• UNIT6:UNDERSTANDING LOAN / CREDIT POLICY

    Key unit competence: To be able to explain the loan/credit procedures 

    Introductory activity:

    Mr. Nkundurwanda is a business man operating his business in Rwanda in 
    small scale business. Apart of his main activity Mr. Nkundurwanda has family 
    responsibilities which require him more finances. The capital amount of his 
    business amounted to Frw 10,000,000, Due to the progress of his business 
    he is in need of Frw 10,000,000 more which will help his business to grow 
    and continue to expand and operate in different countries. In this process 
    there are many alternatives to deal with this issue and Mr. Nkundurwanda 

    needs to find the best one which will meet his needs. 

    Questions;
    What is the activity of Mr. Nkundurwanda?
    What are the challenges do you think that Mr. Nkundurwanda is facing?
    What are the potential alternatives Mr. Nkundurwanda needs to think about 
    to overcome those challenges?
    Among alternatives which one you can you advise Mr. Nkundurwanda to 
    take?

    What will be the importance of alternative chosen by Mr. Nkundurwanda?

    Accounting Management | Student Book | Senior Six

    Learning Activity 6.1


    Answer the following questions 

    1) What do you understand about this picture?
    2) What is the role of the bank in this picture?

    3) What is the relationship between bank and borrower

    6.1.1. Definition of concepts related to the credit

    a. Credit

    By credit, we mean the power which one person has to induce another to put 
    economic goods at his deposal for a time on promise or future payment. Credit 
    is thus an attribute of power of the borrower.” Prof. Kinley.
     “Credit is purchasing power not derived from income but created by financial 
    institutions either as on offset to idle income held by depositors in the bank or 

    as an addition to the total amount or purchasing power.” Prof. Cole.

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    “The term credit is now applied to that belief in a man’s probability and solvency 
    which will permit of his being entrusted with something of value belonging to 
    another whether that something consists, of money, goods, services or even 
    credit itself as and when one may entrust the use of his good name and 
    reputation.” Prof. Thomas.
    On the basis of those definitions it can be said that credit is the exchange 
    function in which, creditor gives some goods or money to the debtor with a 
    belief that after sometime he will return it. In other words Trust ‟is the Credit‟.
    b. Credit policy
    A credit policy includes detailed guidelines for the size of the loan portfolio, 
    the maturity period of the loan, security against loan, the credit worthiness of 
    the borrower, the liquidation of loans, the limits of lending authority, the loan 
    territory, etc.
    Credit policy provides some directions for the use of funds, to control the size 
    of loans and influences the credit decision of the bank. So, the loan policy is a 
    necessity for a bank.
    In formulating the loan policies, the policy formulators must be very cautious 
    because the lending activity of the bank affects both the bank and the public 
    at large. All the influencing factors should be considered such as Size of loan 
    account; Credit for infrastructure; Types of loan portfolio; Acceptable security; 
    Maturity of the loan; Compensating balance; Lending criteria; Loan territory; 
    Limitations of lending authority.
    c. Credit monitoring
    A good lending is that the amount lent, should be repaid along with interest 
    within the stipulated time. To ensure that safety and repayment of the funds, 
    banker is necessary to follow-up the credit, supervise and monitor it. Credit 
    monitoring is an important integral part of a sound credit management. The 
    bank should always be careful for that fund properly utilized for what it has 
    been granted. Banker keeps in touch with the borrower during the life of the 
    loan. There are some steps from the banker’s point of view, to ensure the safety 
    of advance which are documentation, disbursement of advance, inspection, 
    submission of various statements, annual review and market information.
    d. Credit services 
    It is the business of providing loans, other forms of credits and information about 

    credits to people and companies.

