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GLOBAL COLLEGE
ACCOUNTING DEPARTMENT
BASIC ACCOUNTING WORKS LEVEL II

Learning Guide
Unit of Competence: Develop Understanding of Debt
and Consumer Credit
Module Title: Develop Understanding of Debt and
Consumer Credit
LG Code: BUF BAW2 10 0812

TTLM Code: BUF BAW2 M10 1212

CONTENTS PAGE
INTRODUCTION…………………………………………………………………… 3
LO1………………………………………………………………………… 3
Identify and discuss the role of credit in society
 The concepts and terminology of credit
 role of consumer credit
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 advantages and disadvantages of credit

LO2 ………………………………………………………………………… 12
Identify and discuss the range of credit options available
 Types of credit facilities
 Differences between unsecured and secured loans
 Implications of default on secured loans
LO3 … …………………………………………………………………..… 18
Identify and discuss costs of using credit
 Fees and costs associated with
 The features and associated risks of fixed versus variable interest rates
 Ways to compare advertised interest rates,
LO4 … …………………………………………………………………..… 26
Analyze and discuss the effective use of consumer credit
 Strategies to minimize fees
 Ways to avoid credit card fraud
 Ways to compare advertised interest rates,

LO5 … …………………………………………………………………..… 28
Manage personal credit rating and history
 The role of credit reference agencies
 credit reference reports
 Implications of establishing a poor credit history
 methods of obtaining own credit reference report

LO1 Identify and discuss the role of credit in society

1.1 The concepts and terminology of credit provided by a financial institute and debt
incurred by a borrower are analyzed and discussed
1.2 The historical and current role of consumer credit within the society is identified
and advantages and disadvantages of credit use are analyzed and discussed
1.3 The impact of consumer debt on the national economy is analyzed and discussed

Information as required in a timely,

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accurate and effective manner

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The role of consumer credit includes:

enabling approved applicants the ability to purchase items (goods and/or services)
where the cost of the item exceeds current savings available.

Identify the Different Types of Receivables

 The term receivables refers to amounts due from individuals and companies.
 Receivables are claims that are expected to be collected in cash.
 Receivables represent one of a company’s most liquid assets.
 Receivables are frequently classified as:
 Accounts receivable:
 Are amounts owed by customers on account.
 Result from the sale of goods and services (often called trade receivables).
 Are expected to be collected within 30 to 60 days.
 Are usually the most significant type of claim held by a company.
 Notes receivable:
 Represent claims for which formal instruments of credit are issued as evidence of
debt.
 Are credit instruments that normally require payment of interest and extend for time
periods of 60-90 days or longer.
 May result from sale of goods and services (often called trade receivables).
 Other receivables:
 Nontrade receivables including interest receivable, loans to company officers,
advances to employees, and income taxes refundable.
 Generally classified and reported as separate items in the balance sheet.

Explain how Accounts Receivable are Recognized in the Accounts

Two accounting problems associated with accounts receivable are:

1. Recognizing accounts receivable

2. Valuing accounts receivable
Recognizing accounts receivable

 Service organizations -- A receivable is recorded when service is provided on account.

 Debit accounts receivable and credit service revenue
 Merchandisers – A receivable is recorded at the point of sale of merchandise on account.
 Debit accounts receivable and credit sales
 Receivable may be reduced by sales discount and/or sales return

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Advantages and  advantages:

disadvantages of  obtain and can use purchased item immediately
credit may include:  minimizes the need to carry cash or write cheques
 allows for installment payments on expensive items
 convenient form of payment when travelling, especially
overseas
 disadvantages:
 may increase cost of items purchased due to interest
accrued
 usually attracts other fees such as account servicing fees
 can lead to compulsive buying habits
 creates a false sense of wealth.

Describe the Methods Used to Account for Bad Debts

Valuing accounts receivable

 Determining the amount of accounts receivable to report is difficult because some

receivables will become uncollectible.
 This creates bad debt expense – a normal and necessary risk of doing business on
credit.
Two methods are used in accounting for uncollectible accounts:

1. Direct Write-off Method

2. Allowance Method
 Direct Write-Off Method
 When a specific account is determined to be uncollectible, the loss is charged to Bad
Debt Expense.
 For example, assume that Warden Co. writes off M. E. Doran’s $200 balance as
uncollectible on December 12. The entry is:
Dec. 12 Bad Debts Expense 200

Accounts Receivable--M. E. Doran200

(To record write-off of M. E. Doran account)

 Bad debts expense will show only actual losses from uncollectibles.
 Bad debts expense is often recorded in a period different from that in which the revenue
was recorded.

