8 Debtors, Creditors, and Promisory Notes

Chapter 8
Debtors, Creditors and Promissory Notes
Definition of a Debtor and Creditor

Availability of credit has facilitated increase in volume of trade among businesses most of which
is undertaken on credit. A debt or receivable refers to a claim that one entity has against another.
There are different types of claims and therefore different types of debts. This chapter focuses on
trade related debts. While a receivable is a debt from the seller’s perspective, it is a payable from
the buyer’s perspective. Trade debtors and trade creditors are therefore two related perspectives.
Two conditions must be met for a claim to qualify as a receivable. These are:
i) There has to be a measurable value which is expected to be received, with reasonable

certainty, and
ii) The date of collection should be capable of being estimated.
A lottery for example, has a certain date of winner announcement, the amount is known to all but
it cannot be said to be receivable with reasonable certainty.
Trade Debtors
Receivables from credit customers are known as trade debtors. After stocks, trade debtors is
usually the largest item among current assets on a balance sheet. Good credit granting and debt
collection policies are important in management of trade debtors. A lax credit policy increases
sales but the risk of non-collection increases as well. A stringent credit policy will increase the
likelihood of collection but may result in decrease in sales volume.
A debtor may happen to have a temporary credit balance, as is the case when customers pay in
advance of delivery. Such balances are isolated and reported in the balance sheet as current
liabilities titled "Debtors with credit balances".
The subsidiary ledger has a wealth of information regarding particulars and history of individual
customer accounts. This is important information in credit extension decisions and decisions on
provision for doubtful accounts and write offs of uncollectible accounts.
Trade creditors
Trade creditors are payables created by acquisition of material, goods for resale, supplies or
services in the normal operation of the business but for which no payment has been made. It is
important for businesses to manage the level of creditors because if unpaid creditors can enforce
bankruptcy proceedings.
Trade Creditors are reported in a balance sheet as a current liability. As for receivables, creditors
have temporary debit balances. These should be isolated and reported under current assets as
Creditors with debit balances.
Debtors, Creditors and Promissory Notes 155
Uncollectible debts
When businesses sell on credit they expect customers will pay. However, there is always a risk of
default inherent in credit extension. Some customers may not settle their accounts or part of their
accounts. Management of debtors therefore, must take account of the possibility of debts
becoming uncollectible. There are two types of uncollectible debts; doubtful and bad debts.
a) Bad Debts
These are amounts due from customers that a business has determined will not be
collected. There is certainty of non settlement and it is decided no effort will be expended
to collect such amounts. When a debt is considered to be irrecoverable it should be
eliminated from books of accounts. The following general journal entry is made to
eliminate such a bad debt:
Date Description Folio Debit Credit

20X2
May 29 Bad Debts expense 2,000
Trade Debtors 2,000
To record the writing off of bad debts
arising from ABC’s account.
This entry represents what is known as a direct write off; where irrecoverable debts are
written off directly to the Profit and Loss Account. Bad debt expense account is closed to
the profit and loss account at the end of the accounting period.
b) Doubtful Debts
These are debts or part of debts which are overdue, settlement of which is considered
doubtful. While non-collection is certain in bad debts, it is not certain in doubtful debts.
Doubtful debts are therefore, not written off directly lest all effort at collection cease.
They are however, recognized in books of accounts as doubtful accounts. This is
accordance to the prudence concept.
Recognition of doubtful debts is made through a charge against profits through a doubtful
debts expense account. The double entry for such a charge is not made directly to the
debtors account. Instead a contra asset account known as "Provision for Doubtful Debts"
account is set up and credited. This leaves the debtors account and subsidiary ledgers
unchanged.
A general journal entry to record the provision of doubtful debts will be as follows:

20X2
Dec 31 Doubtful Debts expense 2,000
Provision for Doubtful debts 2,000
To record provision for doubtful
debts.
Similar to other contra asset accounts, the balance of the Provision for Doubtful Debts
156 Introductory Financial Accounting
account is set off against Trade Debtors on the balance sheet. The doubtful debts expense
account is closed to the profit and loss account at the end of the accounting period.
Debts write-offs through a provision
If a debt already provided for turns bad it must be removed from books of accounts as it ceases to
be an asset. This involves eliminating the amount from the debtor’s account and also removing a
similar amount from the provision for doubtful debts account. The general journal entry to record
this is as follows:

20X2
Dec 31 Provision for Doubtful Debts 2,000
Trade Debtors 2,000
To record the writing off of bad debts
arising from ABC’s account.
This is known as an indirect write off as there is no direct charge to the Profit and Loss Account.
Recovery of amounts previously written off
When amounts previously written off are recovered profits previously decreased should be
reversed. Receipts from bad debt recovered are ordinarily treated as income not arising from main
operations of a business, also known as other income.
The recording of recovered amounts should normally be preceded by reinstatement in the debtor’s
account of the balance previously written off. This is preferred because it allows a historical note
in the customer’s account which would otherwise be unrecorded, if a direct entry to other income
and cash was made.
The general journal entries to record recovery of bad debts are:

20X2
Dec 31 Trade Debtors 2,000
Bad Debts Recovered 2,000
To record the reinstatement of bad
debts previously written off.