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    e. Credit delivery

    In credit delivery, the borrowers are allowed to draw funds from the account 
    to the extent of the value of inventories and receivables less stipulated margin 
    within the maximum permissible credit limit granted by the bank.
    6.1.2 Types of credit
    The credit assistance provided by a banker is mainly of two types, one is fund 
    based credit support and the other is non-fund based. The difference between 
    fund based and non-fund based credit assistance provided by a banker lies 
    mainly in the cash out flow. Banks generally allow fund based facilities to 
    customers in any of the following manners.
    TRADITIONAL CREDIT PRODUCTS
    • Cash credit
    Cash credit is a credit that given in cash to business firms. It is an arrangement by 
    which, a bank allows its customers to borrow money up to a certain limit against 
    tangible securities or share of approved concern. Cash credits are generally 
    allowed against the hypothecation of goods/ book debts or personal security. 
    Depending upon the nature of requirements of a borrower, bank specifies a 
    limit for the customer, up to which the customer is permitted to borrow against 
    the security of assets after submission of prescribed terms and conditions and 
    keeping prescribed margin against the security.
    • Overdraft:
    A customer having current account, is allowed by the banks to draw more 
    than his deposits in the account is called an overdraft facility. In this system, 
    customers are permitted to withdraw the amount over and above their balances 
    up to extent of the limit stipulated when the customer needs it and to repay it 
    by the means of deposits in account as and when it is convenient. Customer 
    of good standing is allowed this facility but customer has to pay interest on the 
    extra withdrawal amount.
    • Demand loans
    A demand loan has no stated maturity period and may be asked to be paid on 
    demand. Its silent feature is, the entire amount of the sanctioned loan is paid to 
    the debtor at one time. Interest is charged on the debit balance.
    • Term loans
    Term loan is an advance for a fixed period to a person engaged in industry, 
    business or trade for meeting his requirements like acquisition of fixed assets 

    etc. The maturity period depends upon the borrower’s future earnings. Next to

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      cash credit, term loans are assumed of great importance in an advance portfolio 
    of the banking system of country.
    • Bill purchased
    Bankers may sometimes purchase bills instead of discounting them. But this 
    is generally done in the case of documentary bills and that from approved 
    customers only. Documentary bills are accompanied by documents of title to 
    goods such as bills of lading or lorry and railway receipts. In some cases, banker 
    advances money in the form of overdraft or cash credit against the security of 
    such bills.
    • Bill discounted
    Banker lends the funds by receiving a promissory note or bill payable at a future 
    date and deducting that from the interest on the amount of the instrument. The 
    main feature of this lending is that the interest is received by the banker in 
    advance. This form of lending is more or less a clean advance and banks rely 
    mainly on the creditworthiness of the parties.
    INNOVATIVE CREDIT PRODUCTS
    Since the liberalization period there have been drastic changes in the way loans 
    have been granted to individual customers and businessmen. The changing 
    pattern of banks from universal to branch banking after the liberalization period 
    also forced banks to adopt easy lending. Technology has supported the 
    development of financial service industry and reduced the cycle of money to the 
    shortest possible duration.
    • Credit cards
    Credit cards are alternative to cash. Banks allow the customers to buy goods 
    and services on credit. The card comprises different facilities and features 
    depending on the annual income of the card holder. Plastic money has played 
    an important role in promoting retail banking.
    • Debit cards
    Debit card can be used as the credit card for purchasing products and also for 
    drawing money from the ATMs. As soon as the debit card is swiped, money is 
    debited from the individual’s account.
    • Housing loans
    Various types of home loans are offered by the banks these days for purchasing 
    or renovating house. The amount of loan given to the customer depends on 
    the lending policies and repayment capacity of the customer. These loans are 

    usually granted for a long period.

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    • Auto loans
    Auto loans are granted for the purchase of car, scooter and others. It may be 
    granted for purchasing vehicle.
    • Personal loans
    This is an excellent service provided by the banks. This loan is granted to the 
    individuals to satisfy their personal requirements without any substantial security. 
    Many banks follow simple procedure and grant the loan in a very short period 
    with minimum documents.
    • Educational loans
    This loan is granted to the student to pursue higher education. It is available for 
    the education within the country or outside the country.
    • Loans against securities
    These loans are provided against fixed deposits, shares in the market, bonds, 
    mutual funds and life insurance policy.
    • Consumption loans for purchase of durables
    Banks fulfill the dreams and aspirations by providing consumer durable loans. 
    These loans can be borrowed for purchasing television, refrigerator, laptop, 

    mobile, etc.

    6.1.3. Importance of loan
    Credit plays an important role in the gross earnings and net profit of commercial 
    banks and promotes the economic development of the country. The basic 
    function of credit provided by banks is to enable an individual and business 
    enterprise to purchase goods or services ahead of their ability. Today, people 
    use a bank loan for personal reasons of every kind and business venture too. 
    The following are other importance of loan;
    • Exchange of ownership
    Credit system enables a debtor to use something which does not own completely.
    • Employment encouragement
    With the help of bank credit, people can be encouraged to do some creative 
    business work which helps increasing the volume of employment.
    • Increase consumption
    Credit increases the consumption of all types of goods. By that, large scale 

