Chapter 10 Trade Receivables

Question 1

Define the term trade receivables

Answer 1

Trade receivables refer to the amounts owed by customers who buy goods and services from businesses on credit.

Question 2

Why do businesses grant credit to customers?

Answer 2

A business grants credit to its customers to encourage customers to buy goods and services from it. The business will usually grant 30 to 90 days of credit period to its customers.

Question 3

Explain the term allowance for impairment of trade receivables

Answer 3

Allowance for impairment of trade receivables refers to the estimated amount of trade receivables that is likely to be uncollectible in the future. (1m) It is a contra-asset account and is presented as a deduction against trade receivables in the statement of financial position. (2m)

Question 4

Using an appropriate accounting theory, explain why it is necessary for a business to provide for allowance for impairment of trade receivable

Answer 4

According to the prudence theory, assets and profits should not be overstated while liabilities and losses should not be understated. Thus, at the end of each period, business will review the trade receivables balance to estimate the amount of debts likely to be uncollectible and show it as allowance for impairment of trade receivables to be deducted against the book value of trade receivables. This is to ensure that trade receivables balance is not overstated and reflects the net amount that is collectible.

Question 5

Explain the term impairment loss on trade receivables

Answer 5

Impairment loss on trade receivables refers to the change in allowance, it increases when allowance increases and decreases when allowance decreases. It is an expense item reported in the statement of financial performance.

Question 6

Using an appropriate accounting theory, explain why is it necessary for a business to account for impairment loss on trade receivables

Answer 6

According to the matching theory, expenses incurred must be matched against the income earned in the same period to determine that profit for that period. Hence the business will record the change in the allowance as impairment loss on trade receivables in the same financial period as credit sales was earned to determine the profit for the period.

Question 7

Explain ways that the business could do to reduce the potential risk associated with selling to customer on credit terms

Answer 7

> Improving on the credit granting processes
Offer cash discounts to encourage credit customers to pay promptly
Charge interest on overdue accounts
Increasing its debt collection efforts

Question 8

State factors that a business can consider when assessing credit worthiness of credit customers

Answer 8

> Reputation of customer
Customers’ history of repayment
Economic outlook
Specific industry outlook