20X2
Dec 31 Cash 2,000
Trade Debtors 2,000
To record the collection of bad debts
previously written off.
Bad debts recovered account is closed to the profit and loss account at the year end as Other
Income.
Provision for doubtful debts

There are two types of provisions; specific and general.
Specific provision
If an entity can identify customer accounts and amounts in those accounts which are doubtful then
the figure of provision for doubtful debts can be supported by a list of names and balances that are
doubtful. This approach to provision where customer accounts are analyzed and accordingly
provided for is known as specific provision. Specific provision is allowable for taxation purposes.
General provision
Most of the time businesses will be certain that some accounts will turn bad but it may not be
possible to identify with certainty specific customer names and amounts that are doubtful. In this
situation management will make an estimate of an amount to be provided for as doubtful. Past
experience is always helpful in making such an estimate. General provisions are not allowable for
taxation purposes.
The following two methods are usually employed in estimation of an amount of general provision.
i) Percentage of Debtors Method, and

ii) Percentage of Sales Method
Percentage of Debtors Method
At the end of the first year [Year 1] the amount of provision is established by applying the pre-
determined percentage to the balance of total debtors. An entry is then made to create a
provision. At the end of the second year [Year 2], management will determine adequacy of the
provision. The pre-determined percentage may change in such a revision. Again a percentage is
applied to the balance of total debtors to establish the amount of provision required. If the amount
required for second year [Year 2] exceeds the balance in the provision account provision is
increased to the required level. If on the other hand the amount of provision required for second
year [Year 2] is less than the balance in the provision account, provision is decreased to the
required level.
Example
Ya Hua & Co. has a policy of providing 1 percent of debtors as doubtful. Debtors for first three
years of operation were as follows:
Year 1 shs. 500,000

Year 2 shs. 600,000
Year 3 shs. 400,000
The following general journal entries would be made to record provision for doubtful debts during
the three years.
Year 1:

Year 1
Dec 31 Doubtful Debts 5,000
Provision for Doubtful Debts 5,000
Being provision for doubtful debts at
1 percent of debtors shs. 500,000.
Year 2:
In year 2 provision required would be shs. 6,000 (1 percent of shs. 600,000). The balance in the
provision for doubtful debts account is shs. 5,000. Therefore, provision in the books will be
increased by shs. 1,000 only.
The entry being as follows:

Year 2
Being increase in provision for
doubtful debts.
Year 3:
Provision for doubtful debts required for this year is shs. 4,000 (1 percent of shs. 400,000). In the
books provision stands at shs. 6,000. It has to be reduced to the level required for this year. The
entry to effect that is:

Year 3
Profit and Loss Account 2,000
Being writing back of provision in
excess of current year level.
A decrease in provision for doubtful debts is shown as other income in the profit and loss account.
The ledger accounts for the above transactions will be as follows:
Provision for Doubtful Debts Account no. 00

Date Details Fol. Debit Date Details Fol. Credit
Yr. 1 Yr. 1
Dec31 Balance c/f 5,000 Dec31 Doubtful Debts 5,000
Expense
150,000 150,000
Yr. 2 Yr. 2
Jan1 Balance b/f 5,000

Expense
6,000 6,000
Yr. 3 Yr. 3
Dec31 Profit and Loss 2,000 Jan1 Balance b/f 6,000

Expense
6,000 6,000
Yr. 4
Doubtful Debts Expense Account no. 00

Yr. 1 Yr. 1
Dec31 Provision for Doubtful 5,000 Dec31 Profit and Loss 5,000
Debts
5,000 5,000
Yr. 2 Yr. 2
Debts
1,000 1,000
Debtors will be reported in the balance sheet as follows:
Balance Sheet (extract only)

Yr. 1 Yr. 2 Yr. 3
shs shs shs

Current Assets:
Debtors 500,000 600,000 400,000
less: Provision for Doubtful Debts 5,000 6,000 4,000
Net Book Value 495,000 594,000 396,000
Age-wise schedule of debtors
The longer an account has remained uncollected the more doubtful of collection it becomes. An
age-wise schedule of debtors analyzes debtors according to age in months and/or years. A different
percentage of provision is applied to each age group to obtain the total provision required. This is
a more meticulous approach when compared to the application of a percentage on total debtors.
An age-wise schedule has the following features in its format.
Ya Hua & Co.

Age-wise Schedule of Debtors, 31 May 19X3
Account Name Age Total
More than 4 to 5 3-4 2-3 1 -2 less than 1 less than 6
5 years years years years years year months
ABC
DEF
GHK
LMN
Total
Provision % 100% 100% 100% 50% 25% 10% 2%
Provision (Shs.)
Percentage of Sales Method

In this approach, bad debts it is argued, is an expense associated with selling on credit. Therefore,
the matching concept is achieved better if bad debts would be estimated as a percentage of net
credit sales. This method therefore makes no reference to the debtors figure. Instead a percentage
is applied to the credit sales figure at the end of every year and charged against profits to record
provision for doubtful debts.
Example
Ya Hua & Co. was providing for doubtful debts using the percentage of sales method. Company
policy is to provide for doubtful debts at 1 percent of sales. Credit sales for the first three years of
operations were:
Year 1 shs. 500,000

Year 2 shs. 600,000
Year 3 shs. 400,000
The following general journal entries would be made to record provision for doubtful debts during
the three years.