    production may be stimulated which leads to decrease cost of production. In 

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    turn also it lowers the price of product which in result rising standard of living.
    • Saving encouragement
    Credit gives encouragement to the saving habit of the people because of the 
    attraction of interest and dividend.
    • Capital formation
    Credit helps in capital formation by the way that it makes available huge 
    funds to unable people to do something. Credit makes possible the balanced 
    development of different regions.
    • Development of entrepreneurs
    Credit helps in developing large scale enterprises and corporate business. It 
    has also helped the different entrepreneurs to fight against difficult periods of 
    financial crisis. Credit also helps the ordinary consumers to meet requirements 
    even in the inability of payment. 
    • Priority sector development
    Credit helps in developing many priority sectors including agriculture. This 
    has greatly helped in rising agriculture productivity and income of the farmers. 
    Banks in developing countries are providing credit for development of SSI in 

    rural areas and other priority sectors too.

    6.1.4. Importance of liquidity management 

    Liquidity refers to the ability of an organization to pay its suppliers on time, 
    meet its obligation costs, such as wages and salaries and to pay longer-term 
    outstanding amounts such as loan repayment. Adequate liquidity is often a key 
    factor in contributing to the success of failure of a business. For example liquid 
    assets include cash, short term deposits, trade receivables and inventories. 
    Those are called Working capital of a business.
    Cash is the most liquid of assets and it is part of working capital of the business. 
    However, the time taken to convert trade receivables into cash and the time 
    taken to pay creditors affect the liquidity position of the business.
    Liquid assets are current asset items that will, or could soon, be converted into 
    cash, and cash itself. Two common definitions of liquid assets are all current 
    assets or all current assets with the exception of inventories.
    The main source of liquid assets for a trading company is Sales. A company can 
    obtain cash from sources other than sales, such as the issue of shares for cash, 

    a new loan or the sale of non current assets but company cannot rely on these 

    Management Accounting | Experimental Version | Student Book | Senior Six

    and in general, obtaining the liquid funds depends on making sales and profits.
    The management needs to carefully consider the level of investment in working 
    capital and to consider the impact that this is having on a company’s liquidity 
    position; an overview of this is given by the cash operating cycle/working capital 
    cycle.
    Cash operating cycle/working capital cycle is the period of time between 
    the outflow of cash to pay the raw materials and the inflow of cash from 
    customers. The number of days credit taken by accounts receivable has a direct 
    effect on the amount of time money is tied up for in working capital. Therefore, 
    managing the period of credit customers take is vital to the management of the 
    organization’s liquidity.
    6.1.5. Granting loan 
    Granting credit to customers is essential for many organizations and brings 
    many benefits to both organizations and the customers. However, the risks 
    associated with granting credit should be monitored and managed carefully.
    a. Applicant profile
    To make prudent credit decision, bank essentially should know well the borrower 
    well. Without these information bank cannot judge the loan application. 
    Creditworthiness of the applicants is evaluated to ensure that the borrower 
    conforms to the standards prescribed by the bank. It can be said that a loan 
    properly made is half-collected. So, a bank should make proper analysis before 
    making any credit decision. With increasing credit risks, banks have to ensure 
    that loans are sanctioned to „safe‟ and „profitable‟ projects. For this, they need 
    to fine tune their appraisal criteria.
    b. Application form
    It is a document on which the lender bases the decision to lend. A loan 
    application is neither a pledge by the applicant nor a commitment by the lender. 
    It contains essential financial and other borrower information. Detailed business 
    plan, projected income statements showing profit and loss, balance sheet, and 
    cash flow statement are required for a business loan. Loan amount and purpose, 
    period and means of repayment, and guaranties and/or collateral offered are 
    required of a company applying for a loan. Banks generally use standard forms 
    for the applicant to fill-in. It is also known as credit application.
    c. Information required for granting credit
    When assessing the credit status of either on established or a new customer 
    there are a range of sources of information that the credit controller can use.

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    Some are external to the business and others are internal to the business.
    The credit controller needs to consider the customer’s ability and willingness 
    to pay within the stated credit terms and also that the customer will remain 
    solvent. No single source of information can guarantee either of these but there 
    are varieties of sources which can be pooled for a final decision on credit status 
    to be made
    External sources: Bank Reference, Trade reference, Credit reference agencies, 
    Office of Register General, Management accounts from the customer, Media 
    publication, Internet searches.
    Internal sources: Staff knowledge communicated by conversations, emails, 
    meetings, customer visit, financial analysis of either external published financial 
    statements or internal management and previous trading history.

