Chapter 11

Trade payables and trade receivables

 LECTURE OUTLINE
Chapter 11
Initial recognition and measurement of trade transactions
• Discounts
Subsequent measurement
• Interest on accounts in arrears
Derecognition and partial derecognition
• Payment
• Returns
• Allowance for doubtful debts
• Bad debts write off
• Bad debts recovered
Payables reconciliation
Presentation

Footnote 2
Trade payables and trade receivables

• This chapter mainly deals with transactions that

result from the exchange of trade inventories
between a wholesaler (selling entity) and a
retailer (purchasing entity), under two headings,
namely:

 Trade payables
 Trade receivables
Trade payables and trade receivables
• A trade receivable is a financial asset since a
cash amount will contractually be received with
the settlement.
• A trade payable is a financial liability since a
cash amount will, in accordance with a contract,
be paid with the settlement.
• A purchase contract is a financial instrument
since it gives rise to a financial asset for one
entity and a financial liability for another entity
Trade payables and trade receivables
R Entity’s records (purchasing entity)
Dr K17 Payable W Cr
Date Contra account Fol Amount Date Contra account Fol Amount
2023
16 Jan Trade inventories J1 86 250
and VAT input

W Entity’s records (selling entity)

Dr D11 Receivable R Cr
Date Contra account Fol Amount Date Contra account Fol Amount
2023
16 Jan Revenue and J1 86 250
VAT output
 Initial recognition and measurement

• Revenue and trade inventories are measure at

the invoice amount, excluding VAT*.
• Trade receivables and trade payables are
measured at the invoice amount, including VAT*.

• *If both the purchasing and selling entity are registered VAT
vendors
Initial recognition and measurement

• A purchasing entity will recognise trade

inventories purchased on credit as an asset and
the accompanying trade payable as a liability,

• only if the definition and recognition criteria

of an asset and liability respectively were
satisfied.
Initial recognition and measurement

• A selling entity will, in the case of a credit sale

of trade inventories, recognise the trade
receivable (asset) and the accompanying sale
(income)

• only if the trade receivable and the sale satisfy

the definition and recognition criteria of an
asset and income respectively.
Initial recognition and measurement

Example:

R Entity and W Entity are both registered as vendors in

terms of the VAT Act.
W Entity is a wholesaler and one of the suppliers of products
to R Entity.
On 16 April 2022, R Entity received trade inventories, which
were ordered from W Entity on 12 April 2022. The invoice
amount is R104 880 (including 15% VAT) and is payable on
or before 14 May 2022. The cost price of these inventories is
R56 000 according to W Entity’s records.
Both entities use the perpetual inventory system.
Initial recognition and measurement
W Entity’s records (Selling entity)
2023 Dr Cr
16 Apr Receivable R (SFP) 104 880
VAT output (SFP) 13 680
Revenue (P/L) 91 200

2023 Dr Cr
16 Apr Cost of sales (P/L) 56 000
Trade inventories (SFP) 56 000

R Entity’s records (Purchasing entity)

2023 Dr Cr
16 Apr Trade inventories (SFP) 91 200
VAT input (SFP) 13 680
Payable W (SFP) 104 880
Initial recognition and measurement

• With certain outcomes in mind, wholesalers

grant various discounts to retailers.
• These discounts can comprise one or two of the
following discounts per transaction:

 trade discount
 cash discount
 settlement discount
Initial recognition and measurement

• The discounts are not included in the

accounting records of either the purchasing
entity or the selling entity.

• Recognition occurs from the invoice, of which

the invoice amount reflects the price already
after that discount has been calculated.
Initial recognition and measurement
• Trade inventories purchased are measured at
the invoice price (reduced with trade discount
and other similar discounts), excluding VAT.
• Revenue is measured at the invoice price
(reduced with trade discount and other similar
discounts), excluding VAT.
• Trade receivables and the trade payables are
measured at the invoice price (reduced with
trade discount and other similar discounts),
including VAT.
Initial recognition and measurement

Trade discount

• It is a discount that a supplier grants to selected

customers, especially in respect of large orders.
• It is not included in the accounting records of
either the purchasing entity or the selling entity.
• Recognition occurs from the invoice. The
invoice amount reflects the price after the trade
discount.
Initial recognition and measurement

