ACCOUNTING FOR CURRENT ASSETS ~ CASH AND RECEIVABLES

Introduction

Cash and receivables are financial assets. Specifically, cash, cash equivalents, accounts receivable,
and notes receivable are all considered to be financial assets because they are either:

• Cash

• A contractual right to receive cash or another financial asset, from another entity

(such as accounts and notes receivable).

A financial asset derives its value because of a contractual right, or a claim for a

determinable amount. The physical paper that cash or receivables are printed on has

no value by itself. Their real value is based on what they represent. Receivables result from the sale

of goods and services on credit or through lendings, for which the amount has been fixed

or known (determinable) at the time of the transaction. In contrast, the cash value is not

known in advance for nonfinancial assets such as inventories and fixed assets because

their cash value will depend on future market conditions.

Cash and receivables are also monetary assets because they represent a claim to cash

where the amount is fixed by contract.

Cash

Cash is the most liquid asset and is vital for the solvency of a company.

From an accounting perspective, cash is the most liquid asset a company can possess. A cash balance
indicates that a company has cash on hand and can use that cash however it wishes. Cash includes
more than just the physical traditional bills and coins. Cash can include any other currencies, as well
as undeposited cheques and amounts in a current account.

Cash is classified as a current asset on the balance sheet and is therefore increased on the debit side
and decreased on the credit side. Cash will usually appear at the top of the current asset section of
the balance sheet because these items are listed in order of liquidity.

Any asset that can be liquidated for cash within one year can be included as cash, these are known
as ‘cash equivalents’.

Accrual versus Cash Based Accounting

Cash is one of the most important resources of a business organization. Traditional financial

accounting and reporting is based on the fundamental accounting assumptions of accrual and

periodicity so long as the transacting entity is a going concern.

Incomes and expenses under accrual accounting are recognised when they arise regardless of when

the cash arising from such incomes or expenses are received or paid. Under the accrual accounting
financial transactions and events are recognised when there is objective evidence that the

transactions have expired and when the accounting entity is sure how much is due from/to the

transaction. This is regardless of the financial period in which the resultant cash flow from the

transaction exchanges hands between the transacting parties. Accounting for cash on the other

hand follows the cash basis of accounting. Under this approach to accounting, transactions and

events are recognised only when cash is either received or paid by the accounting entity regardless

of the accounting period that led to transaction for which the cash exchanged.

Cash basis accounting records revenue and expenses when cash enters and leaves the business.

Accounting entries in this regard are taken as either receipts or payments. The most common

financial records prepared under the cash basis of accounting include:

1. The cash book

2. The receipts and payments account

3. The petty cash book

The cash book is prepared when recognising cash transactions of profit-oriented business

enterprises. When a similar financial record is prepared for non-profit oriented organisations, it is

called a statement of receipts and payments or a receipts and payments account. The rationale and

mechanism of preparing the petty cash book falls within the realm of materiality for the above

preceding statements.

1. The Single Column Cash Book

The cash book as observed earlier is used in recognizing cash payments and cash receipts. A single

column cash book is prepared when the transactions of a business entity is solely facilitated through

cash payments and receipts. For such a case, one column on either side of the cash book is required.

The column on the debit side is used in recording cash receipts while the column on the credit side is

required to recognise cash payments.

Single column cash book (T - format)

Date Details Folio Amount Date Details Folio Amount

2. The Double Column Cash Book

This type of a cash book is used when business transactions involve receipt and payment both in

cash and through the business bank account. One of the two columns of the cash book is used in

recognizing cash transactions while the other takes care of bank transactions. This happens both on

the debit side for receipts as well as on the credit side for payments.

Double column cash book (T - format)

Date Details Folio Cash Bank Date Details Folio Cash Bank

3. The Triple Column Cash Book

This is a cash book that reflects three types of transactions: cash, bank and cash discounts. This cash

book is presented like the single or double column cash book only that in addition to the two

columns reflecting transactions settled through cash and the bank, it has an additional column on

either side of the account reflecting cash discount transactions. A discount is an allowance given to

customers in the course of transactions such that they only pay a fraction of the invoice value in full

settlement of the transaction. The difference between the full invoice value and the actual value

paid in full settlement is the discount. Discount received is usually credited into the cash book while

discount allowed is usually debited into the cash book. The only difference between the previous

two types of cash books and the triple column cash book is that the discounts column is never

balanced off but is usually totalled up.