Year 1
1 percent of credit sales shs. 500,000.
Year 2
In year 2 a charge of shs. 6,000 (1 percent of shs. 600,000) will be made in the profit and loss
account for provision for doubtful debts. The balance in the provision for doubtful debts account
will increase from shs. 5,000 to shs. 11,000.
The entry being as follows:

Year 2
Year 3
In year 3 a charge of shs. 4,000 (1 percent of shs. 400,000) will be made in the profit and loss
account for provision for doubtful debts. The balance in the provision for doubtful debts account
will increase even further from shs. 11,000 to shs. 15,000.
The entry to effect that is:

Year 3
Profit and Loss Account 4,000
The ledger accounts for the above transactions will be as follows:
Provision for Doubtful Debts Account no. 00

Yr. 1 Yr. 1
Expense
150,000 150,000
Yr. 2 Yr. 2

Expense
11,000 11,000
Yr. 3 Yr. 3


Expense
15,000 15,000
Yr. 4
Doubtful Debts Expense Account no. 00

Yr. 1 Yr. 1
Debts
5,000 5,000
Yr. 2 Yr. 2
Debts
6,000 6,000
Yr. 3 Yr. 3
Debts
4,000 4,000
Debtors will be reported in the balance sheet as follows:
Balance Sheet (extract only)

Yr. 1 Yr. 2 Yr. 3
shs shs shs

Current Assets:
Debtors 500,000 600,000 400,000
less: Provision for Doubtful Debts 5,000 11,000 15,000
Net Book Value 495,000 589,000 385,000
Since the percentage of sales method makes no reference to debtors, provision is always
increasing. As such it can go out of proportion when compared to the debtors figure on the
balance sheet. This is its main weakness which becomes a strong point for employing the
percentage of debtors method. If one employs the percentage of sales method there is a constant
need to review the balance in the provision for doubtful debts account in order to take account of
changes of debtors balance so that it remains reasonable and within limits.
Promissory Notes
A promissory note, more commonly known simply as a note, is a written promise to pay a sum of
money at a definite date. It resembles a cheque in that it is payable to the order of a person,
business or to a bearer. The person who signs the note and making the promise is called a maker.
The one to whose order the note is payable is a payee.
The maker of a note refers to it as a note payable while the entity owning a note refers to it as a
note receivable.
A note that states the interest rate to be paid between the issuance date and the due date is called
an interest bearing note. If a note does not state the interest rate, then interest is included in the
face amount of the note. This is a non-interest-bearing note. The amount that is due at maturity or
due date is known as maturity value. Maturity value of an interest bearing note is the face value
plus interest. For a non-interest-bearing note, maturity value is the same as the face value.
Interest Computation
The formula employed in interest computation is:
Interest = Principal x Rate of Interest x Time
Interest rates are quoted on an annual basis therefore, "time" must be expressed appropriately as a
proportion of a year. In interest rate computations a 360-day year is assumed. Also in calculation
of days to maturity, the day on which a note is dated is not included but the day on which a note
falls due is included.
Notes Receivable
A customer with outstanding debts may require time in excess of the credit period indicated on an
invoice to settle his account. This may happen in the following situations:
i) A customer may know at the time of buying that money will not be available until, for
example after 6 months. The seller in this case may require a signed note rather than sell
on account.
ii) A customer may notice payment of an invoice has fallen due but she has no money. The
seller may accept a note for payment at some future date.
Accounting for notes receivable.
The following example will be used to illustrate accounting for notes receivable.
Example
Ayiman & Co has accepted a shs. 100,000 90 day, 12 percent note in exchange for an accounts
receivable from Mabruki & Co. The note is dated Dec. 1st. The relevant journal entries will be as
follows:
On Receipt of a note:

Year 1
Dec 1 Notes Receivable 100,000
Trade Debtors 100,000
Being Acceptance of a 12 percent 90-
day note in settlement of an account
receivable.
At Year end:

Year 1
Dec 31 Interest Receivable 1,000
Interest Income 1,000
Being recording of interest earned for
30 days from December 1st.
On Maturity:

Year 1
Mar 1 Cash 103,000
Notes Receivable 100,000
Interest Receivable 1,000
Being recording of payment of notes
receivable plus interest.
Dishonoured Notes
If in the above example, the maker Mabruki & Co. failed to pay the amount on the due date the
note would have been dishonored. The claim should be reinstated in trade debtors. A claim for
this purpose would be the face value of the note plus interest earned.
The entry to record this would be:

Year 1
Mar 1 Trade Debtors 103,000
Interest Receivable 1,000
Being recording of default by
Mabruki & Co. of a 12 percent, 90-
day note.
Discounting Notes Receivable
By accepting a note a firm agrees to wait until maturity date of the note to collect payment.
However, because of the need to finance other business activities, instead of retaining the note
until maturity, a firm may transfer the note to a bank through an endorsement. The bank pays the
holder of the note and holds the note until maturity. If the note is not honored at maturity the bank
will claim against the maker. It also can assert a secondary claim against the endorser.
The amount of money an endorser receives upon discounting a note is called proceeds. In order to
calculate proceeds the following steps are undertaken.
Step 1. Calculate maturity value of the note. This is the face value plus interest.
2. Establish the length of time the bank will hold the note. This is the number of
days from the day of discounting to the maturity date.
3. Compute the discount by the following formula:
Discount = Maturity Value of the Note x Discount rate x No of days the bank will hold the note
4. Subtract the discount obtained in Step 3 from maturity value obtained in Step 1.
This gives the proceeds of a discounted note.
Example
Assume that on May 1st Chongoleani Enterprises received a 60-day, 12 percent note for shs.
600,000 from Maforoni & Co. The note matures on June 30. On May 30, Chongoleani discounts
the note at Tanga Market Street NBC which charges a 10 percent per annum discount rate.
Proceeds will be:
shs.
Face value of note 600,000
Interest to maturity (.12*600,000*60/360) 12,000
Maturity Value 612,000
less: Discount (.1*612,000*30/360) 5,100
Proceeds 606,900
The entry to record the discounting is:

