Chapter 11 - Trade Receivables

Let us now go through another topic - Trade Receivables😀.

💨This topic could most probably come out as part of an adjustment in the 1st question on Profit & loss adjustment or as a question on its own which is pretty rare. 

☝Why do a business have trade receivables?

Ans: Trade receivables arise whenever the company makes a credit sales of goods or services to a customer. The customer is given a period to repay the debt. The journal entry are as such:

💨When a business makes a credit sales:

Dr Trade Receivable        $XX  

Cr Sales Revenue                             $SS

💨When a business receives payment from a trade receivable:

Dr Cash at bank   $XX

Cr Trade Receivable             $XX

When a business gives discount to a customer to encourage customer to pay earlier:-

Dr Discount allowed   $XX

Dr Cash at bank          $XX

Cr Trade Receivable              $XX

💨 Impairment of trade receivables 

Credit Risk is a risk that exist for any business which sells goods/service on credit to customer. It is the risk of not able to collect partially or wholly the amount owed to the business from the credit customer. 

When a debtor cannot pays up, the business will suffer a loss since the goods & services it provided cannot be obtained back. As such, the loss is term : Impairment loss on trade receivables. The loss is recorded in the income statement as such:-

Dr Impairment loss on trade receivable 

Cr Allowance for impairment of trade receivable 

At the end of each financial period, a business reviews its existing trade receivables and calculate how much it cannot received from customer based on objective evidence.

   

Some examples of objective evidence are: - 

💥1. Despite numerous letters to the debtor, the debtor has not responded or gives excuses for not paying up.

💥2. There are market or same industry news concerning the debtor having financial difficulties.

💥3. The debtor sends a dishonoured cheque which cannot be encash.

Because of the factors above, the business will have to maintain an Allowance for impairment of trade receivable account which is recorded in the balance sheet as below shows:-

💨Recording allowance for impairment for trade receivable

If the business doesn't have an allowance for impairment of trade receivable account, the initial recording will be as such: -

Dr Impairment loss on trade receivable 

Cr Allowance for impairment of trade receivable 

Lets try some example to understand this concept:- 

☝Company ABC has total trade receivables of $10,000 for the financial year ended 31 Dec 2020. The management has reviewed and conclude that out of this $10,000,  $3,000 of debt belonging to Company XYZ was deemed irrecoverable and would like to provide for this amount. Company ABC currently does not has an Allowance for impairment of trade receivables account. Prepare the i) Allowance for impairment of trade receivable account and ii) Impairment loss on trade receivable account:- 

Ans: 

** Note that the journal entry did not touch any Trade receivable account, it was just Allowance account and Impairment loss account !

💨📈Using the previous example of ABC Pte Ltd with Allowance for impairment of trade receivable balance of $3,000 as at 31 Dec 2020, fast forward to 31 Dec 2021,  due to the worsening economic condition, the management has determined the trade debtors who are unable to paid up to be $5,000 as at 31 Dec 2021 with the additional $2,000 coming from the debt of Company DEF.

So currently the balance in the allowance for impairment on trade receivable is $3,000 , we need to increase to ------> $5,000 which is an additional $2,000 ($5,000 - $3,000). The journal entry will be as below: 

Dr Impairment loss on trade receivable account            $2,000

Cr Allowance for impairment of trade receivable acc                  $2,000    

The allowance for impairment of trade receivable account has a balance of $5,000 currently ($3,000 from company XYZ and $2,000 from company DEF) as at 31 Dec 2021. ** Did we adjust trade receivable accounts??? No:)

💨📉using the previous example of ABC Pte Ltd with Allowance for impairment of trade receivable balance of $5,000 as at 31 Dec 2021. Lets fast forward to 2022, lets say this time because of news that DEF company has won a big tender contract and is able to pay off its debt of $2,000, henceforth as at 31 Dec 2022, management reviewed the trade receivable and will want the allowance for impairment to consist of the debt from company XYZ which is $3,000. 