Triple column cash book (T - format)

Disc Disc
Date Details Folio Cash Bank allowed Date Details Folio Cash Bank received

Purpose of keeping three column cash book

1.) Accurate recording of cash discounts allowed (Dr. side) and cash discount received (Cr. side)

2.) Accurate recording of cash and cheque receipts and payments.

3.) Records opening and closing balances at beginning and end of financial year respectively.

4.) Helps detect errors and fraud.

Example:

The following transactions relate to Ekemefuna and his business, Ekemefuna Enterprises, for the
month of September 2015. Prepare a two-column cashbook for the month ending September, 2015.

Date Transaction
Started the month with sh. 249,520 in the cash till and sh. 617,613 in the business bank
1.9.2015 account.
2.9.2015 Paid for local government rates by writing a cheque of sh. 31,317.
5.9.2015 Paid sh. 11,213 and sh. 7,719 over the counter for electricity and water bills respectively.
7.9.2015 Sold goods at sh. 317,500 for credit, cash and bank in the ratio of 5:3:2 respectively.
Made purchases of sh. 240,000 paying, half of it through the bank and the rest in cash.
10.9.2015 In addition, credit purchase of sh. 180,000 were.
11.9.2015 Made cash and bank collections from debtors of sh. 74,500 and sh. 86,300 respectively.
12.9.2015 Made payments of wages through the bank of sh.72,500.
14.9.2015 Received a cheque of dividends of sh. 33,400 from one of the investments.
17.9.2015 Borrowed a 5% 10-year loan of sh. 500,000 from ABC Commercial bank.
Used the loan proceeds to pay a deposit for motor vehicle acquisition by writing a
19.9.2015 cheque of sh. 312,000.
21.9.2015 Wrote a cheque of sh. 73,000 to one of the credit suppliers.
23.9.2015 Paid sh. 45,000 cash to a plumber for repairs done to the shop building.
25.9.2015 Bought shop office consumables in cash for sh. 21,000.
26.9.2015 Paid wages to the shop clerks of sh. 72,500 in cash.
Made sales of sh. 210,000 with 20% being on credit and the rest through cash and the
28.9.2015 bank account in the ratio of 2:3 respectively.
Collected sh. 56,000 in cash from a credit customer and withdrew sh. 50,000 from the
30.9.2015 business bank account for personal use.

Solution

Example
The following details belong to JJ Wholesalers. Prepare a two-column cashbook for the month
ending March, 2013.

01/03/2013: Started business with capital inform of cash Sh. 100,000.

02/03/2013: Paid rent by cash Sh 10,000.
03/03/2013: Received Loan of Sh 500,000 via cheque from Barclays bank.
04/03/2013: Paid Kenya Motors Sh 65,000 by cheque.
05/03/2013: Made Cash sales of Sh 98,000.
07/03/2013: Nathan a debtor paid us by cheque Sh 62,000.
09/03/2013: Paid Bakes Ltd in cash Sh 22,000.
11/03/2013: Made cash sales paid directly into the bank for Sh 53,000.
15/03/2013: Gilbert paid us in cash Sh 65,000.
16/03/2013: Took Sh 50,000 out of the cash till and deposited it into the bank account.
19/03/2013: Made loan repayment of Sh 100,000 by cheque to Barclays Bank
22/03/2013: Made cash sales paid directly into the bank for Sh 66,000.
26/03/2013: Paid motor expenses by cheque Sh 12,000.
30/03/2013: Withdrew Sh 100,000 cash from the bank for business use.
31/03/2013: Paid wages in cash for Sh 97,000.

Solution

Example
Michael Kamau runs a general grocery shop in Nairobi. The following transactions relate to the shop
for the month of September 2017.