Year 1
May 30 Cash 606,900
Being recording of discounting of a
note with NBC Tanga Market Street.
In this case, the proceeds exceeded the face value of the note. Therefore, Chongoleani ultimately
earns interest income. Sometimes proceeds of a discounted note may be less than the face value
of a note. This deficiency will be recorded as Interest Expense.
Non-interest-bearing notes receivable
A non-interest bearing note is one which has the interest component included in the face value. A
shs. 100,000 60-day, 12 percent per annum interest bearing note could equally have been issued as
a non-interest-bearing note with face value of shs. 102,000. If a shs. 102,000 60-day, non-interest
bearing note is received on Dec. 1 in the place of a shs. 100,000 debt, bookkeeping entries will be
as follows:
On receipt of a note:

Year 1
Dec 1 Notes Receivable 102,000
Trade Debtors 100,000
Discount on Notes Receivable 2,000
Being acceptance of a 12 percent 60-
day note in settlement of an account
receivable.
Note that the interest component is both unearned and uncollected therefore, it is treated as a
contra-asset until it is earned. Like other contra assets it will be deducted from the figure of notes
receivable on a Balance Sheet.
At the year end, an adjusting entry is made as follows:
At year end:

Year 1
Dec 31 Discount on Note Receivable 1,000
Being recording of interest earned for
30 days from December 1st.
Shs. 1,000 is transferred to an income account because interest is earned on a time basis. On 31st
December half of the 60-day interest has been earned. This process of transfer from the contra-
asset account [Discount on Notes Receivable] to an income account is called amortization of
discount on notes receivable. It is an adjusting entry.
On the Balance Sheet Notes Receivable will be stated at a figure of shs. 101,000 which is shs.
102,000 minus the balance of shs. 1,000 on Discount on Notes Receivable account.
On maturity:

Year 1
Jan 1 Cash 102,000
Discount on Note Receivable 1,000
Being recording of payment of note

receivable plus interest.
Trade Creditors and Notes Payable

Trade creditors are accounts payable created by acquisition of material, goods for resale, supplies
or services in the normal operations of the business but for which no payment has been made.
The purchases journal is the source of the trade creditors figure. As it was with trade debtors, it is
also normal practice to maintain a trade creditors subsidiary ledger. A list of names and balances
known as a creditors schedule is extracted from the purchases ledger, an alternate name for the
creditors' subsidiary ledger. This list extracted from B. Asha Grocers books in Chapter Four [page
60] looked as follows:-
B. Asha Grocers
Schedule of Trade Creditors
as at 31 July, 200X
Customer account Balance
Apex Wholesalers 100,000
Ubungo Traders 94,000
Total 194,000
Note that the balance of the Creditors account was also shs. 194,000.
Trade Creditors on a Balance Sheet
Trade Creditors is reported on a balance sheet as a current liability. If certain creditors have
temporary debit balances, these should be reported under current assets as "Creditors with debit
balances". It is not permissible to off-set creditors with normal credit balances against creditors
with debit balances.
Notes Payable
To a maker a promissory note is known as a note payable. Accounting entries for notes payable
are a mirror image of entries encountered when dealing with notes receivable. The following
example will illustrate these accounting entries.
Example:
Malingumu & Co. owes Sandunga Enterprises shs. 100,000 on an overdue account. Malingumu
& Co. issued on November 1st a 90-day, 12 percent note for shs. 100,000 in settlement of the
account.
On issuance of note:

Year 1
Nov 1 Trade Creditors 100,000
Notes Payable 100,000
Being issuance of a 12 percent 90-
day note against an account payable.
At year end:

Year 1
Dec 31 Interest Expense 2,000
Interest Payable 2,000
Being accrual of 60 days interest on
notes payable.
On maturity and payment of note:

Year 1
Jan 30 Notes Payable 100,000
Interest Payable 2,000
Interest Expense 1,000
Cash 103,000
payable plus interest.
Non-interest-bearing notes payable
Assuming the above note were a 90-day, non-interest bearing note, with face value shs. 103,000
entries to record this would have been as follows:
On Issuance of note:

Year 1
Nov 1 Trade Creditors 100,000
Discount on note payable 3,000
Notes Payable 103,000
Being issuance of a 90-day note
against an account payable.
At year end:

Year 1
Dec 31 Interest Expense 2,000
Discount on Notes Payable 2,000
Being armotisation of discount on
notes payable.
On the balance sheet notes payable would be reported at shs. 102,000 which is shs. 103,000 minus
shs. 1,000 - the balance on Discount on Note Payable account.
On maturity and payment of note:

Year 1
Jan 30 Notes Payable 103,000
Interest Expense 1,000
Discount on Notes Payable 1,000
Cash 103,000
payable and armotisation of discount
on notes payable.
Control Accounts [revisited]

Where debtors' and creditors' subsidiary ledgers are maintained, the debtors and creditors accounts
in the general ledger are referred to as a debtors control account and a creditors control account.
Debtors Control Account (Sales Ledger Control Account)
Entries in this account can be identified as:
 Balance at the beginning of the month.

