of the SDB net amount column
  

• Cr   Sales Tax Account with the total of the SDB sales tax amount column.
  

In addition, each line in the gross column of the SDB will be used to Debit individual accounts in the Receivables Ledger so as to record exactly who owes what.

The entries made from the cash book will be:

• Cr   Receivables control account with the total of the Receivables Ledger column
  

In addition, each line in the Receivables column of the Cash Book will be used to Credit individual accounts in the Receivables Ledger so as to record exactly who has paid.

The accounting documents used are:

1. When sales are made, invoices will be issued to customers
   

2. Statements will be sent regularly to customers, setting out what is owed and what has been paid.
   

3. Remittance advices will be received from customers when they pay to explain which invoices are being settled.

3 Credit control

Credit control is the name given to the process of trying to ensure that cash is eventually received for all credit sales.

The process starts with a new customer applying for credit and this should initiate some investigation, such as:

• Asking for the applicant’s recent financial statements.
  

• Enquiries to a credit reference agency to see if the applicant has any history of poor payments.
  

Based on these investigations, the applicant will be accepted or rejected. A credit limit should be set for all customers.

Once credit sales have been made, each customer should be encouraged to pay according to the terms of the contract. There are three ways of proceeding:

• Send statements. These often act as a gentle reminder about what’s due.
  

• Settlement discounts. For example, pay 5% less if paid within 30 days.
  

• Prepare aged receivables analyses and act accordingly on the information contained there.
  

4 Settlement discounts

For example, an invoice is issued to DFH Ltd for $700 on 2^nd January 2013 with terms offering a settlement discount of 5% if settled within 30 days. The invoice was paid on 25^th January 2013. Therefore, because it was paid on time the amount due will be $700 x 95% = $665.

The discount of $35 is an expense of the business. The customer has been ‘let off’ $35 for prompt payment.

The entries in DFH Ltd’s account would be:

The settlement discount is debited to the Discounts Allowed account in the general ledger. This is an expense account.

Occasionally there is a memorandum settlement discount column in the cash book so that, in the case above, $665 would be the amount of cash received and $35 would be entered in the memorandum column. The sum of the memorandum discount column would be debited to the Discounts Allowed account.

It is important to realise that the receivables control account should always reflect in total whatever happens the individual accounts. So, if a customer is given a settlement discount, this must also be credited to the control account.

For example, consider a company with just three customers:

You will see that, the control account balance agrees with the sum of the individual balances in the receivables ledger ($1,300 = $700 + $400 + $200)

Each is entitled to a settlement discount of 5% if the amounts are paid within 30 days. ABC Ltd and DEF Ltd pay within this time limit; GHI does not and pays only $100 of what is owed.

A cash book extract would be:

Posting the cash book:

• Discount column total ($55): Dr Discounts allowed account $55, Cr Receivables control account $55.
  

• Receivables ledger column total ($1,145): Cr Receivables control account $1,145.
  

• Each customer's line (the ringed discount and receivables ledger amounts): post to the individual accounts in the receivables ledger.
  

Note that the sum of the individual balances (now GHI Ltd only) still equals the balance on the control account.

Note that a settlement discount is entirely different to a bulk or trade discount. The bulk or trade discount is to all intents and purposes a straight reduction in the selling price and the only amounts ever invoiced or treated as a sale are after the discount has been removed.

With a settlement discount, the sales and the invoices are for the full amount (after the trade discount) and the discount is contingent upon prompt payment.

5 Discounts received

Everything above is the seller's side. Now look at the same transaction from the buyer's side. When the business is the customer and takes a settlement discount for paying a supplier early, the discount is a discount received. It is income, not an expense: the business has been let off part of what it owed.

The account is the Discounts Received account in the general ledger, and the posting is the mirror image of discounts allowed:

Illustration. On 3 May the business receives an invoice from PQR Ltd for $2,000 offering a 4% discount for settlement within 20 days. It pays on 19 May.

The business pays $2,000 x 96% = $1,920 and is let off $80. PQR Ltd's account in the payables ledger is:

and in the general ledger Dr Payables control account $80, Cr Discounts received $80 - so the control account still agrees with the sum of the individual balances, exactly as it must when a discount is allowed.