Cash discount
• Wholesalers might sometimes deem it fit to
encourage customers to purchase more in cash
by granting cash discount to those customers
that pay in cash.
• A cash discount can either be granted to
customers that have an unutilised trade credit
limit or,
• It can be granted to all customers that purchase
in cash.
Initial recognition and measurement
Example:
On 12 January 2022, R Entity, one of the selected customers
of W Entity, ordered a container with 100 units of a specific
product, cash on delivery (COD).
R Entity usually purchases on credit from W Entity and has a
credit term of 30 days.
The normal price for 100 units of the product is R104 880
(including 15% VAT). On 16 January 2022, the goods were
delivered to R Entity’s premises.
The invoice indicates the COD amount, after accounting for the
10% cash discount.
The cost of sale journal is not required
Initial recognition and measurement
W Entity’s records (Selling entity)
2022 Dr Cr
16 Jan Bank (SFP) 94 392
VAT output (SFP) 12 312
Revenue (P/L) 82 080

R Entity’s records (Purchasing entity)

2022 Dr Cr
16 Jan Trade inventories (SFP) 82 080
VAT input (SFP) 12 312
Bank (SFP) 94 392
Initial recognition and measurement
Settlement discount

• Wholesalers might encourage customers, who

should pay only after the elapse of a credit term
of for example 30 days, to pay within seven or
ten days, by granting a settlement discount.
• It can for instance be structured as follows:
 Customers with a credit term of 30 days receive
a settlement discount of 2% if payment occurs
within seven days from delivery.
Initial recognition and measurement

Settlement discount

• If it is probable that the customer will make use

of the settlement discount (since the customer
always made use of the settlement discount
in the past), the wholesaler and the retailer will
recognise the transaction at an amount which is
reduced with the settlement discount.
• If the customer fails to pay in time, an
adjustment will be made.
Initial recognition and measurement

Settlement discount

• If it is unlikely that the customer will make use

of the settlement discount (since the customer
never made use of the settlement discount
in the past), the wholesaler and the retailer will
recognise the transaction at an amount which is
not reduced with the settlement discount.
Initial recognition and measurement
Example:
• On 12 January 2022, R Entity, one of W Entity’s selected
customers, ordered a container with 100 units of a specific
product.
• On 16 January 2022, the goods were delivered to R Entity’s
premises. The normal price of the inventories was R104 880 and
the credit term as 30 days. The invoice indicated that a
settlement discount of 5% is granted if the amount is paid
within seven days. R Entity has always made use of the
settlement discount in the past.
• The cost price of these inventories, according to the records of
W Entity, is R56 000.
• Both entities use the perpetual inventory system.
Initial recognition and measurement
W Entity’s records (Selling entity)
2022 Dr Cr
16 Jan Receivable R (SFP) 99 636
VAT output (SFP) 12 996
Revenue (P/L) 86 640

2022 Dr Cr
16 Jan Cost of sales (P/L) 56 000
Trade inventories (SFP) 56 000

R Entity’s records (Purchasing entity)

2022 Dr Cr
16 Jan Trade inventories (SFP) 86 640
VAT input (SFP) 12 996
Payable W (SFP) 99 636
 Initial recognition and measurement

• What will happen if R Entity does not pay on the 23rd of

January and only pays on the 25th ? I.e. R entity did not
pay within the settlement period of seven days?
Initial recognition and measurement
W Entity’s records (Selling entity)

2022 Dr Cr
23 Jan Receivable R (SFP) 5 244
VAT output (SFP) 684
Revenue (P/L) 4 560

R Entity’s records (Purchasing entity)

2022 Dr Cr
23 Jan Trade inventories (SFP) 4 560
VAT input (SFP) 684
Payable W (SFP) 5 244
Initial recognition and measurement
W Entity’s records (Selling entity)
2022 Dr Cr
25 Jan Bank (SFP) 104 880
Receivable R (SFP) 104 880

R Entity’s records (Purchasing entity)

2022 Dr Cr
25 Jan Payable W (SFP) 104 880
Bank (SFP) 104 880
Subsequent measurement
• Amortised cost

• During the credit term, no interest is accounted for,

therefore amortised cost = outstanding invoice amount
including VAT.

• If debt is not settled within the credit term, interest* is

charged on the outstanding amount at an agreed interest
rate.

• *for the purposes of Acc 1A, the amount of interest will always be
provided to you.
Subsequent measurement
• In the records of the selling entity, the interest
added (charged) in respect of outstanding
amounts satisfies the definition and
recognition criteria of the element income.

• In the records of the selling entity, such

interest income is debited against the account
of the relevant receivable and credited
against the account “interest income on
receivables in arrears”
Subsequent measurement
• In the records of the purchasing entity, the
interest in respect of the outstanding amounts
satisfies the definition and recognition criteria
of the element expenses.

• In the records of the purchasing entity, such

interest expense is credited to the account of
the relevant payable and debited against the
account “interest expense on payables in
arrears”.
Subsequent measurement

Example:
On 1 March 2022, W Entity debited Receivable
R’s account with an amount of R1 836 in
respect of interest charged on the outstanding
debt, since the invoice amount was still due.

