trade payables

Topic 6.4 – Interested Parties (Trade Payables)

1. Objective

To identify the interested parties who use information about trade payables, to understand the information each party requires, and to learn how trade payables are recorded, controlled and reported in accordance with the Cambridge IGCSE Accounting (0452) syllabus.

2. Interested Parties – who needs the information?

In the context of trade payables the following groups are listed in the syllabus. The table summarises the key information each party expects from the accounts.

Interested Party	Information required about trade payables
Owners / Shareholders	Cash‑flow impact, profitability, ability to pay dividends, overall working‑capital efficiency.
Managers	Timing of cash outflows, effectiveness of credit‑control policy, cost of purchases, any cash discounts gained or lost.
Investors (potential or existing)	Liquidity position, risk of over‑reliance on credit, sustainability of earnings.
Club / Society members (e.g., school clubs)	Whether the club can meet its short‑term obligations and transparency of spending on supplies.
Creditors – banks & suppliers	Credit risk, repayment history, days payable outstanding (DPO), any discounts that have been taken or missed.
Employees	Job security – a high level of unpaid trade payables may indicate cash‑flow problems.
Government / Tax authorities	Correct accounting for VAT (or other sales taxes) on purchases and compliance with tax legislation.
Public / Community	Ethical purchasing, timely payment of suppliers and the effect on local businesses.

3. Why Trade Payables Matter

• They form a major part of current liabilities on the balance sheet.
• They affect cash flow, working‑capital ratios and the ability to obtain further credit.
• Cash discounts and purchase returns linked to trade payables influence profitability.
• External parties use the level of trade payables to assess the firm’s credit risk.

4. Recording Trade Payables

4.1 Basic journal entry for a credit purchase

Transaction	Debit	Credit
Purchase of inventory on credit	Inventory $5,000	Trade Payables $5,000
Purchase of office supplies on credit	Office Supplies Expense $800	Trade Payables $800

4.2 Purchases‑ledger control account

The control account summarises all individual supplier balances. It appears in the general ledger and must reconcile with the total of the subsidiary ledger.

Date	Details	Debit ($)	Credit ($)	Balance ($)
1 Jan	Opening balance			12,000
15 Jan	Purchases on credit		30,000	42,000
28 Jan	Cash discount received (2 % of $10,000)	200		41,800
31 Jan	Payments to suppliers	20,000		21,800

4.3 Common variations

Situation	Journal entry (Debit)	Journal entry (Credit)
Cash discount received (2 % on $5,000)	Trade Payables $5,000 Cash Discount Received $100	Bank $4,900
Purchase returns (goods returned worth $800)	Trade Payables $800	Inventory $800
Dishonoured cheque from supplier ($1,200)	Bank $1,200	Trade Payables $1,200

4.4 Payment of trade payables

When a liability is settled, the trade‑payables account is debited and the bank (or cash) account is credited.

Transaction	Debit	Credit
Payment of $5,000 to a supplier	Trade Payables $5,000	Bank $5,000

5. Impact on the Financial Statements

• Balance Sheet: Trade payables are shown under Current Liabilities. The total in the purchases‑ledger control account is the figure reported.
• Income Statement:
  • Purchase returns reduce the cost of purchases (and therefore increase gross profit).
  • Cash discounts received are recorded as “Discount Received” – a reduction in expenses or, depending on the format, other income.
• Cash‑flow Statement (if required): Payments to trade payables appear as cash outflows from operating activities.

6. Key Ratio – Days Payable Outstanding (DPO)

DPO shows the average number of days the business takes to pay its suppliers.

\[ \text{DPO} = \frac{\text{Average Trade Payables}}{\text{Cost of Purchases per Day}} = \frac{\text{Average Trade Payables}}{\dfrac{\text{Total Credit Purchases}}{365}} \]

Where:

• Average Trade Payables = (Opening Payables + Closing Payables) ÷ 2
• Total Credit Purchases = all purchases made on credit during the period (net of returns and discounts).

Example

Data for the year:

• Opening Trade Payables = $12,000
• Closing Trade Payables = $18,000
• Total Credit Purchases = $150,000

Average Payables

\[ \text{Average Payables} = \frac{12,000 + 18,000}{2} = 15,000 \]

Cost of Purchases per Day

\[ \frac{150,000}{365} = 410.96 \]

Days Payable Outstanding

\[ \text{DPO} = \frac{15,000}{410.96} \approx 36.5\text{ days} \]

The business, on average, settles its suppliers in about 37 days.

7. Implications of DPO for Interested Parties

• Suppliers: A very high DPO may signal cash‑flow pressure and could lead to stricter credit terms.
• Creditors (banks): Use DPO together with liquidity ratios to assess lending risk.
• Managers: Aim for a DPO that maximises cash on hand while preserving good supplier relationships.
• Owners / Investors: Prefer an optimal DPO that supports profitability and dividend potential.
• Government / Tax authorities: Ensure VAT on purchases is recorded correctly; the timing of payment does not affect the tax liability but may be examined during compliance checks.

8. Control and Best Practice

1. Maintain a detailed purchases‑ledger (individual supplier accounts) and reconcile it regularly with the control account.
2. Take cash discounts whenever the business’s cash flow allows payment within the discount period.
3. Record purchase returns promptly to avoid overstating inventory and payables.
4. Monitor DPO each month and compare it with industry benchmarks.
5. Re‑enter any dishonoured cheques correctly to avoid understating liabilities.

9. Key Points to Remember

1. Trade payables arise when goods or services are bought on credit.
2. The basic journal entry always debits an asset or expense and credits Trade Payables.
3. Cash discounts, purchase returns and dishonoured cheques modify the basic entry and affect the income statement.
4. The purchases‑ledger control account summarises all individual supplier balances and must equal the figure shown on the balance sheet.
5. DPO measures how long payables are held; it is a vital indicator for managers, owners, creditors and suppliers.
6. Understanding the needs of each interested party helps the business manage payables efficiently and maintain good external relationships.