 Under this method, no attempt is made to:

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(1) show accounts receivable in the balance sheet at the amount actually expected
to be received; and
(2) Match bad debts expenses to sales revenue in the income statement.
 Use of the direct write-off method can reduce the usefulness of both the income statement
and balance sheet.
 Unless bad debt losses are insignificant, the direct write-off method is not acceptable for
financial reporting purposes.
Allowance Method
 The allowance method of accounting for bad debts involves estimating uncollectible
accounts at the end of each period.
 It provides better matching of expenses and revenues on the income statement and
ensures that receivables are stated at their cash (net) realizable value on the balance
sheet.
 Cash (net) realizable value is the net amount of cash expected to be received. It
excludes amounts that the company estimates it will not collect.
 Three essential features of the allowance method are:
1. Uncollectible accounts receivable are estimated and matched against revenues in
the same accounting period in which the revenues occurred.
2. Estimated uncollectibles are recorded as an increase to Bad Debts Expense and an
increase to Allowance for Doubtful Accounts (a contra asset account) through an
adjusting entry at the end of each period.
3. Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited
to Accounts Receivable at the time the specific account is written off as
uncollectible.
Recording Estimated Uncollectibles

 Allowance for Doubtful Accounts shows the estimated amount of claims on customers
that are expected to become uncollectible in the future.
 The credit balance in the allowance account will absorb the specific write-offs when they
occur.
 Allowance for Doubtful Accounts is not closed at the end of the fiscal year.
 Bad Debts Expense is reported in the income statement as an operating expense (usually
a selling expense).
Recording the Write-Off

 Under the allowance method, every bad debt write-off is debited to the allowance account
(not to Bad Debt Expense) and credited to the appropriate Account Receivable.
 A write-off affects only balance sheet accounts. Cash realizable value in the balance
sheet, therefore, remains the same.
Recovery of an Uncollectible

 When a customer pays after the account has been written off, two entries are required:
(1) The entry made in writing off the account is reversed to reinstate the customer’s
account.
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(2) The collection is journalized in the usual manner.

 The recovery of a bad debt, like the write-off of a bad debt, affects only balance sheet
account.
In “real life,” companies must estimate the amount of expected uncollectible accounts if they
use the allowance method.

 Frequently the allowance is estimated as a percentage of the receivables.

 Management establishes a percentage relationship between the amount of receivables
and expected losses from uncollectible accounts.
Compute the Interest on Notes Receivable

 A promissory note is a written promise to pay a specified amount of money on demand or at

a definite time.
 In a promissory note, the party making the promise to pay is called the maker.
 The party to whom payment is to be made is called the payee.
 Notes receivable
 give the holder a stronger legal claim to assets than accounts receivable.
 are frequently accepted from customers who need to extend the payment of an
outstanding account receivable, and they are often required from high-risk
customers.
 notes receivable, like accounts receivable, can be readily sold to another party.
Promissory notes are negotiable instruments.
 There are three basic issues in accounting for notes receivable:
1. Recognizing notes receivable.
2. Valuing notes receivable.
3. Disposing of notes receivable.
Computing Interest

 The formula for computing interest is:

Face Value of Note (principle) x Annual Interest Rate x Time (in terms of one year

 The interest rate specified on the note is an annual rate of interest. The time factor in the
computation expresses the fraction of a year that the note is outstanding.
When the maturity date is stated in days, the time factor is frequently the number of days divided
by 360. For example, the maturity date of a 60-day note dated July 17 is determined as follows:

Term of note 60 days

Days in July 31

Date of note 17

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Note’s days in July 14

Days in August 31

Plus note’s days in July 14

Notes days to the end of August 45 45

Maturity date, September 15

 When the due date is stated in terms of months, the time factor is the number of months
divided by 12.

Recognizing Notes Receivable

 To illustrate the basic entry for notes receivable, the text uses Brent Company’s $1,000, two-
month, 8% promissory note dated May 1. Assume that the note was written to settle an open
account. The entry for the receipt of the note by Wilma Company is as follows:

May 1 Notes Receivable 1,000

Accounts Receivable—Brent Company 1,000

(To record acceptance of Brent Company note)

 The note receivable is recorded at its face value, the value shown on the face of the note.
 If a note is exchanged for cash, the entry is a debit to Notes Receivable and a credit to Cash
in the amount of the note.
Valuing Notes Receivable

 Like accounts receivable, short-term notes receivable are reported at their cash (net)
realizable value.
 The notes receivable allowance account is Allowance for Doubtful Accounts.
 The computations and estimations are similar to the ones related to accounts receivable.

Describe the Entries to Record the Disposition of Notes

Receivable
 Notes may be held to their maturity date, at which time the face value plus accrued interest is
due.
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 In some situations, the maker of the note defaults, and appropriate adjustment must be made.
 A note is honored when it is paid in full at maturity.
 A dishonored note is a note that is not paid in full at maturity.

Explain the Statement Presentation of Receivables

 Each of the major types of receivables should be identified in the balance sheet or in the
notes to the financial statements.
 Short-term receivables are reported in the current asset section of the balance sheet below
short-term investments. These assets are nearer to cash and are thus more liquid.
 Both the gross amount of receivables and the allowance for doubtful accounts should be
reported.
 Notes receivable are listed before accounts receivable because notes are more easily
converted to cash.
 Bad Debts Expense is reported under “Selling expenses” in the operating expense section
of the income statement.
 Interest Revenue is shown under “Other Revenues and Gains” in the nonoperating section
of the income statement.

Identify and discuss the range of credit options

LO2 available

2.1 Types of credit facilities used by businesses are analyzed and compared
2.2 Types of credit facilities used by individuals are analyzed and compared
2.3 Differences between unsecured and secured loans are analyzed and discussed
Implications of default on secured loans are explained to the client

1. credit facilities

Describe the Principles of Sound Accounts Receivable

Management
 Managing accounts receivable involves five steps:
1. Determine to whom to extend credit.
2. Establish a payment period.
3. Monitor collections.
4. Evaluate the receivables balance.
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5. Accelerate cash receipts from receivables when necessary.

 Determine to whom to extend credit.
1. Risky customers might be required to provide letters of credit or bank guarantees.
2. Particularly risky customers might be required to pay cash on delivery.
3. Ask potential customers for references from banks and suppliers and check the
references.
4. Periodically check financial health of continuing customers.
 Establish a payment period.
1. Determine a required payment period and communicate that policy to customers.
2. Make sure company's payment period is consistent with that of competitor
 Monitor collections.
1. Prepare accounts receivable aging schedule at least monthly.
2. Pursue problem accounts with phone calls, letters, and legal action if necessary.
3. Make special arrangements for problem accounts.
4. If a company has significant concentrations of credit risk, it is required to discuss this risk
in the notes to its financial statements.
5. A concentration of credit risk is a threat of nonpayment from a single customer or class
of customers that could adversely affect the financial health of the company.

Identify Ratios to Analyze a Company's Receivables

 Liquidity is measured by how quickly certain assets can be converted into cash. The ratio
used to assess the liquidity of the receivables is the receivables turnover ratio.
 The ratio measures the number of times, on average, receivables are collected during the
period.
 The receivables turnover ratio is computed by dividing net credit sales (net sales less cash
sales) by the average net accounts receivables during the year.
 A popular variant of the receivables turnover ratio is to convert it into an average collection
period in terms of days. This is computed by dividing the receivables turnover ratio into 365
days.
 The general rule is that the average collection period should not greatly exceed the
credit term period (i.e., the time allowed for payment).
In some cases, receivables turnover may be misleading. Therefore, it is important to know how a
company manages its receivables.

Consumer credit  fixed:

facilities may include:  personal loans
 leases including mobile phones, cars, business premises,
office equipment including personal computers
 hire purchase
 'buy now, pay later' schemes
 revolving:
 credit cards

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 store cards
 overdraft.

Describe Methods to Accelerate the Receipt of Cash from Receivables

 Two common expressions apply to the collection of receivables:
1. Time is money—that is, waiting for the normal collection process costs money.
2. A bird in the hand is worth two in the bush—that is, getting the cash now is better than
getting it later or not at all.
 There are three reasons for the sale of receivables.
1. The size of the receivables may cause a company to sell them because it may not want to
hold such a large amount of receivables .
2. A final reason for selling receivables is that billing and collection are often time-
consuming and costly.
 Three parties are involved when national credit cards are used in making retail sales: (1) the
credit card issuer, who is independent of the retailer, (2) the retailer, and (3) the customer.
 A retailer’s acceptance of a national credit card is another form of selling—factoring—
the receivable by the retailer.
There are several advantages of credit cards for the retailer:
1. Issuer does credit investigation of customer.
2. Issuer maintains customer accounts.
3. Issuer undertakes collection process and absorbs any losses.
4. Retailer receives cash more quickly from credit card issuer.
 To illustrate, Morgan Marie purchases $1,000 of compact discs for her restaurant from
Sondgeroth Music Co., and she charges this amount on her Visa First Bank Card. The
service fee that First Bank charges Sondgeroth Music is 3 percent. The entry by Sondgeroth
Music to record this transaction is:
Cash 970

Service Charge Expense 30

Sales 1,000

(To record Visa credit card sales)

Sale of receivables to a factor:

 A common way to accelerate receivables collection is a sale to a factor. A factor is a finance

company or a bank that buys receivables from businesses for a fee and then collects the
payments directly from the customers.