Sept 1st : Cash in hand Sh. 31,400; Bank balance Sh. 50,800; Capital account Sh. 82,200
Sept 3rd: Bought goods in cash for Sh. 8,200
Sept 4th: Purchased goods on credit from Jambo ltd for Sh. 11,600 less 10% trade discount.
Sept 7th: Sold goods on credit to Simon at Sh. 17,800 less 20% trade discount.
Sept 10th: Withdrew cash from the bank amounting to Sh. 1,000 for private use.
Sept 12th: Sold goods on credit to Eric at Sh. 12,800.
Sept 14th: Paid Sh. 10,000 in cash to Jambo ltd in full settlement of their account.
Sept 15th: Received Sh. 8,000 in cash from Eric in part settlement of his account
Sept 17th: Goods worth Sh. 800 were returned by Eric.
Sept 21th: Purchased goods on credit at Sh. 17,400 from Shauri ltd.
Sept 24th: Paid Sh. 12,000 to Shauri ltd by cheque; discount given was Sh. 600.
Sept 25th: Purchased furniture on credit from Magic furniture for Sh. 16,000
Sept 26th: Transferred Sh. 4,400 from the cash till to the bank account.
Sept 27th: Eric was declared bankrupt and could only pay Sh.2,000 of the debt by cheque the
rest being treated as a bad debt.
Sept 28th: Goods worth Sh. 1,200 were returned to Shauri ltd.
Sept 29th: Goods worth Sh. 800 were taken by Michael Kamau for his personal use.
Sept 29th: Paid Sh. 1000 by cheque for advertising.
Sept 29th: Paid wages to shop assistant in cash amounting to Sh. 3,600.
Sept 29th: Made cash sales of Sh. 43,600
Sept 29th: Banked Sh. 40,000
Sept 29th: Received cash of Sh. 11,800 from Simon in part payment of their account after
allowing a discount of Sh. 200.
Required;
a) Prepare a three-column cash book

Solution

The Statement of Cash Flows

A cash flow statement is prepared to provide information about the sources and application of cash
and cash equivalents of an organization. It also sheds light on the operating, investing and financing
activities of an organization. Usually, the amount of profit made during an accounting year and the
cash balance at the end of the same accounting year would not be the same.
This may be attributed to the following factors among others:
1. Non cash items- the items that do not involve the movement of cash but are included in the
determination of profit e.g. depreciation, amortization, provisions, etc
2. Credit transactions that are used in the determination of profits e.g., credit sales and credit
purchases
3. Cash transactions that are excluded in the income statement of the period in which cash was
involved e.g. prepaid expenses, unearned revenues, etc
4. Investing activities-affect the balance sheet items and not necessarily the income statement items
e.g. investing in marketable securities, purchase of fixed assets, investments
5. Financing activities-affect the balance sheet items and not necessarily the income statement items
e.g. issue of shares, redemption of loans and shares,

Users of the cash flow statement assess the following:

1. The firm’s ability to generate positive cash flows in future periods
2. The firm’s ability to meet maturing obligations and pay dividends
3. Reasons for the difference in the accounting net profit and the related net cash flows from
operations
4. The cash and non-cash aspects of the company’s investment and financing transactions for the
period

Presentation of Cash Flow Statements:

The statement should classify cash flows into the following categories:

1. Operating activities’ cash flows: these are cash flows that arise out of the principal revenue
producing activities enterprises. These include:
• Receipts from sale of goods and services, fees, royalties, commissions, etc.
• Payments for supplies, services, salaries, taxes, etc.
• Cash flows arising from sale or purchase of securities held for trading purposes
• Advances and loans made by financial institutions since this constitutes the main revenue
generating activity of such institutions
To be excluded from the cash flows from operating activities are:
• Gains from disposal of fixed assets which should be reflected under the investing activities
• Losses from disposal of fixed assets which should be reflected under the investing activities

2. Investing activities’ cash flows: are cash flows from activities that result in the acquisition and
disposal of long term and other investments excluding cash equivalents. Such activities reflect the
expenditures in resources that will help in generating future income and cash flows. These include:

• Cash payments for acquisition of fixed assets, equity and debt securities of other firms,
• Receipts from the disposal of the above items
• Receipts of interests and dividends from investments
• Cash receipts from the payment of advances and loans made to other properties, other than
advances and loans made by a financial institution.

3. Financing activities’ cash flows: cash flows from activities that result in changes in size and
composition of equity capital and borrowings of enterprises. These include:

• Cash proceeds from issuing shares and other equity instruments

• Cash repayments of amounts borrowed
• Cash proceeds from issuing loans, notes, bonds, mortgages and other short- or long-term
borrowings.