Bearing in mind that the balance in allowance for impairment for trade receivable is $5,000 as per prev year adjustment, now that we need to reduce it to $3,000 , prepare the journal entry:- 

Reduction of allowance for impairment of trade receivables:-

Dr Allowance for impairment of trade receivable         $2,000

Cr Impairment loss on trade receivable account                            $2,000

** We are so used to seeing Dr impairment loss that once it changes to Cr Impairment loss, we wonder whats is it, its an entry to reduce expenses:)

💨Now, referring to the previous example, as at 31 Dec 2022, our allowance for impairment of trade receivable account balance is $3,000.

Lets say on 1st Feb 2023, DEF Company was declared bankrupt, and was able to pay $2,000 and the remaining $1,000 is to be written off, prepare the entry. 

💥 Note that, we have previously provided for DEF allowance in the allowance for impairment of trade receivable account.

Henceforth, we will not be debiting to Impairment loss on Trade Receivable account, instead we will adjust only the Allowance for impairment of Trade Receivable account and Trade Receivable account - DEF Company:- 

1st Step - Adjusting for the $2,000 that DEF Company is able to pay :-

Dr Cash at Bank    $2,000

Cr Trade Receivable DEF Company $2,000

 Dr Cash at bank $2,000 Cr Trade Receivable $2,000 for receipt of $2,000

 

2nd Step-Write off of debt of $1,000 by DEF Company.

💥Since there are sufficient balance in the Allowance for impairment of trade receivable to adjust, we can avoid touching Impairment loss account. 

The journal entry will be as such for the write off: -

Dr Allowance for impairment of trade receivable   1,000

Cr Trade Receivable - DEF Company                                     1,000

2 Points to note:

💡 DEF Trade receivable account is nil at the end of their settlement and write off.

💡 Had the writeoff belonged to another trade receivable other than DEF Company let say Company TUV, will the writeoff entry still be the same?

Ans: Yes, the writeoff entry Dr Allowance for impairment of trade receivable and Cr Trade Receivable -TUV will still be the same provided the amount being written off is less than the allowance for impairment of trade receivable balance (i.e. lower than $3,000).

Now lets test your understanding by attempting this question:-

                                                                                                                          

💥Note: when trade receivable - Pickachu paid his outstanding debt, no adjustment was made in the Allowance for impairment of trade receivable. Pls note that even though Pickachu was one of the debts which contributed to the allowance for impairment, any payment from Pickachu or other trade debtor should not result in an adjustment in the allowance for impairment unless it is a write-off.

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Chapter 10 - Non Current Asset

 Welcome to chapter 10 of my POA teacher, which is my blog address for you who ended up here by chance haha lets focus on Non Current Asset or Fixed asset in this topic😊

💨What are Non -Current assets?

Non Current assets are assets that a business uses to assist them to generate income. It can be a machine/property/house/ office equipment or vehicles. 

💨2 types of expenditure related to non current assets:

1. Capital Expenditure 

Capital Expenditure refers to costs to purchase the non current assets. The non current asset costs include all expenses incurred to bring the fixed asset to a working condition such as import duties, insurance,freight & installation costs are included in the fixed asset costs. Capital expenditure provides benefits to the business for more than 1 financial period. It is recorded in the Balance sheet under the non current asset category. 

2. Revenue Expenditure

Revenue expenditure refers to expenses that are used to operate/repair/maintain the fixed asset. Example would be petrol expenses for a non current asset of motor vehicle. The benefit of these exenditure are less than 1 financial period as a result these expenses are not recorded in the balance sheet, they are however recorded as an expenses in the income statement.

💨Double entry for purchasing a capital expenditure

Dr Non current asset     $XX

Cr  Bank/Trade creditor                     $XX

**Ps: Include all costs such as import duties, carriage inwards,installation costs that are incurred in bringing the fixed asset to working condition.

☝What is Depreciation?

 Ans: Depreciation is the allocation of an asset original cost over the useful life of an asset. 

When we depreciate assets, we are applying the matching accounting concept . Rmb that all expenses incurred have to be matched with the income generated within the same financial period? The same applies for depreciation as well --->

Income generated from Non- current Asset  MATCH   with Expenses generated from the same Non- current asset.

☝What are the types of depreciation?

