PROFITIZE Case Study: How TechCo Recorded the Settlement of Accounts Payable (Trade Credit)

Introduction:

TechCo, a company that manufactures electronic gadgets, had previously purchased raw materials on trade credit from a supplier (i.e., TechCo did not pay the supplier when the raw materials were delivered to TechCo by the supplier). Now, it's time for TechCo to settle this trade credit (accounts payable) by making the necessary payment.

The Situation:

TechCo had purchased 1,000 units of raw materials from a supplier on trade credit. The cost per unit was $50, making the total cost $50,000. The supplier extended trade credit to TechCo, allowing TechCo to pay the supplier later. The purchase of raw materials was also subject to a 10% VAT, amounting to $5,000. Therefore, the total amount TechCo had to pay, including VAT, was $55,000.

TechCo has now made the payment to settle this trade credit.

Case Facts:

• Number of units purchased by TechCo: 1,000

• Cost per unit: $50

• Total cost (before VAT): $50,000

• VAT (10%): $5,000

• Total amount TechCo needs to pay the supplier in future: $55,000

IFRS Journal Entries

Now, let’s think about how TechCo would record this transaction in their accounting books according to IFRS (International Financial Reporting Standards). TechCo needs to make the following journal entries:

1. When the materials were initially purchased on credit:

Debit: Inventory for the total cost (including VAT) of the raw materials.

Credit: Accounts Payable for the total amount  (including VAT) owed to the supplier by TechCo.

1. When the trade credit is settled and payment is made:

Debit: Accounts Payable for the total amount owed to the supplier by TechCo.

Credit: Cash/Bank for the total amount paid by TechCo to the supplier.

Can You Figure Out the IFRS Journal Entries?

Based on the information provided:

1. When the raw materials were purchased on credit:

Debit: Raw Material Inventory for $50,000 (cost before VAT)

Debit: VAT Receivable for $5,000 (VAT)

Credit: Accounts Payable for $55,000 (total amount owed to the supplier)

1. When TechCo settles the trade credit:

Debit: Accounts Payable for $55,000 (total amount owed to the supplier)

Credit: Cash/Bank for $55,000 (total amount paid to the supplier)

Explanation:

• Raw Material Inventory (Debit): Reflects the value of the raw materials purchased and added to TechCo's inventory.

• VAT Receivable (Debit): Represents the VAT that TechCo can reclaim from the government.

• Accounts Payable (Credit): Represents the liability TechCo owes to the supplier.

• Cash/Bank (Credit): Decreases as TechCo makes the payment to settle the trade credit.

This case study shows how TechCo recorded the purchase of raw materials on credit and the eventual payment by TechCo to settle that credit, including the accounting for VAT. The journal entries reflect the initial recording of the purchase and the final settlement of the trade credit. ​

Disclaimer: This case study is designed to enhance digital financial literacy and business management skills among students, to help them apply these concepts in real-world scenarios to boost their earnings, employability and entrepreneurial potential. The case was edited by Razi Amin, a Harvard MBA with 30+ years of leadership and advisory experiences at major international banks in New York, London, Hong Kong and Washington, DC. Razi is also a member of Harvard Alumni for Global Women's Empowerment. While AI technology was used for prompt-engineering to generate case content, every case has been rigorously reviewed and edited to ensure accuracy, clarity, and educational effectiveness. Reproduction of this case material is prohibited without permission from ASPEN Capital Solutions LLC.