Format of Presenting the Statement of Cash Flows

Two methods of presenting the cash flow statements include:

1. The direct method

2. Indirect method

The Indirect Method

The net cash flows from operating activities is determined by adjusting net profit or loss for the
effects of transactions of non-cash nature and any deferrals or accruals of past or future operating
cash receipts or payments

Statement of Cash Flows - PROFORMA

XYZ LTD Statement of Cash Flows for the year ended 31 December 2018
Sh. Sh.
Cash flows from operating activities
Net profit before taxation x
Adjustments for:
Depreciation x
Profit on sale of non-current asset (x)
Interest expense x
Op. profit before working cap. changes x
Increase in accounts receivable (x)
Increase in inventories (x)
Increase in accounts payable x
Cash generated from operations x
Interest paid (x)
Dividends paid (x)
Taxation paid (x)
Net cash from operating activities x

Cash flows from investing activities

Purchase of non-current assets (x)
Sale proceeds of non-current assets x
Interest received x
Dividends received x
Net cash from investing activities x

Cash flows from financing activities

Proceeds from issue of shares x
Repayment of debenture loan (x)
Net cash from financing activities x

Net increase in cash & cash equivalents x

Cash and cash equivalents b/f x
Cash and cash equivalents c/f x

Example
 Daveine Limited -Statement of Financial Position as at 31 December 2018
2018 2017
Sh. Sh. Sh. Sh.
ASSETS
Non-current assets 545,000 410,000
Current assets:
Inventories 90,000 81,000
Receivables 83,000 75,000
Cash 45,000 64,000
218,000 220,000
763,000 630,000
EQUITY AND LIABILITIES
Capital and reserves:
Sh.1 ordinary shares 150,000 100,000
Share Premium Account 20,000
Accumulated profits 476,000 431,000
646,000 531,000
Current liabilities:
Trade payables 97,000 69,000
Corporation tax payable 20,000 30,000
117,000 99,000
763,000 630,000

Statement of profit or Loss for the year ended 31 December 2018

Sh.
Turnover 1,000,000
Cost of sales (700,000)
Gross profit 300,000
Administrative expenses (199,000)
Operating profit 101,000
Interest (1,000)
profit before tax 100,000
Tax (39,000)
profit after tax 61,000

The following information is relevant:

(1) Administrative expenses include depreciation of sh.40,000

(2) During the year there had been sales of non-current assets for sh.30,000. The assets sold had
originally cost sh.50,000 and had a net book value of sh.20,000.

(3) Dividends paid during the year were sh.16,000

Required:
Prepare a Statement of Cash Flows for the year ended 31 December 2018 using direct method.

The Direct Method

Although the presentation of the investing and financing activities remain the same, under this
method, information about major classes of gross cash receipts and gross cash payments are
disclosed. The presentation of cash flows from operating activities is shown as follows:

Cash received from

customers x
Cash payments to suppliers (x)
Cash paid to and on behalf of
employees (x)
Other cash payments (x)
Net cash inflow from operating
activities x

Example

Posh Florist has the following Statement of profit or Loss for the year ended 31 December 2020

Statement of profit or Loss for the year ended 31 December 2018

Sh.
Revenue 1,200,000
Cost of sales (840000)
Gross profit 360,000
Distribution and administrative expenses (120,000)
Net profit before tax 240,000

The following are extracts from Posh Florist’s Statements of Financial Position:

Sh. Sh.
Current assets
Inventory 160,000 140,000
Trade receivables 259,000 235,000
Current liabilities
Trade payables 168,000 138,000

Additional information:

(1) expenses include depreciation of sh.36,000, bad debt write-offs of sh.14,000 and employment
costs of sh.42,000

(2) during the year Posh Florist disposed of a non-current asset for sh.24,000 which had a book value
of sh.18,000, the profit on which had been netted of expenses

Required:
(a) Show how the cash generated from operations would be presented on the Statement of Cash
Flows using the indirect method.

(b) Show how the cash generated from operations would be presented on the Statement of Cash
Flows under the direct method.

Receivables
Account’s receivables are short term assets that arise out of selling of goods or services on credit.
Credit sales are a viable option of revenue generation when the benefits arising from such sales

(extra sales over and above the cash sales) are higher than the extra costs arising from such sales.
These extra costs include:

1. Bad debts expenses

2. Provisions for bad debts iii. Record management costs

3. Costs of managing the accounts receivables accounts

4. Credit worthiness assessment cost

5. Opportunity costs of funds tied up in the accounts receivables

Terms of Trade

Terms of trade define the conditions that define a credit sale and they usually include the credit
period, the discount period and the discount rate.