1. Straight- line method 

A Straight line method depreciate non current asset equally throughout its useful life. For E.g. a  Machine bought for $10,000 has a useful life of 5 years, how much is its depreciation expenses per year?  Ans: $2,000 per year ($10,000/5 years)

2.  Reducing- balance Method 

A reducing balance method calculates depreciation based on its Net Book Value(NBV) multiply by the depreciation rate. The NBV is calculated by the initial asset original cost less off the accumulated depreciation. 

For e.g. Calculate the depreciation amount for a machine with $10,000 purchase price having an accumulated balance of $2,000 at a depreciation rate of 20%.

Depreciation amount = (Original cost - Accumulated depn)  X depreciation rate

                                     = (10,000 - 2,000) X 20%

                                     = $1,600  

👀Journal entry for depreciation: - 

Dr Depreciation expenses - Machine           $1,600

Cr Accumulated Depreciation - Machine                        $1,600

 Next, I especially want to focus on the disposal of non current asset which is not difficult once you know the steps, you will laugh if it come out in your exams😂

💨4 steps Disposal of Non-current asset -  

Step 1 -  Create a sale of Non-current asset Account and transfer the original asset costs from non-current asset to the sale of Non-current asset Account.

Step 2 -Transfer the Non current asset's accumulated depreciation expenses thus far from the accumulate depreciation account to the sale of Non-current asset Account

*Depending on the question, if the question specify "no depreciation is charged in the year of disposal", we can safely extract the depreciation amount in the accumulated depn account, otherwise, we will need to pro-rate the depreciation expenses, for e.g. an asset is sold in March and the business finance year is from 1st Jan to 31 Dec, we will need to 

---> Dr Depreciation Expenses $XX

       Cr Accumulated Depn Exp         $XX

(3/12 X yearly depn exp)

Step 3- Charge the proceed of the sales to the Sale of non current asset account, for e.g. cash proceed 

---> Dr Cash at Bank  $XX

       Cr Sale of Non Current Asset  $XX

** May not always be cash, payment could be in the form of an non current asset too. 

Step 4 - Calculate the Gain/loss of the disposal of the non Current asset.

Not very difficult right haha, ok come lets attempt this question for a clearer understanding

☝Test your understanding 

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Chapter 9 - Inventory

 Inventory - every companies need inventory be it a manufacturing or trading one😊. A Service company may need inventory but inventory costs will not be a high porportion of its total costs, a hair saloon may have shampoo or clips but its main costs will still be the hairdressers wages.👩

When a business purchase inventory, the double entry are as such: -

Dr Inventory                                                           XX

Cr Cash at bank/ Trade payable                                                         XX

When a business returns inventory 

Dr Cash at bank/trade payable                       XX 

Cr Inventory                                                                          XX

☝Question: - 

☝ Question - When a customer returns goods why isn't the Cost of sales and inventory account affected? 

Ans: Its because the business like the prev example above has purchases of 200 squids and also sale pf 200 squids which has already take place and cannot be reversed/adjusted.

 Instead we Debit Sales returns when a customer returns goods as, it will reflect a reduction to the business sales as such in the income statement: -

 

☝Question - When do we adjust the inventory account?

Ans: when we return goods back to Suppliers, the double entry is as follow:- 

Dr Trade Creditor/Supplier     $XX

Cr Inventory                                           $XX 

💨Which brings us to the next point, what are the items inside inventory account other than the cost of the product?

1. Freight/transport costs of bringing the good to the company 

2. Import duties or custom duties 

3. Insurance 

4. Packing materials 

5. Salaries paid to workers to process the goods to finished product

💨FIFO - First In First Out    

What is FIFO, it means First In First Out - it is a method to calculate the cost/product as part of the cost of sales. A business say for example that buys & sell Squid -- I like squid lah haha, the purchase price cannot always be the same right? Henceforth how do we determine the cost of the squid everytime we sell? The FIFO method assumes that the cost of the squid that is sold will be based on the earliest purchase  batch of the squid, until the earliest batch of  purchase is finish, then it will move to the 2nd batch of earliest purchase as its cost price.

☝Question - 

The total inventory at month end is $300.

Impairment/loss/Fire

💨Whenver we are asked to value stock, people always say "Lower of cost or Net book value lor, so easy"

But exactly whats that huh?