 Debits coming mainly from the sales journal with a few entries from the general journal.
 Credits coming mainly from the cash receipts journal, the return inwards journal and the
general journal.
 Balance at the end of the month.
Creditors Control Account (Purchases Ledger Control Account)
Entries in this account consist of:
 Balance at the beginning of the month.

 Credits coming from the purchases journal and sometimes from the general journal.
 Debits coming from the cash payment journal, return outwards journal and the general
journal.
 Balance at the end of the month.
At any one time, the balance as per the control account should always be equal to the total of the
schedule of balances extracted from the subsidiary ledger.
Contra entries
It is possible for a business to sell goods to another business and also buy from it. In such a
situation an entity involved can be both a debtor and a creditor in the books of accounts.
Normally, that entity's account will be maintained in the sales ledger and also in the purchases
ledger. Where settlement in these transactions is effected separately there is no complication.
However, usually settlement will be made in respect of the net amount due after netting off
balances in the sales ledger and purchases ledger. This netting off exercise gives rise to contra
entries.
Example:
Somo who is in tie-and-dye trade sells batik to Madam, a textile products merchant. Somo also
buys dyeing agents from Madam.
As at 31st July the position in Somo's books was:

i. Amount due from Madam from batik sales shs. 140,000.
ii. Amount due to Madam from purchases of dyeing agents shs. 100,000
iii. On that date Madam sent a cheque for shs. 40,000 in full settlement of account.
In the sales and purchases ledgers Madam's account would appear as follows:
Debtors’ subsidiary ledger:
Madam Account no. 00

20X2 20X2
Jul 31 Balance b/f 140,000 Jul 31 Cash 40,000
Creditors’ subsidiary ledger:

20X2 20X2
Jul 31 Balance b/f 100,000
After receipt of the cheque of shs. 40,000 Madam is a debtor by shs. 100,000 and also a creditor
by the same amount. These two amounts cancel out. To effect the netting off Madam's account
in the debtors subsidiary ledger will be credited with shs. 100,000 and her account in the creditors
subsidiary ledger will be debited by the same amount. Effectively the balance in the debtor's
account has been transferred to off set the balance in the creditor's account.
Such a contra entry is recorded as below:

Year 1
Jul 31 Creditors – Madam 100,000
Debtors - Madam 100,000
Being contra entry to offset Madam’s
debt.
These journal entries will be posted in both the control accounts and to the personal accounts in
the subsidiary ledgers. After posting is done Somo's subsidiary ledgers with respect to Madam's
account will look as follows:
Debtors’ subsidiary ledger:

20X2 20X2
Jul 31 Balance b/f 140,000 Jul 31 Cash 40,000
31 Creditors 100,000
140,000 140,000
Creditors’ subsidiary ledger:

20X2 20X2
Jul 31 Debtors 100,000 Jul 31 Balance b/f 100,000
100,000 100,000
Errors Affecting Control and Subsidiary Ledger Accounts

Errors that occur in recording of transactions and preparation of financial statements may affect
control accounts and personal accounts in the subsidiary ledgers. They may otherwise affect only
control accounts or only personal accounts in the subsidiary ledgers. In order to correct such
errors one needs to understand the accounts affected. The following examples will illustrate the
principles involved:
Example:
The trial balance of Leyla Enterprises as at 30th May fails to balance, the credit side exceeding the
debit side by shs. 40,000. This amount was posted to a suspense account.
On scrutiny the following errors were found:
a) The sales journal was undercast by shs. 50,000.

b) Cash shs. 5,000 collected from Mafunda & Co. had been wrongly credited to Mafundo &
Co. in the sales ledger.
c) Purchases of shs. 45,000 entered in the purchases journal had been credited to Okita
Enterprises in the purchases ledger as shs. 54,000.
d) The creditors column in the Purchases journal was overcast by shs. 40,000.
e) A purchase of shs. 150,000 on credit from Melina & Co. was not recorded in the books.
The process of correcting the errors will start with error analysis and finalize with correction.
a) Analysis of Error
Undercasting of the sales journal by shs. 50,000 means that the normal posting of the
sales journal to the general ledger has been under-recorded by shs. 50,000. Posting to
subsidiary ledger however, is not made from the sales journal total, therefore this error
does not affect subsidiary ledgers.
correction:

Year 1
Jul 31 Debtors Control 50,000
Sales 50,000
b) Analysis of Error
This error was made within the sales ledger and therefore affected only personal accounts
of Mafunda & Co. and that of Mafundo & Co. It does not affect the control account.
correction:

Year 1
Jul 31 Mafundo & Co. 5,000
Mafunda & Co. 5,000
Note that this correction is made in the subsidiary ledger only.
c) Analysis of Error
The entry in the purchases journal was entered correctly at shs. 45,000. Therefore,
posting to the creditors control account must have been made correctly. The error was
made in posting to the personal account of Okita Enterprises in the purchases ledger.
correction:
Correct clerically the entry of shs. 54,000 to the amount of shs. 45,000.
d) Analysis of Error
Posting to creditors control account resulted in an overstatement of creditors by shs.