For instance, 2/10, n/30 means that a 2% discount would be given for accounts that are paid within a
discount period of 10 days, otherwise the net amount of the trade receivable should be paid within
the credit period of 30 days.

Recognition of Debtors and Accounting for Bad Debts

Accounting principles used are:

1. Prudence

2. Matching

Bad debts arise when it becomes impossible to collect some of the accounts receivables. They are
treated as normal business expenses and written off as period costs against the revenues of the
period in which the bad debts arose according to the accounting principle of matching. The
prudence principle of accounting demands that economic values are not to be exaggerated.
Accordingly, it is critical to estimate the likely bad debts and treat them as expenses immediately to
avoid overstating current accounts receivables and profit. This estimation is usually treated in the
provision for bad debts account.

The following journal entries apply to the accounting for bad debts and provisions for bad debts:

1. When the possible bad debts that may arise from the current accounts receivables are
estimated, they are journalised as follows:
 Dr. Bad Debts Account XX

Cr. Provision for Bad Debts Account XX

2. When a specifically identified accounts receivable becomes uncollectible e.g. due to the
bankruptcy of the debtor, death of the debtor, etc. Such an amount is immediately written
off from the books of the business by passing out the following journal entry:

Dr. Provision for Bad Debts Account XX

Cr. Accounts Receivable Account XX

3. When bad debts previously written off are recovered, two journal entries are made, the first
one being to reverse the original write off by the amount of the recovery and the second
one being to recognise the accounts receivable in the traditional way. These are shown as:

(a) To reverse the write off given the recovery:

Dr. Accounts Receivable Account XX
Cr. Provision for Bad Debts Account XX

(b) To record the receivable from the recovery:

Dr. Cash Account XX

Cr. Accounts Receivable Account XX

4. Sometimes, bad debts may be directly written off against the accounts receivables and
written off as expenses in the period the account becomes unrecoverable. Under these
circumstances, the relevant journal entry is identified as:

Dr. Bad Debts Expense Account XX

Cr. Accounts Receivable Account XX

5. Whereas an increase in the provision for bad debts is taken as an expense, when there is a
decline in this account, the difference is usually taken as an income as follows:

Dr. Provision for Bad Debts Account XX

Cr. Income Statement Account XX

Methods of Estimating Provisions

The provisions figure is often made from estimations made by a business entity. The most common
methods applied in such estimations are:

1. Percentage of sales method: bad debt provisions are computed as a proportion of a period’s net
credit sales. The estimation is done from the income statement point of view and may provide an
estimate in line with the matching principle of accounting.

2. Percentage of accounts receivables method: bad debt provisions are computed as a proportion of
a period’s net accounts receivables. This may be taken as a fixed proportion of the receivables or
may depend on an ageing schedule of the accounts receivables. Various percentages based on past
experience are applied to each age category to determine the amount of the expected bad debts.

Example.

ABC Ltd sales on credit and has the following receivables classified according to their age after the
sale was made:

Amount
Age Category (Sh.)
Not yet due 100,000
1 - 30 days past due 120,000
31 - 60 days past due 60,000
61 - 90 days past due 80,000
91 - 120 days past
due 50,000
Over 120 days past
due 70,000

Total 480,000
The company has estimated that 1.5%, 2.5%, 7%, 10%, 20% and 50% of the respective age category
receivables would prove to be uncollectable. The provision for bad debts account shows a balance of
Sh.11,700 before this credit analysis was done. Prepare a journal entry to show the impact of this
analysis on debtors and how they would be presented in the balance sheet.

Solution

Factoring

This is an arrangement whereby a business transfers its trade debtors outright to a finance company
or pledges its trade debtors as security for borrowing. Factoring is a financial transaction whereby a
business sells its accounts receivable to a third party (called a factor) at a discount in exchange for
immediate money

with which to finance continued business. The purpose of factoring is to increase the speed of
collection of the trade receivables and thereby avoid the cost of managing the receivables account.

The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating
the factor obtains all of the rights and risks associated with the receivables i.e.:

1. The right to receive the payments made by the debtor for the invoice amount

2. The loss if the debtor does not pay the invoice amount.

There are three principal parts to the factoring transaction:

1. The advance, a percentage of the invoice face value that is paid to the seller upon submission,

2. The reserve, the remainder of the total invoice amount held until the payment by the account
debtor is made and
3. The fee, the cost associated with the transaction which is deducted from the reserve prior to it
being paid back the seller.