    6.1.6. Evaluating credit worthiness 

    The purpose of analyzing the financial statements for credit control assessment 
    is to find the indicators of the customer’s performance and position in four main 
    areas as follow:
    Profitability Indicators; Liquidity indicators; Debt indicators; Cash flow indicators
     Profitability Ratios
    When credit has been granted one major concern will be the profitability of the 
    customer. If the customer is not profitable in the long term then it will eventually 
    go out of the business and this may mean a loss, in the form of an irrecoverable 
    debt, if it has been granted credit.
    Gross profit margin: Gross profit/Revenue*100% It shows how profitable the 
    trading activities of business are.
    Net profit margin: PAT/Revenue*100%. It indicates the overall profitability of 
    the business
    Return on capital employed (ROCE): Net profit/Capital employed*100%
     Net asset turnover: Capital employed/Revenue. It measures the number of 
    times that revenue represents capital employed (or net assets).
    Liquidity Ratios
    The purpose of calculating liquidity ratio is to provide indicators of the shortterm and
     medium-term stability and solvency of the business. It is also to assess 

    if the business can pay its debts when they fall due. There are two overall ratios:

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    Current ratio: Current assets /Current Liabilities. Ideal ratio is 2:1
    Quick ratio or acid ratio: (Current assets-Inventory)/Current liabilities. Ideal ratio 
    is 1:1
    Gearing Ratios
    When assessing a customer’s credit status, the credit controller will also be 
    concerned with the longer-term stability of the business. One area of anxiety 
    here is the amount of debt in the business ‘ capital structure and its ability to 
    service this debt by paying periodic interest charges.
    Main measures are: 
    Gearing ratio= Long term debt/ (Long term debt + Equity)*100%. Is a measure 
    of the proportion of interest-bearing debt to the total capital of the business.
    Interest cover = Profit before interest and tax / Interest. It is calculated as the 
    number of times that the interest could have been paid, it represents the margin 
    of safety between the profits earned and the interest that must be paid to service 
    the debt capital.
    Credit scoring
    Credit scoring is a method of assessing the credit worthiness of an individual 
    or organization using statistical analysis and is used by the organizations such 
    as banks, utility companies, insurance companies and landlords to assess the 
    ability of an individual or organization to repay any loans or pay for services or 
    goods.
    A credit score is a number ranging from 300-850 that depicts a consumer’s 
    creditworthiness. The higher the credit score, the more attractive is the borrower. 
    A credit score is based on credit history such as number of open accounts, total 
    levels of debt, and repayment history. 
    Lenders use credit scores to evaluate the probability that an individual will repay 
    loans in a timely manner.
    Your credit score, a statistical analysis of your creditworthiness, directly affects 
    how much or how little you might pay for any lines of credit you take out.
    Illustration
    A company has share capital of Frw 200million, resources totaling Frw 188million 
    and a loan of Frw 100 million . The net profit for the year is Frw 45million, after 

    deducting depreciation of Frw 12 million and interest of Frw 6million.

    Management Accounting | Experimental Version | Student Book | Senior Six

    Solution:

    Opening a new customer account
    Once a decision has been made to grant credit to a customer then a file and 
    account in the trade receivable ledger must be set up. 
    The following information will be required: Business name of the customer; the 
    contract name and title within the customer’s business; business address and 
    telephone number; the credit limit agreed upon; the payment terms agreed.

    Refusal of credit

    The credit controller may decide that it is not possible to trade with a new 
    potential customer on credit terms.
    It is a big decision for the credit controller as the business will not wish to lose 
    this potential customer’s business but the credit controller will have taken a 
    view that the risk of non- payment is too high for credit terms to be granted.
    It simply means that on the evidence available to the credit controller, the chance 
    of non-payment is too high for the company to take the risk.
    The reasons are the following:
    A non-committal or poor bank reference
    Poor trade references
    Concerns about the validity of any trade references submitted
    Adverse press comment about the potential customer
    Poor credit agency report
    Indications of business weakness from analysis of financial statements
    Lack of historical financial statements available
    Information from a member of the business’s credit circle
    The credit controller will consider all the evidence available about a potential 
    customer and the reason for the refusal of credit may be due to a single factor 
    noted above or a combination of factors.