40,000. The rest of postings of purchases journal to the general ledger and to the
subsidiary ledger were correct. This means debit and credit postings coming from the
purchases journal were not equal which results in a difference in trial balance.
correction:

Year 1
Jul 31 Creditors Control 40,000
Suspense Account 40,000
e) Analysis of Error
A transaction has been completely omitted therefore both the control account and
subsidiary ledger account are affected.
correction:

Year 1
Jul 31 Purchases Account 150,000
Creditors Control - Melina 150,000
If the correcting journal entries above are posted, the suspense account would be cleared as
illustrated below:
Suspense Account no. 71

20X2 20X2
May 30 Difference in 40,000 May 30 Creditors Control 40,000

T/Balance
40,000 40,000
Example
The balance on Jean-Pierre Yansane's creditors control account as at 31st December 19X3 was
shs. 555,650. A list of balances on the subsidiary ledger as at that date showed the following:
Debit Credit
shs. shs.
Sundry credit balances 510,200
Fofana Enterprises 2,250
Bangura & Co. 15,000
Net Total 492,950
An investigation discovered the following:
i) The purchases journal had been undercast by shs. 3,500.
ii) A purchase of shs. 25,000 from Tunde had not been posted to his personal account.
iii) The debit balance on Fofana Enterprises account was caused by the error of posting
payment to Fofana's account as shs. 4,700 instead of shs. 2,450.
iv) The debit balance on Bangura's account represents a payment in advance demanded from
Jean-Pierre.
v) Discounts received of shs. 34,550 had been posted to personal accounts but not to the
control account.
vi) A bad debt of shs. 3,250 written off Keita's personal account in the debtor's subsidiary
ledger has been posted to the creditors control account.
vii) An invoice for shs. 41,000 from Salif had been badly typed and Jean-Pierre's bookkeeper
had read it as shs. 26,000.
viii) A contra entry of shs. 1,150 between Babatunde's account in the debtors' and creditors'
ledgers had been correctly entered in the personal accounts but had not been entered in the
control accounts.
In order to reconcile the balance as per the creditors' schedule with that of the control account
errors discovered need to be corrected. These corrections are shown in the creditors control
account and in the creditors schedule.
Creditors Control Account no. 51

20X2 20X2
Dec 31 Discount received [v] 34,550 Dec 31 Balance c/f 555,650
Debtors control [vi] 3,250 Purchases [i] 3,500
Debtors control [viii] 1,150 Purchases [vii] 15,000
Balance c/f 535,200
574,190 574,190
Creditors Schedule
Debit Credit
shs. shs.
Sundry credit balances 510,200
Fofana Enterprises 2,250
Bangura & Co. 15,000
Tunde's omitted posting 25,000
Salif's invoice under-recorded 15,000
Net Total 535,200
Need for control accounts and subsidiary ledgers
Following are benefits derived from the two records:-
a) They provide a checking mechanism on each other. This is because the control account
balance always has to agree with the total from the subsidiary ledger. Therefore, errors
can be detected easily.
b) Control accounts enable efficient retrieval of information for preparation of interim

reports and financial statements. The figure of total debtors or creditors is readily
available from the control account without having to extract individual balances from
subsidiary ledgers.
c) Usually control accounts are under the charge of a responsible official and separated from
maintenance of subsidiary ledgers. This ensures strong internal control and prevention of
fraud because every entry in control accounts comes under the scrutiny of a responsible
official.
Review Questions
1. What are the essential features of a receivable?
2. Explain the difference between a bad debt and a doubtful debt.
3. What is the purpose of maintaining subsidiary ledgers? Give four benefits derived from
maintaining a subsidiary ledger.
4. List the books of prime entry from which entries are made:
a) in a debtors subsidiary ledger? and
b) in debtors control account?
5. Why should estimated doubtful debts be recognised in books of accounts before they
actually prove uncollectible?
6. What is the difference between specific and general provision for doubtful debts?
7. There are two approaches for estimating a general provision for doubtful debts. What are
they and what is their basic difference?
8. What is a direct write-off? Is there any difference between a direct write-off and a write-
off through a provision?
9. What is a promissory note and what are its essential features?
10. Distinguish between an interest bearing and a non-interest bearing note.
11. What is discounting a note? Describe the procedure of computing proceeds of a

discounted note.
12. If a note provides for payment of principal shs. 100,000 and interest at the rate of 9
percent, will the interest amount to shs. 9,000? Explain.
13. What is a contra entry?
14. Which of the two methods of accounting for doubtful debts provides for recognition of
the expense at an earlier date?
15. A company computes the amount of provision for doubtful debts as 1 percent of net credit
sales. Over a number of years, credit sales have remained unchanged. However, the
balance in the provision for doubtful debts account has continued to rise. What
suggestions would you make to the company?
Exercises
1. After the accounts are adjusted and closed at the end of the accounting year, Debtors
account has a balance of shs. 890,000 and Provision for Doubtful debts has a balance of
shs. 18,000.
a) What is the net value of debtors to be reported on the balance sheet?
b) If a debtor with shs. 4,800 outstanding is written-off, what will be the net value
of debtors after such a write-off?
2. A balance of shs. 50,000 in a customer's account is considered to be bad and is to be

written off. Give the entry to record the write-off in the general ledger (a) assuming that it
is written off through a provision and (b) assuming the direct write-off method is used.
3. A company has Debtors of shs. 549,300 and a balance in the provision for doubtful debts
account of shs. 19,500. Management decides that an account with a balance of shs. 7,200
is uncollectible and should be written off. What is the effect of the write-off on the
current year profit and loss account? What is the effect on total current assets? Why?
4. Bob Bargains received a note from a customer with the following terms:
Face value of note shs.100,000