Factoring arrangements vary widely, but typically the factor charges a commission of 1% to
3% of the amount of receivables purchased.

Differences between unsecured and secured loans include:

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 a secured loan is supported by an underlying asset while an unsecured loan is not

unsecured loans attract higher interest rates due to increased risk to the
lending institution.

Implications of  any shortfall in sale of repossessed asset against outstanding

default on secured loan amount must be paid by borrower
loans include:  repossession of the underlying asset by the lending institution.
Self Check
 Define receivables. What are the different types of receivables? Why is it necessary to have
them in different categories
 Explain how accounts receivable are recognized in the accounts. How are accounts
receivable valued on the balance sheet?
 What methods are used to accelerate the receipt of cash from receivables? Why do companies pay
fees for this service. Prepare journal entries for credit card sales.

LO3 Identify and discuss costs of using credit

3.1 Fees and costs associated with different types of credit options are analyzed
and compared
3.2 The features and associated risks of fixed versus variable interest rates are
analyzed and compared
3.3 Ways to compare advertised interest rates and the effects of fees and charges
are analyzed and discussed

2. credit facilities
Fees and costs associated with different credit options may include

 account servicing fees

 credit purchase fees
 late payment fees
 loan establishment fees

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withdrawing from a foreign Automatic Teller Machine (i.e. the ATM of a lending
institution other than your own).
Fees and costs may be analyzed and compared using:

 manually, comparing fees and costs drawn from tables and charts provided by
financial institutions and analyzed using a calculator

Procurement steps

Procurement life cycle in modern businesses usually consists of four steps:

 Information gathering: If the potential customer does not already have an established
relationship with sales/ marketing functions of suppliers of needed products and services
(P/S), it is necessary to search for suppliers who can satisfy the requirements.
 Supplier contact: When one or more suitable suppliers have been identified, requests for
quotation, requests for proposals, requests for information or requests for tender may be
advertised, or direct contact may be made with the suppliers.
 Background review: References for product/service quality are consulted, and any
requirements for follow-up services including installation, maintenance, and warranty are
investigated. Samples of the P/S being considered may be examined, or trials undertaken.
 Negotiation: Negotiations are undertaken, and price, availability, and customization
possibilities are established. Delivery schedules are negotiated, and a contract to acquire
the P/S is completed.

Ways to compare  informing the client of the 'comparison rate' which includes all
advertised interest associated fees and charges.
rates may include:

LO4 Analyze and discuss the effective use of consumer credit

4.1 Ways to avoid excessive or unmanageable debt are analyzed and discussed
4.2 Strategies to minimize fees on credit are identified and discussed
4.3 The importance of meeting minimum payments on credit cards is analyzed
and discussed
Information Sheet Strategies to minimize fees

Strategies to minimize fees on credit may include:

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 consolidating savings and credit facilities with the one institution where account
servicing fees can be cancelled out
 knowing how many free transactions come with the card
paying the minimum monthly installment on time.

Ways to avoid credit card fraud include:

 not disclosing Personal Identification Number (PIN) to anyone

 selecting a PIN only the card holder would know
signing the back of the credit card

LO5 Manage personal credit rating and history

5.1 The purpose and use of credit reference reports in assessing loan applications
is analyzed and discussed
5.2 Implications of establishing a poor credit history are analyzed and discussed
The right to access and methods of obtaining own credit reference report are
analyzed and discussed

3. Strategies to minimize fees

Credit reference reports refers to:

reports established and maintained by credit reference agencies which record all negative
events (i.e. defaults) listed by creditors against debtors.

Implications of  higher interest rate penalties

establishing a poor  inability to obtain finance in the future
credit history may  may disadvantage applications for rental accommodation
include:  necessity to obtain guarantor in future loans.

Methods of obtaining own credit reference file may include:

writing, emailing or telephoning the relevant agency requesting a copy of your file,
having provided relevant details to identify self.
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Self Check

1. What are the roies of credit referens?

2. Implications of establishing a poor credit history mayinclud ?

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