Question
Should long outstanding trade creditors and other account payables be written off or derecognized in a similar way to the write-off of account receivables considered irrecoverable?
What are the circumstances under which accounts payable balances may be written off or reversed?
Answer
Trade creditors and other accounts payables constitute financial liabilities of the company which are payable to the respective creditors according to the terms of contracts.
The liability of the entity does not extinguish by the mere passage of time. IFRS 9 Financial Instruments states that financial liabilities should only be de-recognized by an entity when the related contractual obligation is ‘discharged, cancelled or expired’.
Therefore, long outstanding trade and other payables should not be written off from the statement of financial position simply because they have not been paid long after their due date although receivables may be written off immediately in the accounting period in which they are considered as irrecoverable. This is an application of the prudence concept which requires a degree of caution in the preparation of financial statements in order to avoid the overstatement of income and assets and the understatement of liabilities and expenses.
Trade creditors and other payables may be de-recognized in the following circumstances:
1. Discharge of liability
The payment of liability results in the discharge of contractual obligation. The liability must be reduced to the extent of the payment by cash or the transfer of other assets.
Where payment is made through the transfer of any assets other than cash, it may be necessary to recognize gain or loss for the difference in carrying value of those assets and the amount of liability offset.
Payment of liability within the certain duration specified in the contract may entitle the payer to a cash discount which is accounted for by reducing the payables balance and the recognition of discount received.
It may also be necessary to recognize gain or loss on the settlement of foreign currency payables.
Following accounting entries may be recorded to account for the payment of accounts payables:
|
Debit |
Payables balance |
This represents the gross amount of liability to be de-recognized from the balance sheet. |
|
Credit |
Cash / Bank / Other asset |
Net cash payment or the carrying value of assets other than cash for the settlement of liability. |
|
Credit |
Discount received |
Early settlement cash discount received. |
|
Debit |
Exchange loss |
In case of appreciation of a foreign currency payable balance. |
|
Credit |
Exchange gain |
In case of depreciation of a foreign currency payable balance. |
|
Debit |
Loss on transfer of other assets |
In case of transferred asset other than cash having carrying value higher than the amount agreed for settlement. |
|
Credit |
Gain on transfer of other assets |
In case of transferred asset other than cash having carrying value lower than the amount agreed for settlement. |
2. Cancellation of liability
Liability in respect of trade creditors and other payables may be cancelled or reduced as a result of the operation of law or an agreement with the creditor to waive the contractual liability.
Liability may be cancelled through the operation of law where for instance the creditor fails to fulfill a term of the contract which entitles the debtor to offset the resulting liquidated damages against the outstanding payable.
Liability may also be reduced or waived as a result of negotiation with the creditor.
The cancellation of liability results in savings to the entity and should therefore be recognized as other income since the saving of cash outflows are not attained through the ordinary course of business operations.
Following journal entry shall be recognized to account for the cancellation of liability:
|
Debit |
Payable |
|
|
Credit |
Other Income |
|
3. Expiry of term
Agreement may specify a term over which the creditor has to claim the outstanding amount at the expiry of which the debtor seizes to be liable for the amount due towards the payable.
As with the cancellation of liability, following accounting entry shall be recognized to account for the expired liability:
|
Debit |
Payable |
|
|
Credit |
Other Income |
|
Quiz
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Question
You are the finance manager at ABC PLC. During the finalization of financial statements for the year ended 31 December 2013, the accounts officer has identified for your review certain payable balances that have been outstanding for several accounting periods.
Which of the following liabilities may be derecognized from the statement of financial position?
A trade payable has been outstanding since 5 years due to adverse liquidity of ABC PLC.
Incorrect.
Inability to settle an obligation does not extinguish the financial liability of an entity.
Dividend payable is outstanding in respect of a shareholder for 5 years. Articles of association of ABC PLC states shareholders shall claim dividend within 3 years of the date of declaration after which any dividend due will lapse.
Correct.
The term over which the dividend had to be claimed has lapsed resulting in the expiry of liability.
An amount payable to tax authorities in respect of prior periods had been recognized several years ago. Due to the adverse liquidity of ABC PLC, tax authorities have agreed to waive half of the liability upon the request of CFO.
Correct.
This constitutes the partial cancellation of the liability. Half of the liability shall be de-recognized.