Date of note 15th June 1992
Life of note 60 days
Interest rate 6%
Note discounted 30th July 1992
Discount rate 7%
Required:
Calculate
a) the length of time the company held the note.
b) maturity date of the note.
c) maturity value of the note.
d) the amount of the discount.
e) proceeds of the note.
f) entry to record receipt of the proceeds at the date of discount.
5. Home Appliances ages its debtors and applies the following percentages to determine the
provision for doubtful debts.
1 - 30 days 1% 91 days - 6 months 30%

31 - 60 days 5% Over 6 months 100%
61 - 90 days 12%
The aging process resulted in the following breakdown of debtors
1 - 30 days shs.342,500
31 - 60 days shs 95,300
61 - 90 days shs 53,600
91 days-6 months shs 26,200
Over 6 months shs 9,400
shs. 527,000
The balance on the provision for doubtful debts account currently stands at shs. 12,370.
Before preparing final adjusting entries all debtors of over 6 months were written off.
Required:
a) A completed age-wise schedule of debtors.

b) A journal entry to record the write-off.
c) An adjusting journal entry for provision for doubtful debts.
Problems
1. Pwani & Co. a fishing firm offers fairly generous credit terms to its high risk customers.
Provision is made for doubtful debts at a varying percentages based on the level of
debtors at the balance sheet date and an assessment of general economic conditions. Data
for the last three accounting periods are as follows:
Year ending 31 Dec. 19X0 19X1 19X2

Trade Debtors (before allowing shs. 933,400 shs. 706,000 shs.
for any bad debts) 1,031,000
Bad debts (businesses shutting shs. 8,400 shs. 6,000 shs. 31,000
down)
Provision for Doubtful debts 10% 12½% 15%
The provision for doubtful debts at 1st January 19X0 amounted to shs. 65,000.
Required:
a) Prepare the provision for doubtful debts account for each of the three years to
31st December 19X0, 19X1, 19X2 respectively, showing how the balances
would appear on the balance sheets as at these dates.
b) Assuming that a bad debt of shs. 5,000 written-off as bad in 19X0 was
subsequently recovered in 19X1, state briefly how this would have affected the
profit for the year to 31st December 19X0, and also how it would be treated in
the accounts for the year to 31st December 19X1.
2. During the course of the audit of Kessy & Co. it was found that the net total balances of
shs. 162,800 extracted from the purchase ledger on 30th June, 19X2 did not agree with
the balance on the purchase ledger control account.
Audit tests revealed the following errors and when the necessary adjustments had been
made the books balanced.
i) Purchase ledger balances had been omitted from the list of balances as follows:
Credits shs. 4,500
Debits shs. 2,000
ii) The purchase returns day book had been undercast by shs. 500.
iii) Discounts received of shs. 250 had not been recorded in the control account. This
however, was recorded in the cash book and the correct purchase ledger account.
iv) A credit balance of shs. 150 in the purchase ledger had been incorrectly listed as a
debit balance.
v) shs. 600 worth of goods were returned and no entry had been made regarding this
in the control account.
vi) A payment of shs. 900 on 29th June 19X2 had been correctly entered in the
control account; this amount was posted to the purchase ledger on 4th July 19X2.
vii) A debit balance of shs. 80 in the purchase ledger has been written off but no entry
was made in the control account.
Required:
a) Prepare a statement reconciling the original net balances extracted from the
purchase ledger with the adjusted final balance on the purchase ledger control
account.
b) Prepare the purchase ledger control account showing the necessary adjustments
and the balance on the account before these adjustments.
3. Trama Vama sells heavy agricultural machinery. Credit terms are customary and usually
involve promissory notes and a mortgage on the machinery sold. The annual accounting
period ends on December 31. Transactions involving notes were:
Note No. 1:
19X2
Feb 1 Sold equipment to Masanja for shs. 4,000,000; received a shs. 1,600,000 down
payment and a four-month, 12 percent, interest bearing note for the remainder.
Mar 1 Discounted the note at the local NBC branch at a 10 percent discount rate.
June 1 Due date of the note plus interest. Masanja paid the note and interest in full.
Required:
a) Give the journal entries for Trama Vama on each of the three dates.
b) Give the journal entry on the due date, June 1, assuming instead that Masanja
defaulted on the note and Trama Vama paid the local NBC branch the face
amount of the note plus interest.
Note no. 2:
19X2
Dec. 1 Sold equipment to G.Kabumba for shs. 3,000,000; received shs. 500,000 cash
down payment and a three-month, 12 percent, interest - bearing note for the
balance.
Dec. 31 End of accounting period
19X3
Jan. 1 Start of new accounting period
Mar. 1 Due date of principal plus interest. G. Kabumba paid the note plus interest in full.
Required:
c) Give the journal entries for Trama Vama on each of the four dates. (state any
assumptions you make).
d) How much interest revenue should be reported on the 19X2 income statement?
e) Show how Note No. 2 should be reported on the balance sheet as at 31 December
19X2.
4. The book-keeper of Tenatena Stores prepared a schedule of balances of individual

suppliers accounts from the creditors subsidiary ledger at 30th June 19X1 and arrived at a
total of shs. 86,538,280.
He passed the schedule over to the accountant who compared this total with the closing
balance on the creditors ledger control account reproduced below:
Creditors Control Account