    Communication of changes or refusal

    If a credit facility is to be changed or not granted to a potential customer then 

    this must be communicated in a tactful and diplomatic manner. The reason for

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    the change or refusal of credit must be politely explained and any future actions 
    required from potential customer should also be made quite clear.
    Communication method
    It is common to communicate the reasons for the refusal of credit in a letter 
    initially. In the letter the credit controller may suggest that a telephone call may 
    be appropriate in order to discuss the matter and any future actions.
    6.1.7. Terms and conditions associated with Overdraft and 
    loan 

    Most of us are familiar with the concept of an overdraft, which is a form of 
    short-term borrowing from the bank, available to both business and personal 
    customers. The overdraft allows the account holder to continue withdrawing 
    money even when the account has no funds in it or has insufficient funds to cover 
    the amount of withdrawal. If a bank is approached for an overdraft, then it will 
    normally agree an overdraft facility. This is the amount by which the business’s 
    account is allowed to be overdrawn. It is then up to the customer to determine 
    how much of this overdraft facility is to be used by having an actual overdraft. 
    And loan is credit facility under which a bank allows funds withdrawn to exceed 
    fund deposited in accordance with specified terms and conditions
    Among the terms and conditions associated with overdraft and loan application, 
    it should be disposed within a reasonable period of time and state specific time 
    period from the date of acknowledgement, within which the decision on loan 
    request will be conveyed to the borrower.
    In case of rejection, specific reasons should be conveyed in writing. Credit limits 
    which may be sanctioned may be mutually settled.
    Terms and conditions governing credit facilities such as margin security should 
    be based on due diligence and creditworthiness of borrower.
    Lender should ensure timely disbursement of loans sanctioned.
    Lender should give notice of any change in the terms and conditions including 
    interest rates and service charges.
    6.1.8. Types of investments, risks and their terms and conditions
    There are five major factors to be considered when any investor chooses 

    investments

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    a. certificate of deposit (CD)

    A certificate of deposit is a document issued by a bank or building society 
    which certifies that a certain sum, has been deposited with it, to be repaid on a 
    specific date. The term can range from seven days to five years but is usually for 
    six months. CDs are negotiable instruments which means, they can be bought 
    and sold. Therefore, if the holder does not want to wait until the maturity date, 
    the CD can be sold in the money market. CDs offer a good rate of interest, are 
    highly marketable and can be liquidated at any time at the current market rate. 
    The market in CDs is large and active; therefore they are an ideal method for 
    investing large cash surpluses.
    b. Government securities 
    • Bills of exchange
    A bill of exchange can be defined as an unconditional order in writing from 
    one person to another, requiring the person to whom it is addressed to pay a 
    specified sum of money, either on demand (a sight bill) or at some future date (a 
    term bill). A cheque is a special example of a type of bill of exchange. 
    • Trading in bills of exchange 
    Most bills of exchange are term bills with a duration or maturity of between two 
    weeks and six months and can be in any currency. If one company draws a bill 
    on another company, this is known as a trade bill. However, the market in these 
    is small. Most bills are bank bills, which are bills of exchange drawn and payable 
    by a bank, the most common of these is known as a banker’s acceptance. There 
    is an active market in such bills and a company with surplus cash could buy a 
    bill of exchange at a discount and either hold it to maturity or sell it in the market 
    before maturity again at a discount. The difference between the price at which 
    the bill is purchased and the price at which it is sold or it matures is the return

    to the investor. Commodities (Gold) are physical products such as gold. They 

    arQuestions:

    What do you observe on the above picture?

    Explain the function of each image found in this picture

    After watching careful this picture is there any relationship between the 

    images in the picture?e traded on commodity exchanges where standard contracts are bought and 

    sold.

    c. Shares Equity

    An Equity investment is generally the purchase of shares in another company. 
    Often this takes place through a stock market. Income is from dividend payments 
    and capital gains on the increase in the share value.
    Investments in companies that are traded on a stock exchange are very easily 
    sold, so these are a relatively liquid form of investment. However, unless 
    the investment is a speculative one, in anticipation of a rapid increase in the 
    company’svalue, investments in equity are normally held for longer periods.
    Property and land
    Investing in property and land is generally a very safe investment. However, 
    the costs of maintaining and generating an income from property and land are 
    higher than for other forms of investment.
    These are generally long-term investments due to the costs and time associated 
    with purchasing and selling land and property.