• Recognise the journals for W & R entity’s

records.
Subsequent measurement
W Entity’s records (Selling entity)

2022 Dr Cr
1 Mar Receivable R (SFP) 1 836
Interest income on outstanding debt (P/L) 1 836

R Entity’s records (Purchasing entity)

2022 Dr Cr
1 Mar Interest expense on payables in arrears (P/L) 1 836
Payable W (SFP) 1 836
Payables reconciliation

• Every month, payables department of the purchasing entity

prepares a payable reconciliation for EACH payable.

• Every month, the selling entity (wholesaler) sends a statement to

the purchasing entity (retailer) as a reminder to make payment.

• This statement is a representation of the receivables account of

the retailer) in the wholesaler’s records.

• The account for the trade receivable (in the wholesaler’s records)
and the account for the trade payable (in the retailer’s records)
contain on opposite sides comparable entries
Payables reconciliation

• The retailer uses this statement to verify the transactions with the
wholesaler.

• This is done by reconciling the payables account of the

wholesaler in the retailer’s records with the statement that is
received from the wholesaler.

• After comparison, any errors of omissions caused by the retailer

are corrected in the retailer’s records by way of correcting
journals which are then posted to the GL.

• Any errors caused by the wholesaler are reflected in the

reconciliation statement for correction by the wholesaler.
Payables reconciliation

Example 11.7:

• R Ltd and W Ltd are both VAT vendors.

• Both entities use the perpetual inventory system.
• R Ltd is the retailer
• W Ltd is the wholesaler
Payables reconciliation
Example 11.7:

R Ltd’s records
Date Contra accounts Doc Dr Cr Balance

20.7
1 Jul Balance b/d 322 000 322 000
2 Jul Trade inventories W117 78 200 400 200
and VAT input
4 Jul Bank EFT 111 178 250 221 950
14 Jul Trade inventories KN W37 8 625 213 325
and VAT input
31 Jul Bank EFT 167 143 750 69 575
Payables reconciliation
Example 11.7:
On 3 August 20.7, the following statement was received from W Ltd:
W Ltd
1 Smith Street, Johannesburg 011 559 1000

Statement of R Ltd - 31 July 20.7

Date Contra accounts Doc Dr Cr Balance

1 Jul Balance b/d 322 000 322 000

2 Jul Revenue and VAT output W117 78 200 400 200

4 Jul Bank EFT 111 178 250 221 950

14 Jul Returns (in) and VAT KN W37 8 625 213 325

output

28 Jul Revenue and VAT output W162 87 400 300 725

Payables reconciliation
Example 11.7:

Additional information:

• Invoice W162 represents the sale of trade inventories by W Ltd

to R Ltd which were delivered and received by R Ltd on 28 July
20.7. R Ltd’s payables clerk inadvertently entered the transaction
into the account of Payable V.
Payables reconciliation
Example 11.7:

Correcting journal

28 Jul Dr Payable V (SFP) 87 400

Cr Payable W (SFP)
87 400

GL account
Payables reconciliation
Example 11.7:

Payables reconciliation* as at 31 July 20.7

20.7 Dr Cr Balance
31 Jul Balance per statement 300 725 300 725
31 Jul EFT 167 not accounted 143 740 156 975
for

*Balance as per statement received from supplier reconciled to the

balance as per payables GL account
Derecognition and partial derecognition

• Payment
• Returns
• Impairment/ bad debts
Derecognition and partial derecognition

Returns

Inventories which have already been recognised in

the records of the purchasing entity as well as the
selling entity show a defect or the goods received
are not in accordance with the specifications of the
order.
Derecognition and partial derecognition

Returns

• The purchasing entity will return the goods

together with a document called a debit note
• This declares the purchasing entity’s intention
to debit the selling entity’s payables account
in the records of the purchasing entity.
Derecognition and partial derecognition

Returns

• Should the selling entity agree, then the selling

entity will issue a credit note
• This confirms that the supplier (the selling
entity) credited the purchasing entity’s
receivable account
Derecognition and partial derecognition
Example:
• On 20 April 2022, R Entity returned some of the trade
inventories that were received on 16 April 2022, to
W Entity. The amount on the debit note is R28 500
(including 15% VAT) and the reason is indicated as
“latent defects”.

