Trade receivables are amounts owed by customers who bought goods or services on credit. They are a current asset, always recorded against a named customer, and removed only when the customer pays.
Before granting credit, a business assesses a customer's credit-worthiness using accounting information (e.g. the trade receivables balance, credit terms, overdue days; plus, for G3, trade receivables turnover and collection period) and non-accounting information (the customer's industry and economic outlook, the customer's reputation, and supplier references). In a credit-worthiness SBQ, state your decision first, then support it with evidence linked to financial impact — 2 points for G2, 3 points for G3 — with the decision worth 1 mark and each point worth 2 (evidence + impact).
Accounting for trade receivables records the credit sale (Dr Trade receivables / Cr Sales revenue or Service fee revenue), the cost side for goods (Dr Cost of sales / Cr Inventory), and the later collection (Dr Cash at bank / Cr Trade receivables). Sales returns, discount allowed, and dishonoured cheques all reduce or restore the receivable.
Because some customers may not pay, a business sets up an Allowance for impairment of trade receivables — a contra-asset (normally a credit balance) estimated as a percentage of the ending trade receivables balance, following the prudence theory. It is deducted from trade receivables on the Statement of Financial Position.
Each year-end change in the allowance is recorded as an Impairment loss on trade receivables (an expense), following the matching theory: an increase is an expense (Dr Impairment loss / Cr Allowance); a decrease is a reversal (Dr Allowance / Cr Impairment loss). A confirmed uncollectible debt is written off against the allowance (Dr Allowance / Cr Trade receivables). The impairment loss for the year is the new required allowance minus the current allowance after any write-offs.
To interpret the allowance account, remember it carries a credit balance: a credit entry increases the allowance (impairment loss), while a debit entry decreases it (a write-off or a reversal). Read the particulars column to identify which.