Date Details Fol Debit Date Details Fol Credit
19X1 19X1
Jun 30 Purchase Returns 560,180 June 1 Balance b/f 89,271,130
Jun 30 Bank 96,312,700 June 30 Purchases 100,483,490
Jun 30 Balance c/f 84,688,310 June 30 Debtors Ledgers 3,049,750

Control
192,561,190 192,561,190
July 1 Balance c/f 84,688,310
During his investigation into the discrepancy between the two figures the accountant discovered a
number of errors in the control account, individual ledger accounts and the schedule. You may
assume that the total of each item posted to the control account is correct except to the extent that
they are dealt with in the list below:
1) One supplier had been paid shs. 10,220 out of petty cash. This had been correctly posted
to his personal account but had been omitted from the control account.
2) The credit side of one supplier's personal account had been under-added by shs. 30,000.
3) A credit balance on a supplier's account had been transposed from shs. 548,140 to shs.
584,410 when extracted on the schedule.
4) The balance on one supplier's account of shs. 674,320 had been completely omitted from
the schedule.
5) Discounts received shs. 12,560 and shs. 8,130 had been posted to the wrong side of two
individual creditors' accounts.
6) Goods costing shs. 39,600 had been returned to the supplier but this transaction had been
completely omitted from the relevant journals or daybooks.
Required:
a) Make correcting entries in the creditors ledger control account and conclude with a
corrected closing balance.
b) Prepare a statement starting with the original total of the schedule of individual creditors
then identifying and correcting errors in that schedule and concluding with an amended
total.
c) List down three reasons why businesses maintain Debtors' and Creditors' Control
Accounts and subsidiary ledgers as well.
5. In the books of Tipwatipwa, Debtors amounted to shs. 1,000,000 at 1st January 19X1.
No provision for doubtful debts existed because the company's policy was to write off bad
debts directly to expense when they were proved to be totally irrecoverable. On 1st July
19X1, the policy was changed and debtors were provided for as soon as they appeared
doubtful.
During, 19X1, the following events occurred.
a) On 10th February an account suddenly became bad and management decided to

write off the balance of 1,750.
b) On 12th April cash of shs. 2,100 was received. This related to an account which
had been written off as bad in 19X0, at which time no recovery of the amount
was anticipated.
c) On 1st July debtors which management thought would be difficult to collect

amounted in total to 96,410. Against this sum, management decided to set up a
provision of shs. 30,000.
d) On 31st August a customer went into liquidation and management decided to

provide in full for the balance owing of shs. 7,500. This balance had not been
included in the 30,000 set up on 1st July.
e) On 3rd October the account referred to in (d) above became totally uncollectible
and management decided to write off the balance.
f) On 31st December management reviewed Debtors. Against debtors with larger

balances they decided to set up a specific provision of shs. 29,740 and against the
small amounts totalling shs. 50,000, they decided that an amount equal to 3
percent should be provided.
Required:
Ignoring the entries that would be necessary to record sales to, and cash collected from
customers in the normal course of events, show how the above events would be recorded
in the:
i) Debtors Control Account.
ii) Provision for Doubtful Debts Account.

iii) Profit and Loss Account.
iv) Balance Sheet; (showing only how Debtors would appear on it).

8 Debtors, Creditors, and Promisory Notes

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8 Debtors, Creditors, and Promisory Notes

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Chapter 8

Debtors, Creditors and Promissory Notes

Definition of a Debtor and Creditor

i) There has to be a measurable value which is expected to be received, with reasonable

Date Description Folio Debit Credit

Date Description Folio Debit Credit

Debts write-offs through a provision

Date Description Folio Debit Credit

Recovery of amounts previously written off

The general journal entries to record recovery of bad debts are:

Date Description Folio Debit Credit

Date Description Folio Debit Credit

Provision for doubtful debts

i) Percentage of Debtors Method, and

Percentage of Debtors Method

Year 1 shs. 500,000

Date Description Folio Debit Credit

The entry being as follows:

Date Description Folio Debit Credit

Date Description Folio Debit Credit

The ledger accounts for the above transactions will be as follows:

Provision for Doubtful Debts Account no. 00

Dec31 Balance c/f 6,000 Dec31 Doubtful Debts 1,000

Dec31 Balance c/f 4,000 Dec31 Doubtful Debts 1,000

Doubtful Debts Expense Account no. 00

Debtors will be reported in the balance sheet as follows:

Balance Sheet (extract only)

shs shs shs

Net Book Value 495,000 594,000 396,000

Age-wise schedule of debtors

Ya Hua & Co.

Percentage of Sales Method

Year 1 shs. 500,000

Date Description Folio Debit Credit

The entry being as follows:

Date Description Folio Debit Credit

The entry to effect that is:

Date Description Folio Debit Credit

The ledger accounts for the above transactions will be as follows:

Provision for Doubtful Debts Account no. 00

Dec31 Balance c/f 11,000 Dec31 Doubtful Debts 6,000

Dec31 Balance c/f 15,000 Dec31 Doubtful Debts 4,000

Date Details Fol. Debit Date Details Fol. Credit

Doubtful Debts Expense Account no. 00

Debtors will be reported in the balance sheet as follows:

Balance Sheet (extract only)

shs shs shs

The formula employed in interest computation is:

Interest = Principal x Rate of Interest x Time

Accounting for notes receivable.

Date Description Folio Debit Credit

Date Description Folio Debit Credit

Date Description Folio Debit Credit

The entry to record this would be:

Date Description Folio Debit Credit

Discounting Notes Receivable

3. Compute the discount by the following formula: