Sales and receivables

This chapter looks at how to record transactions and events related to sales and receivables.

Learning objectives

By the end of this chapter, you should be able to:

• Record sales transactions and sales returns in the general ledger accounts.
• Identify and explain examples of receivables.
• Identify the benefits and costs of offering credit facilities to customers.
• Describe the purpose of an aged receivables analysis.
• Describe the purpose of customer credit limits.
• Account for the following discounts allowed to customers: trade and settlement discounts

Sales

Definitions

Sales

Also known as revenue: income arising from the sale of products and/or services to customers in the normal course of business.

When a business makes a sale, it can either receive cash immediately or allow the customer to pay later.

• Sales where payment is received immediately are called cash sales.
• Sales where payment is received at a later date are called credit sales.

Receivables

Credit sales create receivables. These are first recorded in the sales daybook and supported by sales invoices issued to customers.

Definitions

Receivables

Amounts due from customers (debtors), recorded in the receivables ledger, a personal ledger.

Each customer’s account shows the amount owed from credit sales. The balance reduces whenever the customer makes a payment, so the account reflects the outstanding amount due.

Summary: double-entry for sales (ignoring sales tax)

Below is a summary of the journal entries based on the double-entry bookkeeping for sales.

1. For every cash sales:

   Debit: Cash and bank ledger account

   Credit: Sales or revenue ledger account

2. For every credit sale:

   Debit: Receivables ledger account

   Credit: Sales or revenue ledger account

3. For every subsequent cash payment made by a customer for an earlier credit sale:

   Debit: Cash and bank ledger account

   Credit: Receivables ledger account

Why companies sell on credit

• Companies sell on credit to increase sales volume by attracting customers who are more willing to buy when payment is deferred.
• Offering credit provides a competitive advantage by delivering payment flexibility that improves customer satisfaction.
• Credit terms promote customer retention by fostering long-term business relationships

Costs or effect of selling on credit

• A significant portion of cash flow becomes tied up in receivables, potentially impacting funding for growth plans.
• Risk of customers defaulting on payments.
• May need external financing to maintain operations while awaiting customer payments, resulting in interest cost.
• Costs of evaluating customer creditworthiness

Controlling credit risk

A credit limit is the maximum balance a customer is allowed to owe at any time. Before granting credit, a business assesses a customer’s creditworthiness and sets a limit that caps its exposure to default; orders that would push a customer’s balance over this limit are held or referred for approval before being fulfilled.

An aged receivables analysis lists each customer’s outstanding balance split by how long it has been outstanding (for example, current, 30-60 days, 60-90 days, and over 90 days). It helps a business target the chasing of overdue debts, spot customers who are breaching their credit terms, and identify balances that may need to be written off as irrecoverable.

Other factors or activities that affect receivables

So far, we’ve treated receivables as if they only reduce when customers pay. In practice, other events can also change the amount due. For example, customers may return goods, some may default, and others may receive discounts for prompt payment.

Sidenote

Factors affecting receivables

Specifically, we shall focus on the following factors:

• Sales returns
• Discounts

Irrecoverable debts and the allowance for irrecoverable debts are covered in a later chapter.

Sales returns

Definitions

Sales returns

Also known as returns inwards, these are goods sold by the business but returned by customers due to damage, inferior quality, excess quantity, among other possible reasons. Customers are issued credit notes upon return of the goods.

Sales returns are recorded in the sales returns daybook. If the customer has already paid for the goods being returned, the business may need to refund the payment, depending on the business’s sales return policy.

In this chapter, the main focus is on sales returns that relate to a receivable (i.e., credit sales). A sales return reduces the amount owed by the customer, so it affects the receivables balance that was recorded earlier.

Journal entry for sales returns

Based on this, for any sale returns, the journal entry will be:

Debit: Sales returns ledger account

Credit: Receivables ledger account.

Discounts

Businesses sometimes offer discounts to customers and also receive discounts from suppliers. When a business offers a discount to a customer, it is described as a discount allowed. When a business receives a discount from a supplier on purchases, it is referred to as a discount received.