    Diversification and types of investment

    A business should aim to create a diversified portfolio of investments, with 
    a spread of risk and return. Marketable securities can be ranked in order of 
    increasing risk and increasing expected return.
    Government securities Low risk
    Other ‘public’ corporation stocks
    Company loan stocks
    Other secured loans
    Unsecured loans
    Convertible loan stocks

    Preference shares

    Equities   High risk

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    Government stock

    The risk of default is negligible and hence, this tends to form the base level for 
    returns in the market. The only uncertainty concerns the movement of interest 
    rates overtime, and hence, longer dated stocks will tend to carry a higher rate 
    of interest.
    Company loan stock
    Although there is some risk of default on company loan stock (also called 
    corporate bonds), the stock is usually secured against corporate assets.
    CDs and Bills of Exchange
    The riskiness of CDs and bills of exchange varies with the creditworthiness 
    of the issuers. They are riskier than government securities, but less risky than 

    shares.

    Application activity 6.1.

    Questions 

    8. Give and explain the types of loans
    9. What is the purpose of analyzing financial statements in evaluating 
    the credit worthiness? 
    10. Discuss the importance of liquidity management 
    11. List external sources of available external information which help to 
    understand creditworthiness? 

    12. What do you understand by A certificate of deposit (CD)?

    Management Accounting | Experimental Version | Student Book | Senior Six

    6.2. Effect of legislation to credit control

    Learning Activity 6.2




    Questions:

    What do you observe on the above picture?
    Explain the function of each image found in this picture
    After watching careful this picture is there any relationship between the 

    images in the picture?

    6.2.1. Law legislating the credit and remedies for breaches

    a. Relevant contract law and remedies for breaches
    • What is a contract?
    A contract is a legally enforceable agreement between two or more parties.
    Main elements of contract: Agreement; Consideration and Intention to create 
    legal relations

    • The importance of contract

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    The importance of contract law is that if a contract is made between two parties 
    and if one party does not satisfactory carry out its side of the agreement, the 
    other party can take the defaulting party to court for breach of contract.
    The following are the main legal contract elements
    a) Offer: An offer is the beginning of a contract.
    b) Acceptance. An offer can be accepted in writing, in person or over 
    the phone. Volunteer of each group to operate or Free Consent of each 
    group. 
    c) Consideration. Consideration is something of value that the parties are 
    contracting to exchange.
    d) Mutuality of obligation; each contracted party has reciprocal duties 
    and responsibilities, one to another. 
    e) Competence/Capacity: Competent parties who have the legal capacity 
    to contract. By this each party legally assign what is able to do to another 
    and to the business concerned. 

    f) Legality: all job contracts must be legal tender.

    An invitation to treat

    Care must be taken to distinguish between an offer and the invitation to treat. 
    An invitation to treat is an invitation by the seller of goods for the buyer to make 
    an offer to buy them at that price. Examples are advertisements, catalogues, and 
    the price tickets displayed on goods.
    Duration of an offer

    If an offer is made then it does not have to remain in place indefinitely. There are 
    a number of ways in which an offer can be brought to an end:
    If there is a set time period for an offer, then the offer will lapse at the of time 
    period. If there is no express time period set then the offer will lapse after a 
    reasonable period of time.

    An offer can be revoked by the offeror at any point in time before it has been 
    accepted. Revocation of an offer means that the offer is at cancelled.
    An offer comes to an end if it is rejected. An offer can be rejected by a counter 
    offer. Eg. If an offer is made to sell an item for Frw 1M and the offeree replies 
    to say that he will buy at Frw 0.9M this is a rejection of the original offer to seller.
    The offer comes to an end when a valid acceptance is made.

    Acceptance of an offer

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    The acceptance of an offer must be absolute and unqualified
    Acceptance can be made verbally or in writing
    If an offer requires a particular form of acceptance (such as verbal, in writing or 
    by fax) then this is the form in which the acceptance must be made.
    It must be unqualified- if any additional conditions or terms are included in an 
    acceptance then takes the form of counter-offer, which rejects the original offer.
    Value
    The second required element of a contract is that of there being some value. 
    The basis of contract law is that we are dealing with a basis of contract law is 
    that we are dealing with a bargain of some sort, not just a promise by one of the 
    parties to a contract to do something.
    What is required for there to be a valid contract is known in legal terms as 
    consideration. Consideration can be thought of as something given, promised 
    or done in exchange for the action of the other party.
    In terms of business transactions, the consideration given for a sale of goods is 
    either the money paid now or the promise by a receivable to pay at a later date.
    Both parties must bring something of value to the contract for it to be legally 
    binding i.e. valid. It can be item or service.
    Unilateral Contracts
    Most contracts are known bilateral Contracts meaning that two persons or 
    parties have taken action to form a contract. Unilateral Contracts involve an 
    action undertaken by one person or a group alone. In contract law, Unilateral 
    Contracts allow one person to make a promise, so only they are under an 
    enforcement obligation
    A common example is with the insurance contracts, the insurance company 
    promises it will pay the insured person a specific amount of money if certain 
    event happens. If the event doesn’t happen, the company won’t have to pay. The 
    insured party doesn’t make any promise and to his part of the deal, only needs 
    to pay the insurance premium.
    Defective contracts
    There are situation in which an apparent contract will only have limited legal 
    effect or even no legal effect at all.
    A void contract is not a contract at all. The parties are not bound by it and if they 
    transfer property under it, they can sometimes recover their goods even from a

