The different debtors that can be found in company accounts is illustrated by the follow- ing extract from Unilever’s 1996 accounts.
From this we can see that the amounts owed to a company come from a variety of sources.
Most companies would show total debtors on the face of the balance sheet, disclosing the detail in the notes.
One of the sad facts of life is that not everyone pays the money that they owe. In common with other current assets, debtors should be shown at the lower of cost or net realisable value.
This means that companies are required to make provisions for doubtful debts, and the value of debtors shown on the balance sheet should be after making doubtful debt provision.
These doubtful debt provisions are not usually disclosed, although some companies do dis- close them, as the extract from British Steel’s 1997 accounts shows.
If we are analysing a company we need to know the composition of the debtors, and the split between the debtors that are due within a year, and more than a year. If the company has a lot of money falling due in more than a year, we would ideally like to know precisely
11 Debtors
£ million Due within one year:
Trade debtors 3107 3325
Prepayments and accrued income 289 313
Other debtors 744 762
4140 4400
Due after more than one year:
Prepayments to funded pension schemes 305 191
Other debtors 132 133
437 324
Total debtors 4577 4724
DEBTORS (UNILEVER) Extract 11.1
The Company The Group
1997 1996 1997 1996
£m £m £m £m
Amounts falling due within one year:
Trade debtors 688 733 1287 1565
Less allowances for doubtful debts (22) (26) (36) (38)
666 707 1251 1527
DEBTORS (BRITISH STEEL) Extract 11.2
what it is and when it is likely to be paid. Unfortunately companies do not have to disclose this unless it is necessary for a true and fair view.
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Trade debtors
Trade debtors are one of the most important components of debtors, as they relate to the company’s sales during the period. In some businesses they are more important than in oth- ers. In its 1997 accounts Tesco, on a turnover of £13 887 million, had no trade debtors – do you get an invoice at the checkout? Whereas, in its 1997 accounts British Steel had £666 mil- lion net trade debtors, on a turnover of £7224 million. In a manufacturing business such as British Steel, debtors will always feature in the accounts.
Debtor days
Debtors relate to the sales that have been made in the period and this is how we measure them. In the same way that we calculated stock days, we can calculate the number of days that it is taking the company to collect money from its customers. The formula for calculat- ing debtor days, also called the collection period, is:
Trade debtors x 365 Turnover
Unfortunately we are comparing slightly different numbers. The turnover excludes VAT, whereas the debtors includes it. Some businesses do show their VAT-inclusive sales, but unfortunately they tend to be companies like Tesco, which do not have any trade debtors.
So, as usual, we are working with imperfect information.
This calculation of debtor days is illustrated by using the following example:
Year 1 Year 2 Year 3 Year 4
Turnover 1000 1050 1150 1300
Trade debtors 170 190 220 260
We can see that the company is taking longer to collect its money than it used to, as sales have increased by 30 per cent but debtors have increased by over 50 per cent. This is quantified by using the debtor days ratio:
Year 1 Year 2 Year 3 Year 4
Debtor days 62.1 66 69.8 73
The debtor days have increased by almost 11 days over the four years. This is important as every extra day’s credit the company gives its customers in year four requires the company to find another 3.562 in cash (1300 ÷ 365). Over the past four years the debtors have increased partly through increased sales values and partly through extended credit terms.
There are different ways of showing the collection period. Whilst it is usually expressed in days, it could also be expressed in months, or debtors could be expressed as a percentage of turnover.
Year 1 Year 2 Year 3 Year 4
Debtor months 2.0 2.2 2.3 2.4
Debtors as a percentage of turnover 17.0% 18.1% 19.1% 20.0%
EXAMPLE
11 Debtors However we choose to calculate it, the company is giving longer payment terms to its cus- tomers. The one thing that we can say for certain is that this will not have been through choice. All companies would like to be like Tesco and get cash for their sales, but unfortu- nately life is not like that. Companies have to give the same credit as everyone else in the industry, otherwise they do not get the sales! But it is a balance, extending credit is essen- tially the same as a price cut. However, some companies will give extended credit to get a large order.
Debtor days could increase for a number of reasons. The company could be giving more credit, or its customers may be experiencing cash flow problems themselves and are delay- ing payment, or are just unwilling to pay. (This could be a particular problem if the company has a few, very large, customers who may almost be able to dictate their own credit terms.) Whilst some companies are more efficient at credit control than others, large companies do put a lot of effort into controlling their debtors, and would monitor the age profileof their debtors. (A debtor age profile analyses the total debtor figure into amounts outstanding for less than 30 days, 30 to 60 days, 61 days to 90 days, and over 90 days. Unfortunately it is only prepared as an internal control document.)
One thing that we must recognise is that increasing debtor days is not necessarily a sign of inefficiency. The debtor figure represents the amount of money that the company is owed by its customers at the year end. Small changes in the pattern of trading can distort the ratio.
This is illustrated in the example below, which is an extension of our previous example.
The sales in the last quarter of the financial year are a slightly greater percentage (+2 per cent) of the total sales in year four than in year three. As the trade debtors are the sales that have not been paid for, these should relate to the sales that were made in the last quarter. If you recalculate debtor days based on the sales for the last quarter (multiplying by 91 – the number of days in the period) debtor days have improved slightly, rather than deteriorated ([260 ÷ 500] x91 days = 47.3 days, compared to 47.4 days based on the same period last year).