The factor’s overall profit is the difference between the price it paid for the invoice and the money
received from the debtor, less the amount lost due to non-payment.

Advantages

1. Factoring provides a large and quick boost to cash flow. This may be very valuable for businesses
that are short of working capital.
2. Where there are many factoring companies’ prices may be competitive

3. It can be a cost-effective way of outsourcing sales ledger while freeing up time to manage the
business

4. It assists smoother cash flow and financial planning

5. Some customers may respect factors and pay more quickly

6. One may be given useful information about the credit standing of your customers and they can
help you to negotiate better terms with your suppliers

7. One will be protected from bad debts if you choose nonrecourse factoring

8. cash is released as soon as orders are invoiced and is available for capital investment and funding
of your next order

9. Factors will credit check your customers and can help your business trade with better quality
customers and improved debtor spread

Disadvantages

1. Queries and disputes may have to be referred on. For this reason, factoring works best when a
business is efficient and there are few disputes and queries

2. Costly

3. It may reduce the scope for other borrowing - book debts will not be available as security.

4. Factors will restrict funding against poor quality debtors or poor debtor spread, so you will need
to manage these funding fluctuations.

5. It may be difficult to end an arrangement with a factor as you will have to pay off any money, they
have advanced you on invoices if the customer has not paid them yet.

6. Some customers may prefer to deal directly with the vendors. vii. Factors may negatively affect
the relationship with the customers if they use high pressure collection methods.

Factoring with Recourse

In recourse factoring, the factor does not take on the risk of bad debts i.e. The factor will be able to
reclaim their money from the seller if the customer does not pay. The factoring agreement will
specify how many days after the due date for payment you must refund the advance. The
transaction is recorded as:
Dr. Cash XX
Dr. Due from factor (retention money) XX
Dr. Discount on transferred debtors (cost) XX
Cr. Liability on transferred debtors XX

Factoring without Recourse

In non-recourse factoring, the factor takes on the bad debt risk. It accepts specified risks around the
debtor’s failure to pay, but it does not insure against debts that are unpaid because of genuine
disputes. Because of this, non-recourse factoring will be more expensive than recourse factoring.
One never has to refund the advance to the factor, but you must pay interest to the factor for the
period specified by the factoring agreement. The factor takes over all your rights to pursue the
customer for payment. This includes the right to take legal action. The transaction is recorded as:

Dr. Cash Account

XX
Dr. Due from factor (retention money) XX
Dr. Discount on transferred debtors (cost) XX
Cr. Debtors XX

Invoice Discounting

This is a form of short-term borrowing often used to improve a company’s working capital and cash
flow position. Invoice discounting allows a business to draw money against its sales invoices before
the customer has actually paid. To do this, the business borrows a percentage of the value of its
sales ledger from a finance company, effectively using the unpaid sales invoices as collateral for the
borrowing. Although the end result is the same as for debt factoring the financial arrangement is
somewhat different.

• Features of Invoice Discounting

When a business enters into an invoice discounting arrangement, the finance company will allow the
business to draw down a percentage of the outstanding sales invoices. The finance company will
charge a monthly fee for the service, and interest on the amount borrowed against sales invoices. In
addition, the finance company may refuse to lend against some invoices, for example if it believes
the customer is a credit risk, sales to overseas companies, sales with very long credit terms, or very
small value invoices. The lender will require a floating charge over the book debts (trade debtors) of
the business as security for the funds it lends to the business under the invoice discounting
arrangement. Responsibility for raising sales invoices and for credit control stays with the business,
and the finance company will often require regular reports on the sales ledger and the credit control
process.

Advantages

1. By receiving cash as soon as a sales invoice is raised, the business will find that its cash flow and
working capital position is improved.

2. The business will only pay interest on the funds that it borrows, in a similar way to an overdraft,
which makes it more flexible than debt factoring.
3. Invoice financing can be arranged confidentially, so that customers and suppliers are unaware that
the business is borrowing against sales invoices before payment is received.

Drawbacks

1. In some industries, financing debts can be associated with a company that is in financial distress.
This can result in suppliers becoming reluctant to offer credit terms, which will reverse many of the
benefits of the arrangement.