• On 22 April 2022, W Entity issued a credit note dated 22

April 2022 to the amount of R28 500 (including 15% VAT)
to R Entity. The cost price of the inventories received
back from R Entity, amount to R10 000 for W Entity.
Derecognition and partial derecognition
W Entity’s records (Selling entity)
2022 Dr Cr
22 Apr Returns (in) (P/L) 24 783
VAT output (SFP) 3 717
Receivable R (SFP) 28 500

2022 Dr Cr
22 Apr Trade inventories (SFP) 10 000
Cost of sales (P/L) 10 000

R Entity’s records (Purchasing entity)

2022 Dr Cr
22 Apr Payable W (SFP) 28 500
VAT input (SFP) 3 717
Trade inventories (SFP) 24 783
Derecognition and partial derecognition

Impairment of trade receivables

• Trade credit is granted to a customer prudently

• However, still a risk (known as a credit risk)
that a trade receivable will not pay the
outstanding amount.
• Due to dishonesty (the receivable “disappears”)
or financial problems as a result of the downturn
of the economy (e.g. COVID 19)
Derecognition and partial derecognition

Impairment of trade receivables

• When it is evident that the trade receivable is

likely to make different or lower payments
• Trade receivable remeasured to reflect the
probable future economic benefits that will flow
from the receivable
• This adjustment is called an impairment of the
trade receivable (allowance for doubtful
debt)
Derecognition and partial derecognition

Impairment of trade receivables

• The entity must recognise a loss allowance at

an amount equal to the lifetime expected
credit losses* on the trade receivables.

• *This amount will be provided to you

Derecognition and partial derecognition

Impairment of trade receivables

To create/increase the allowance for doubtful

debts
 Dr Bad debts expense (P/L)
 Cr Allowance for doubtful debts (SFP)

*no VAT implications

Derecognition and partial derecognition

Impairment of trade receivables

To decrease the allowance for doubtful debts

 Dr Allowance for doubtful debts (SFP)
 Cr Bad debts expense (P/L)

*no VAT implications

Derecognition and partial derecognition

Bad debts

• As soon as (after numerous warnings) it

becomes probable that the trade receivable is
not going to pay its debt
• the trade receivable no longer satisfies the
definition of an asset
• since it is no longer probable that future
economic benefits will flow from the trade
receivable.
Derecognition and partial derecognition

Bad debts

• The write-off of debt as irrecoverable must be

approved in writing by the owner or the credit
manager.

• Bad debts are also referred to as credit losses

that result from the credit risk associated with
trade receivables.
Derecognition and partial derecognition

Bad debts
Such a trade receivable must be derecognised by:
 Dr Bad debts expense (P/L)
 Dr VAT input (SFP)
 Cr Trade receivable: Receivable R (SFP)
Derecognition and partial derecognition

Bad debts recovered

The double entry rules are as follows:

 Dr Bank (SFP)
 Cr Bad debts expense (P/L)
 Cr Vat output (SFP)
Derecognition and partial derecognition
Example 11.8:
• AP Entity conducts business as a retailer that sells goods
for cash or on credit. AP Entity is a registered vendor in
accordance with the VAT Act.
• Trade receivables must be presented on the reporting date
at the amount that will probably be received from the trade
receivables.
• Consequently, during the period between the reporting
date and the date on which the financial statements are
approved, the probable recoverability of each trade
receivable must be evaluated with reference to the lifetime
expected credit losses calculation.
 Derecognition and partial derecognition
Year 1 Balance Write off Allowance Reason/Action
31/12/21
Receivable DP 14 500 14 500 Insolvent
Receivable DY 4 500 4 500 Disappeared
Receivable DD 45 500 25 000 Lifetime expected credit
losses calculation
Receivable DW 80 500 30 000 Lifetime expected credit
losses calculation
Receivable DR 35 500 15 000 Lifetime expected credit
losses calculation
Receivable DN 37 200 20 000 Lifetime expected credit
losses calculation
Other 202 300
receivables
420 000 19 000 90 000
Derecognition and partial derecognition

As at 31 December 2021
 R19 000 of bad debts still has to be written off. (The
credit manager authorised the write-off); and
 the allowance for doubtful debts still has to be created.

Required:
a) Provide the journals to recognise the above.
Derecognition and partial derecognition
2021 Dr Cr
31 Dec Bad debts (P/L) 16 522
VAT input (SFP) 2 478
Receivable DP (SFP) 14 500
Receivable DY (SFP) 4 500
Derecognise receivables DP and DY as per
authorisation by the credit manager.

2021 Dr Cr
31 Dec Bad debts (P/L) 90 000
Allowance for doubtful debts (SFP) 90 000
Recognise an allowance for doubtful debts in
respect of specific trade receivables
Derecognition and partial derecognition

Example 11.8

• Self study: Year 2 (required b)

Presentation

Statement of Profit or Loss

• Bad debts presented in the “Distribution,
administrative and other expenses” line

Statement of Financial Position

• Receivable and allowance for doubtful debts* presented
in the “Trade receivables” line