Consequently, if the company says elsewhere in the accounts that sales increased in the last period, expect that the calculated debtor days will also have increased. A fall in sales may well lead to an apparent improvement in credit control. A similar distortion could occur if
Analysis of sales by quarter Table 11.1
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total Year 4
Sales 200 300 300 500 1300
Percentage of annual sales 15.4% 23.1% 23.1% 38.5%
Debtors at the year end 260
Debtor days based on last quarter’s sales 47.3
Year 3
Sales 190 270 270 420 1150
Percentage of annual sales 16.5% 23.5% 23.5% 36.5%
Debtors at the year end 220
Debtor days based on last quarter’s sales 47.7
the company sells high-value items. A small increase in its sales towards the end of the year would be reflected in higher debtors.
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Factoring
An expanding manufacturing business can rapidly run into cash flow problems. Sales double, stocks and debtors will probably double, and they will be unable to fund this from the doubling of their creditors. We saw the trend during the early 1990s for large companies to delay paying smaller companies, recognising them as a source of interest-free borrowing.
(a practice not too dissimilar to our payments to the electricity companies – how many of us paid on the blue bill before discounts were given for prompt payment?) As a result, compa- nies have found ways of using their debtors to generate finance. Increasingly, companies have turned to factoring as a way of releasing cash from their debtors.
In factoringthe company sells the invoices to a factoring house (which is usually part of a bank or an international factoring organisation), which will then give the company up to an agreed percentage (usually 80 per cent) of the invoice value as cash. The balance will be paid (less the factoring company’s fees) on the payment of the invoice by the customer.
There are different types of factoring agreements, they can be:
● disclosed:the customer deals with the factor, rather than the company, that manages the sales ledgers);
● undisclosed: the customer deals with the company, which still manages the sales ledger in the normal way. This is also called invoice discounting;
● with recourse: if the customer does not pay, either in full or by a certain date, the com- pany will repay any advances that have been received from the factor;
● non-recourse:the factor cannot force the company to repay in the event of non-payment by the customer;
● with partial recourse: some non-refundable proceeds are received by the company.
FRS 5 (Accounting for the Substance of Transactions) discusses the accounting treatment of the different types of factoring agreements and invoice discounting agreements in Applica- tion Note C. All companies whose agreements have any recourse back to the company will have to disclose in the notes to the accounts:
● that they are factoring
● the amount of factored debtors at the end of the year.
Accounting treatment
The underlying principle of FRS 5 is that the party who has the significant risks and benefits from the agreement should show the transaction in its accounts. Consequently, the specific accounting treatment will depend on the nature of the recourse involved in the agreement.
Non-recourse agreements
Neither the debtors nor the advance from the factor will show on the balance sheet. It will be derecognised. The cost of factoring will be charged to the profit and loss account.
Limited recourse agreements
The debtors will be reduced by the amount of any non-recourse advances, to show a net debtor position. This is called a linked presentationin the standard. This should only be used
11 Debtors where the company selling the invoices cannot be forced to re-acquire them in the future.
The non-recourse advances could take several forms. For example, they could be in the form of credit insurance, or a credit protection policy. The cost of factoring will be separately dis- closed in the notes to the accounts. The factoring cost will be split between any adminis- tration costs and interest charges, which should show on the appropriate lines of the profit and loss account.
Full recourse agreements
The gross debtors will be shown on the balance sheet, less any provisions for bad debts and the advances from factors will show as a separate line within the notes to the creditors. This is called separate presentation. The factoring cost will be split between any administration costs and interest charges, which should show on the appropriate lines of the profit and loss account.
INTERNATIONAL DIFFERENCES
There are few international differences in accounting for debtors. The Fourth Directive requires separate disclosure of any debtors falling due in more than a year in member states.
These would not be classified as current assets in either the USA or Canada.
Some countries’ provisions are affected by the tax rules. In Germany a provision must be taken through the profit and loss account to be allowable for tax. Japanese companies tend to provide at the maximum level that is allowable for tax purposes, regardless of whether it is true and fair.
Types of debtor
Not all debtors shown in a set of UK accounts are current, as some fall due after a year.
The notes to the accounts will disclose the separate components to the debtors. The debtors are not necessarily related to sales, they could be:
● trade debtors – these debtors represent the money owed for sales during the year;
● other debtors – this is money owed for sales of fixed assets and other non-trading items;
● prepayments and accrued income;
● any unpaid called-up share capital;
● pension fund prepayments;
● finance-lease receivables in finance company’s accounts;
● loans.
Additionally, a parent company’s accounts must also legally disclose:
● any amounts owed by group undertakings – this will be shown on the parent com- pany’s balance sheet only;
● any amounts owed by undertakings in which the company has a participating interest.
TRADE DEBTORS
Trade debtors are one of the most important elements of the debtor figure in most com- panies’ accounts. All companies should be trying to reduce their investment in debtors, to give as little credit as possible. However, a balance has to be struck between shortening the collection period and gaining sales. Extending the credit period is effectively the same as a price discount.
SUMMARY