Discounts are classified into

1. Trade discounts
2. Cash settlement discounts.

Definitions

Trade discounts

A trade discount is a reduction in the listed price of goods or services, usually based on purchase volume, order frequency, or promotional offers. It is commonly given by manufacturers or wholesalers to retailers or distributors.

Since the discount is automatic and certain, sales are always recorded at the net amount (after deducting the trade discount).

Cash settlement discounts

Also called cash discounts, these are reductions offered to credit customers as an incentive for early payment. For example, a business may offer a 5% discount if payment is made within 30 days of sale.

Unlike trade discounts, cash discounts are uncertain at the time of sale because it depends on whether the customer pays within the discount period.

Treatment of cash settlement discounts

Under IFRS, cash settlement discounts are treated as reductions in revenue. IFRS 15 Revenue from Contracts with Customers requires that:

• revenue should be recognised net of any discounts offered where customers are expected to make early payment.
• revenue should be recognised gross of any discounts offered where customers are not expected to make early payment.

In both cases, if the actual settlement differs from the expectation used when recording the sale, an adjustment is made to reflect the actual outcome.

Exam tip: A settlement discount allowed to a customer adjusts revenue - it’s never recorded as a finance expense. A trade discount is never recorded in the ledgers at all; it’s deducted before the net sale amount is posted.

Example of a cash settlement discount transaction

A clothing manufacturer issues an invoice for $1,000 to a credit customer with payment terms of 2% discount if paid within 10 days. The customer who owes $1,000 is entitled to a discount amount of $20 (i.e., $1,000 × 2%) if he decides to make payments within 10 days.

Scenario 1: where there are expectations of the customer paying within the discount period

If management has strong reasons to believe that the customer would make payment within the 10-day period, then the sales/revenue and receivables would be recognised as the net of the discount. The journal entry would be:

	Debit	Credit
Receivables	$980
Revenue		$980
Being credit sales net of 2% discount

Scenario 2: where there are no expectations of the customer paying within the discount period

Using the same example, assume management has strong reasons at the time of sale to believe that the customer would not pay within the 10-day discount period. In that case, the sales/revenue and receivables to be recognised would be the gross of the discount. The journal entry would be:

	Debit	Credit
Receivables	$1,000
Revenue		$1,000
Being credit sales

Upon actual settlement

If the customer’s actual payment timing matches management’s original expectation, no adjustment is needed - the amount received equals the amount already recognised. If it doesn’t match, the revenue recognised earlier was based on the wrong expectation and needs to be adjusted so it matches the amount the customer actually pays: $980 if paid within 10 days, or $1,000 if paid later. The table below shows the settlement entry for each combination of expectation and actual payment timing.

Actual payment timing	Scenario 1: recognised net ($980)	Scenario 2: recognised gross ($1,000)
Paid within 10 days	Dr cash $980; Cr receivables $980 (no adjustment needed)	Dr cash $980, Dr revenue $20; Cr receivables $1,000
Paid after 10 days	Dr cash $1,000; Cr receivables $980, Cr revenue $20	Dr cash $1,000; Cr receivables $1,000 (no adjustment needed)

Self review questions

Jentro Company Limited had the following transactions during March 2023. You are required to prepare journal entries for all transactions.

1. Sold goods to Johnson Ltd on credit for $15,000 and offered a cash settlement discount of 2%. Management had expectations that the customer would not make a payment within the policy period.

Do you know the answer?

2. Sold merchandise to Smith & Co on credit for $12,000. Smith & Co has been a loyal customer, hence was offered 2% discount off the normal price.

Do you know the answer?

3. Received cash from Johnson Ltd $14,700, being the full settlement of the amount owed (assume that payment was made within the discount policy period).

Do you know the answer?

4. Smith & Co returned goods worth $2,000.

Do you know the answer?

Refer to ACCA technical write-up on discounts written by a member of the examination team.