    Management Accounting | Experimental Version | Student Book | Senior Six

    third party. This normally comes about due to some form of common mistakes 
    on a fundamental issue of the contract.
    A voidable contract is contract which one party may set aside. Property 
    transferred before avoidance is usually irrecoverable from a third party. Such 
    contracts may be with minors, or contracts induced by misrepresentation, duress 
    or undue influence. In these cases, it can be deemed that a party did not have 
    legal capacity to consent to a contract. For instance here can be intoxication, 
    mental health impairment or being too young to enter into contract. A contract 
    may be voidable due to coercion; this is where one party to the contract may be 
    using behaviors towards the other party.
    An unenforceable contract is a valid contract, property transferred under it cannot 
    be recovered, even from the other party to the contract. However, it either party 
    refuses to perform or to complete their part of the performance of the contract, 
    the party cannot compel them to do so. A contract is usually enforceable when 
    the required evidence of its terms, for example written evidence of a contract 
    relating to land, is not available. 
    Terms in a contract
    Legally, different terms of a contract have different effects.
    Express terms are terms that are specifically stated in the contract and are 
    binding on both parties.
    Conditions are terms that are fundamental to the contract and if they are broken 
    then the party breaking them will be in breach of contract and can be sued for 
    damages. The injured party can regard the contract as is ended.
    Warranties are less important terms in a contract. If any of these are not fulfilled 
    then there is a breach of contract but the contract remains in force. The injured 
    party can still claim damages from the court for any loss suffered but he cannot 
    treat the contract as is terminated.
    Implied terms are terms of a contract which are not specifically stated but are 
    implied in such a contract, either by trade custom or by law.
    Remedies for breach of contract
    A breach of contract arises where one party to the contract out of its side of the 
    bargain, such as a credit customer who does not pay. The following are some 
    of the remedies: 
    Action for the price- a court action to recover the agreed price of the goods/

    services

    Management Accounting | Experimental Version | Student Book | Senior Six

    Monetary damages- compensation for loss
    Termination-one party refusing to carry on with the contract
    Specific performance-a court order that one of the parties must fulfill its 
    obligations
    Quantum merit -payment ordered for the part of the contract performed
    Injunction- one party to the contract being ordered by the court not to do 
    something
    In terms of credit customer not having paid for goods or services provided, the 
    most appropriate remedy would normally be an action for the price.

    6.2.2. Terms and conditions associated with granting credit

    The credit terms offered to a customer are part of the agreement between the 
    business and the customer and as such should normally be in writing. The terms 
    of credit are the precise agreements with the customer as to how and when 
    payment for the goods should be made. The most basic element of the terms 
    of credit is the time period in which the customer should pay the invoice for the 
    goods. There are a variety of ways of expressing these terms as follow:
    Net 10/14/30 days- Payment is due 10 or 14 or 30 days after delivery of the 
    goods.
    Weekly credit-all goods must be paid for by a specific date in the following 
    week.
    Half-monthly credit-all the goods delivered in one-half of the month must be 
    paid for by a specified date in the following half-month.
    Monthly credit-all goods delivered in one month must be paid for by a specified 
    date in the following month.
    Settlement and cash discounts
    In some cases customers may be offered a settlement discount or cash discount 
    for payment within a certain period which is shorter than the stated credit period.
    The terms of such a settlement discount may be expressed as:
    Net 30 days, 2% discount for payment within 14 days. This means that the 
    basic payment terms are that the invoice should be paid within 30 days of its 
    date but that if the payment is made within 14 days of the invoice date a 2% 
    discount can be deducted. It is up to the customer to decide whether or not to 

    take advantage of the settlement discount offered.

    Management Accounting | Experimental Version | Student Book | Senior Six

    6.2.3. Data Protection law

    Data Protection law is becoming increasingly onerous in the modern, digital 
    world. For instance, in Europe, the new General Data Protection Regulation 
    legislation(GDPR) places significant responsibilities on companies to safeguard 
    the data they use, and only to keep personal data that is authorized to be kept 
    ,and is current, complete and accurate.