As with a settlement discount allowed, a trade or bulk discount received is different: it is simply a reduction in the purchase price. The invoice is for the net amount and that net amount is what is debited to Purchases. It never reaches a Discounts received account.

6 Aged receivables analysis

This looks at all the invoices still owed by customers and displays them in age categories.

Typically the age categories are something like:

≤ 30 days

30 to ≤ 60 days

60 to ≤ 90 days

90 to ≤ 180 days

> 180 days

Usually, the older an unpaid debt becomes, the less likely to be paid. Also, as debts become older more extreme action is likely to be taken to try to force payment. For example, final warnings, then taking customers to court.

The layout of an aged analysis is usually something along the lines of:

7 Irrecoverable (bad) debts

Sometimes, despite all efforts to sell only to credit-worthy customers and to follow up old amounts carefully, it becomes clear that a debt is irrecoverable and no money will ever be received. Perhaps the customer has gone into liquidation (or simply disappeared!)

There is then no point in continuing to record the debt as a receivable (an asset) when it is worthless: the amount should be written off, ie reduced to zero. This is an expense to the business and will be recorded in an irrecoverable debts account (sometimes called a bad debts account).

As always, whatever adjustment you make to an individual debtor you must make to the receivables control account too. Writing off bad debts is one use of the journal.

Look at this example:

One of the receivables accounts in the receivables ledger is:

It has been decided that none of the $3,800 due from Badone Ltd will be recovered and that this amount should be written off.

The journal to do this is:

The accounts would then be:

One of the receivables accounts in the receivables ledger is:

8 Irrecoverable (bad) debts and sales tax

Debts are not usually written off until all reasonable hope of recovery is gone and this usually takes time. Sales tax will probably have been charged on the sales giving rise to the debt, and will have been paid over to the government. Now it is clear that the sales tax will never be collected from the defaulting customer.

Where the tax authorities allow it, the seller can reclaim the sales tax that was charged on a debt which has been written off. FA2 examines a generic sales tax, so assume the relief is available unless you are told otherwise.

So, if the $3,800 above contained sales tax at 20%, the sales tax content of that debt would be $3,800/6 = $633.33 and the net amount of the sale would be 3,166.67 (check: 3,166.67 x 20% = $633.33).

Therefore, the cost of the irrecoverable debt is reduced by the sales tax amount as follows:

The debit to the sales tax account will reduce what has to be paid to the government in the future, so gives tax relief on the irrecoverable sales tax.

9 Allowances for irrecoverable debts

Once a write-off occurs the debt is, in effect, forgotten about and will not be pursued. However, before that stage is reached it will often begin to look unlikely that the debt will be recovered, but the company does not yet want to give up all hope and does not want to write off the debt. Nevertheless, to value the debt at its full amount would be over-optimistic.

In this case, an allowance can be made to reduce the value of the receivables. The allowance can be calculated using a combination of approaches:

• A specific debt is identified as ‘doubtful’. This will be a specific allowance for irrecoverable receivables.
  

• Historical experience might suggest that, say, 4% of debts generally have to be written off, though we do not know now which ones these will be. This might sometimes be known as a general allowance for irrecoverable receivables.
  

The allowance will be a credit balance in an Allowance for Irrecoverable Debts Account and is netted off against the receivables amount in the statement of financial position. Setting up the allowance is an expense because the allowance reduces the value of an asset. The expense is debited to the Irrecoverable Debts Expense Account and hence to the statement of profit or loss.

The adjustment is made by journal, in the same form as the write-off journal above. To create an allowance, or to increase one:

To reduce an allowance, reverse it: Dr Allowance for irrecoverable debts, Cr Irrecoverable debts expense - the credit reduces the expense in the statement of profit or loss, and can even turn it into income if the reduction is bigger than the debts written off in the year.

Note what is journalled: only the MOVEMENT in the allowance, never the whole closing allowance. Work out the allowance you need at the year end, compare it with the balance brought down, and journal the difference.

Say that at the end of the next period of account, receivables are $140,000. Of this, an amount of $10,000 is to be written off, there is to be a specific allowance for irrecoverable debts of $15,000 and a general allowance for irrecoverable debts of 5%.

Any change in the Allowance for Irrecoverable Debts Account is posted to the Irrecoverable Debts Expense Account.