Let me explain - Cost refers to the initial/historical purchase price that is the price that was sold by supplier to you ;

Net book value would refers to Selling price less additional costs to bring the stock to its current condition. The selling price could be a market price, i.e.  the price that the stock can fetch at current market condition less selling cost.

See if either the costs is lower or the Net Book Value is lower then we will apply the lower of the 2 values.

For e.g. our stock costs is $500 current however its net book value( Selling price - selling costs) is $450, we will have to choose $450.

Henceforth impairment has occured because our stock in our balance sheet current asset is still $500 while the net book value is $450 , a reduction of $50.

we will need to pass our impairment journals : -

Dr  Impairment loss( Income Statement)                  $50 

Cr  Inventory/Stock( Balance sheet)                                        $50

☝Why is impairment needed?

Ans: it is because we need to fulfil the prudence accounting principle in that we should not overstate assets and undervalue our liabilities as this will present a wrong balance sheet information to user of our financial statements. 

☝Ok, what happens when we don't pass impairment losses above? 

Ans: Our profit and inventory values will be overstated by $50.

Test your understanding - try doing this question

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Chapter 8 - Prepayments and Accural

 Lets start on prepayment & accrual:)  Prepayment & Accruals is an important topic, it will definitely come out as part of the income statement adjustment and/or a question on its own. 

💥Why do we need all these accruals & prepayments? 

 If you can recall in earlier topics, when we prepare the income statement & Balance sheet, it was prepared based on an earned/incurred basis in the financial period. 

For income/expenses which are Outside of the period or which are not earned/incurred, we will therefore have to exclude them. This is to satisfy the accrual accounting concept as well as the Matching accounting concept.

💨FYI, matching accounting concept refers to matching the income earned with the expenses incurred for the financial period. 

Expenses first, there are 2 types of expenses namely: (i) Accrued Expenses & (ii) Prepaid Expenses 

(i) Accrued expenses refer to an expense that is incurred in the current financial period which will be paid in the next accounting period. No invoice for this expenses has been received yet however the business has incurred this expenses in the current financial period.

☝Question-  A business financial year end is from 1 Jan 20X1 to 31 Dec 20x1 however the electricity bills is received half yearly from 1st April 20X1 to 30 Sept 20X1. How about the Electricity expenses from 1st Oct 20X1 to 31 Dec 20X1? 

Ans: Accrue the Electricity for this period 

Using the electricity bill from  1st April 20X1 to 30 Sept 20X1 as a proxy for e.g. $600 for 6 mths and accrue them:

Accrue Elect from 1st Oct 20X1 to 31 Dec 20X1: 3/6 mths X $600 = $300

Therefore , we  Dr Electricity Expenses $300 & Cr Accrued Electricity Exp $300 

The electricity expenses will lower the profit and accrued electricity will increase liability in the balance sheet. 

(ii)Prepaid Expenses refers to expenses whereby we paid for the expenses which we have not yet incurred in the financial period. 

☝Question- Company ABC whose financial year is between 1 Jan 20X1 to 31 Dec 20X1 paid for 15 months club membership from Jan X1 to Mar X2 in Jan X1 for $1,500. 

Since from Jan X2 to Mar X2 are considered outside of the financial period, the 3 months payment are therefore prepaid club membership expenses.

Therefore, to record the payment of the club Membership 

Jan X1 : Dr Club Membership Exp $1,500 Cr Cash at Bank $1,50

To remove Jan X2 to Mar X2 expenses 

Dec X1: Dr Prepaid Membership $300 Cr Club Membership Exp $300

The total club membership expenses would be $1,200 while prepaid club membership would be $300. 

Now lets go on to Income, there are 2 types of namely: (iii) Income Receivables & (iv) Income Received in advance

(iii) Income Receivables refers to income which has been earned in the current financial period but will only be received in the next financial period. This could be due to invoicing not done to customer yet which result in the late collection. The revenue for the current financial period should still be recorded. 

☝Question - ABC Ltd earns $100/mth for the rental of tables and chairs to Bebe Restaurant. For the year ended 31 Dec 20X1, the rental income of Nov X1 and Dec X2 had not been received . ABC Ltd has not billed Bebe Restaurant and no records exist.

(iv) Income Received in advance refers to income which has not been earned but received in advance. 