2. Invoice discounting is an expensive form of financing compared to an overdraft or bank loan.

3. As the finance company takes a legal charge over the sales ledger, the business has fewer assets
available to use as collateral for other forms of lending. This may make taking out other loans more
expensive or difficult.

4. Once a business enters into an invoice discounting arrangement, it can be difficult to leave as the
business becomes reliant on the improved cash flow.

Accounting for Bills of Exchange

A bill of exchange is an unconditional order in writing addressed by one person to another requiring
the person to whom it is addressed to pay on demand or at a fixed or determinable future time, a
certain sum of money to, or to the order of a specified person or the bearer. it can be a bill
receivable to the drawer or a bill payable by the drawee and acceptor. For credit sales, the drawer of
the bill of exchange is usually the seller while the drawee to whom the bill is addressed is the debtor
who subsequently becomes the acceptor when he assents to the order.

Subsequently he becomes liable to the bearer of the bill. The maturity value or the amount payable
on the bill is usually the sum of the face value (principle) plus the accrued interest over the term of
the bill to the maturity date. The following journal entries and accounting treatments are applicable
to bills of exchange.

1. On receipt of the bill upon sales on credit:

Dr. Bills receivable XX

Cr. Sales XX

2. On collection of the bill plus accrued interest upon maturity

Dr. Cash XX
Cr. Bills receivable XX
Cr. Interest revenue XX

3. Bills dishonoured: The acceptor of the bill may fail to pay upon maturity in which case the
bill is said to be dishonoured. Such a bill is removed from the bills receivable account and
recorded among the trade debtors and recorded at the maturity value as follows:

Dr. Trade debtors XX

Cr. Bills receivable XX
 Cr. Interest revenue XX
4. Bills discounted: bill discounting involves the conversion of the bills receivable into cash before
the maturity date. It involves selling the bills receivable to a bank or other finance company with
recourse to the holder. here the bearer endorses and delivers the bill to the bank for cash proceeds
that usually are the maturity value of the bill excluding the discount representing an advance
interest charge over the discount period (period between discount date and maturity date). Here the
journal entry is:

(a) if the proceeds are less than the face value:

Dr. Cash XX
Dr. Interest revenue XX
Cr. Bills receivable XX

(b) if the proceeds are higher than the face value:

Dr. Cash XX
Cr. Bills receivable XX
Cr. Interest revenue XX
4. Dishouring a discounted bill: the seller will be forced to pay the bank the due amount
including a protest fee due to the bank if they had endorsed the bills discounted. The
accounts receivables are then restored to the original amount plus the protest fee and
recorded in the books of the seller as follows:
Dr. Accounts receivable XX
Dr. Protest fee XX
Cr. Cash XX

End of period adjustment for interest revenue: this is recorded as:

• To record the interest accrued at the end of the year

Dr. Interest receivable XX

Cr.Interest revenue XX

• To record receipts at the end of maturity

Dr. Cash XX
Cr. Bills receivable XX
Cr.Interest revenue XX

Example .

Kabete Ltd sold goods worth Sh.750,000 on credit and offered its customers a trade discount of 10%
of the gross sales. The sales were made under the credit terms 1.75/10, n/30. Some customers
representing 12% of the net receivables paid within the first 10 days after the sale. The remaining
debtors were treated as follows:

The first 28% were sold away to a factor without recourse who paid everything except Sh.11,000
that represented the factoring cost and Sh.45,000 retention money that was receivable after the
expiry of 30 days. The next 35% were converted into bills receivable. Sh.92,000 of these bills were
discounted after ten days at Sh.88,000 while the rest were collected upon maturity except Sh.35,000
worth of bills receivable that were dishonoured after accruing an interest of Sh.2,500. The remaining
accounts receivables were allowed to run to their maturity. The provision for bad and doubtful debts
was increased by Sh.5,500 because of this category of accounts receivables. All the customers under
this category paid their dues to Kabete Ltd by the end of the credit period except an account
receivable of Sh.17,500 that was written off as bad and unrecoverable.

Identify and explain two important GAAPs Kabete Ltd would rely on when providing for bad and
doubtful debts [2 Marks]

Prepare journal entries to record the above transactions if the retention money was subsequently
received after expiry of the credit period. [8 Marks]