☝Question- ABC Ltd earns $100/mth for the rental of tables and chairs to Bebe Restaurant. For the year ended 31 Dec 20X1, ABC Ltd received 13 months of rental income from Jan X1. 

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Chapter 7 - Trial Balance

 Once all source documents has been recorded in the journals and the journals has been posted to the ledgers, the business can start to prepare the trial balance. 

The trial balance is a balance of all accounts ledger with amount balances at a given date.  

The purpose of a Trial balance is :- 

💥 To check for any arithmetic errors &

💥 Assist in the preparation of financial statements

Lets do a question and do up the trial balance: -

1. Owner Fittbitt contributed $10,000 cash to the business

2. The company purchased stock at $50,000 list price and obtained a trade discount of 10% for hope of continued patronage and larger quantities purchase from supplier TB.

3. Sales of $2,000 were made to Customer C on credit.

4. Rental and electricity of $5,000 each is accrued on a monthly basis. 

1st Step: Prepare the individual ledger accounts : -

Based on the ending balance of the ledger above, we prepare the Trial balance: -

The Debits and Credits has to be equal otherwise, a check have to be made to investigate the reason.

There you go, a trial balance:)

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Chapter 6 - Cash Book

 Lets start on chapter 6- Cash book & Petty cash book. First on Cash book, the cash book may refer to the cash in hand that is being held by the business or the cash inside the bank account. 

Whenver a customer pays up, the double entry will be: -

Dr Cash at bank      $XX

Cr Customer A                   $XX

However, when we introduce cash discount allowed to customer, the double entry changes, for e.g. Customer A pays us $90 for a debt owning of $100 to us, meaning we allowed customer A to enjoy a discount of $10. ($100 - $90). The double entry will be as such: -

Dr Cash at bank                  $90

Dr Discount allowed(Exp) $10

Cr Customer A                                 $100

Lets move onto Supplier next, for supplier, since we will be the one paying them, the discount will be termed as discount received.

Whever we pay a supplier, the double entry will be :- 

Dr Supplier B      $XX

Cr Cash at bank                  $XX

 However, when we introduce cash discount received from Supplier B, the double entry changes, for e.g. when we pay Supplier B for a debt owning of $100 to them, meaning we received a cash discount of $10 from supplier B. (Note: its a Discount received for payment to suppliers & Discount allowed for payment received from customers).The double entry will be as below:-

Dr Trade Creditor - Supplier B     $100

Cr Cash at bank                                                                 $90

Cr Discount Received(income)                                         $10

You may ask what's the difference between a trade discount and a cash discount?

1. Purpose - A cash discount is offered to encourage its credit customer to settle their debts within a shorter time than the credit period given. A Trade discount is given to encourage customer to buy in larger quantities.

2. Calculated - A cash discount is a discount off the invoice price while trade discount are not shown on invoices. For e.g. A cash discount of 20% given to early payment, the original invoice amount is $100. The invoice will still shows $100. 

If a trade discount of 20% given to encourage increase quantities purchase of $100 original price, the invoice will not state $100, instead it will shows $80 in the invoice. 

3. Recording in ledger: - Cash discount are recorded as discount received/allowed while trade discount are not recorded.  

4. Discount given: - Cash discount arises when the customer pays up earlier than his credit terms while a trade discount is given at the sale/purchase of goods, before the invoice is issued. 

Dishonoured cheques 

Dishonoured cheques are cheques that are received from customers which are rejected by the bank, that is no funds inflow. The reasons why a cheque is dishonoured can be found below: -

1. The Cheque has expired - issued more than 6 months ago and no longer valid. 

2. The information on the cheque is incomplete or inconsistent, e.g. no date or signature is not consistent with the authorised version. 

3. Insufficient funds - Supplier who issues the cheque might not have sufficient funds in the bank account.

For e.g. On Receipt of a cheque by customer C for $$40 for a original debt owning of $50, we will pass  the below entries: -

Dr Bank $40

Dr Discount allowed $10

Cr Trade Receivable - Cust C $50

Having informed by the bank that the cheque was dishonoured, we reverse the transaction :- 

Dr Trade Receivable - Cust C $50 

Cr Bank                                                  $40

Cr Discount allowed                               $10

Lets move onto cash book: -

A cash book normally has 3 columns on each side of debit/credit: - Discount allowed/cash in bank/cash in hand on the debit side and Discount received/cash in bank/cash in hand on the credit side.

Normally a payment voucher needs to be filled in before a business can issue out funds to supplier/staff, for receipt of funds, a receipt will normally be issued after funds has been received ----> Source documents.

Questions

On 30 Jun 20X1,an amount received from Customer A of $90 for settlement of an amount owning of $100, the recording to cashbook will be as such: 

** Notice the discount allowed of $10 which will not be entered to bank balance, instead it will be Charged to Discount Allowed Acc @ Dr Discount Allowed $10 at the month end. 

Lets try payment to supplier: -

On 30 Jun 20X1, we made a payment  of $90 to supplier B  for settlement of an amount owning of $100, the recording to cashbook will be as such: 

The double entry will be Dr Supplier B $100 , Cr Discount received $10 & Cr Bank $90

Since we only need to pay $90 for an original owning of $100, the $10 is hence a discount received for the business.  The $10 discount received is also not added to the cash at bank balance but instead is charged off the discount received account Cr Discount received at the month end. 

💥Question: assuming a sales of $100 was made to Customer D, we gave customer D a cash discount of $20 for early repayment, how much sales revenue does the business records in its book?

Answer: $100, since the cash discount was given after invoice has been received, the discount will impact discount allowed - $20 which will be shown as a separate account from the Sales Revenue account. 

Petty Cash fund 

A business sometime keep some sum of money for low value expenditures such as refreshments, transport or toiletries such as toilet paper. 

The amount paid from the fund plus the amount remaining in the fund has to be equal to a fixed sum called the imprest amount or float.

(Float here doesnt refers to A & W float, although it is very tasty to drink)

For e.g. a petty cash fund of $100 paid out $60, the amount remaining of $40 + Paid out amount of $60 will be $100, which is the imprest amount.

The $60 paid out will be reimbursed to the fund such that the imprest amount of $100 is maintained. 

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Chapter 5 - Bank Reconciliation

 Next Chapter Bank Reconciliation, if a question on bank reconciliation were to appear in my O levels, I will be so happy and grinding teeth to teeth😁 That is provided I know how to do!

There are basically 4 steps in a bank reconciliation : -

Step 1. Compare the opening balance of the bank statement and the cash at bank account. Both opening balance  has to be correct in order to start your matching. 

    

The 2 items on the bank statement 1.chq no. 118 and 2.Trfr to supplier A amount has been taken in by the business in their Cash at bank account, whereas the opening balance of the Bank Statement - $5,550 Cr has yet to take in the effect of these 2 transactions. 

This could be due to customer for chq 118 telling the account clerk beforehand and the account clerk posting the trfr to Supplier A in the accounting system before actually processing the payment. 

Nevertheless, by adjusting these 2 entries in the bank statement, the opening balance of the bank statement is the same as the opening balance of the cash at bank account.

Step 2: 

Compare the transactions in the debit column of the cash at bank account against the Credit(Deposit) column of the bank statement &

Compare the transactions in the credit column of the cash at bank account against the Debit(Withdrawal) column of the bank statement. 

The cells highlighted in green were used to adjust the opening balance of the bank statement, henceforth they are considered to be non - reconciling/Ok.  For the cells which are not in green or crossed, we will have to adjust them in later steps.

Step 3: Draw up a revised bank account 

The purpose is to update the cash at bank account with items which appear in the bank statement which are not taken in yet by the business cash at bank account. The interest expense of $50 & Direct deduction - car instalment of $1000 appears in the bank statement but does not appear in the cash at bank account which is why we have to adjust in our cash at bank acc.

Step 4: Prepare a Bank Reconciliation Statement 

Having cleared the items in the bank statement, now the only outstanding are items in the cash at bank account which has not been reconciled or not slash at Step 2. 

Take note that the Credit balance as per bank statement means that your bank statement is positive and that you are taking up items which has been passed in the cash at bank account but not at the bank statement to tie to your revised bank account balance of $3,450.

Done, your bank reconciliation is finished :)

Remenber,  different format applies depending when your bank statement balance is Debit or Credit balance, it is the direct opposite of each other.