    Due to mounting international regulation, pressure is being exerted on Rwandan 
    economy to improve regulations, to in turn protect its key export markets.
    Recently adopted legal frameworks in Rwanda exclusively focus on security 
    and confidentiality of electronic communication data, leaving aside all other 
    categories of personal data. In Rwanda, there is information and communication 
    Technology law that provides that ‘Every subscriber or user’s voice or data 
    communications carried by means of an electronic communication network or 
    service must remain confidential to the subscriber and or user for whom the 
    voice or data is intended (ICT, 2016:art 124), but development of the law and 
    regulation is ongoing.

    General Data Protection Regulation (GDPR) is the latest European regulation 
    relating to data protection, which more strictly enforces data subject rights and 
    significantly increases the potential fines for breaches.
    What follows may be considered best practice based on the General Data 
    Protection Regulation requirements:
    What is personal data?
    The GDPR applies to the processing data that is:
    Wholly or partly by automated means or 
    The processing other than by the automated means of personal data which 
    forms part of, or is intended to form part of, a filing system.

    What are identifiers and related factors??

    An individual is ‘identifiable’ if you can distinguish him from other individuals.
    A name is the most common means of identifying someone. However, whether 
    any potential identifier actually identifies an individual depends on the context.
     GDPR provides non-exhaustive list of identifiers, including:
    Name

    Identification number, location, data and 

    Management Accounting | Experimental Version | Student Book | Senior Six

    An online identifier 
    An online identifier includes IP address and cookie identifiers which may be 
    personal data. Other factors can identify an individual.
    There will be circumstances where it may be difficult to determine whether data 
    is personal data. If this is the case as a matter of good practice, you should treat 
    the information with care, ensure that you have a clear reason for processing the 
    data and, in particular, ensure you hold and dispose of it securely.
    Inaccurate information may still be personal data if it relates to an identifiable 
    individual

    Eight principles of good practice

    Information should be:
    Fair and lawfully processed 
    Processed for limited purposes
    Adequate, relevant and not excessive
    Accurate and up to date
    Not kept for longer than necessary
    Processed in line with the data subject’s rights
    No transferred to countries elsewhere unless such data is adequately protected 
    in those countries

    6.2.4. Legal and administrative procedures for debt collection 
    Restitutionary and compensatory damages

    Restitutionary damages aim to strip from a wrongdoer, any gains made by 
    committing a wrong or breaching a contract. They are concerned with the 
    reversal of benefits that we have been earned unjustly by the defendant at the 
    expense of the claimant.
    If the monetary remedy or damages is to be the loss made by the claimant, these 
    are known compensatory damages and are intended to provide the claimant 
    with the monetary amount necessary to replace what was lost and nothing 

    more. Common examples are loss of wages or income.

    Management Accounting | Experimental Version | Student Book | Senior Six

    Bringing a dispute to court

    If it is decided that the only course of action to recover money owed by a credit 
    customer is that of legal action, then the first step is to instruct a solicitor. The 
    solicitor will require details of the goods or services provided, the date the liability 
    arose, the exact name and trading status of the customer, any background 
    information( Such as disputes in the past) and a copy of any invoices that are 
    unpaid.
    Which court?
    Outstanding amounts owed to an entity are civil claims. Uncomplicated claims 
    with a similar value will be dealt with in the local district court. Larger and more 
    complex claims will be heard provincial courts.

    Methods of receiving payment under a court order
    Once there has been a court order that the money due must be paid, there are 

    a number of methods of achieving this.


    Management Accounting | Experimental Version | Student Book | Senior Six


    6.2.5. Bankruptcy and insolvency

    Bankruptcy arises when an individual cannot pay his or her debts and is declared 
    bankrupt. Insolvency is where a company cannot pay its debts as they fall due.

    Petition for bankruptcy

    A statutory demand can be issued for a payment of the amount due within a 
    certain period of time. This may result in the customer offering a settlement. 
    If, however, there is no settlement offer from the customer a petition for a 
    bankruptcy will be received from the court.
    Once the individual has received the statutory demand they have 21 days, either 
    to pay the debt or reach an agreement to settle the outstanding amount.
    There are time limits in making a statutory demand and these are:
    The demand should be made within four months of the debts. If the debt is older 
    than four months a court has to be contracted to explain the reasons behind 
    the delay.
    Normally a statutory demand cannot be made after six years have elapsed.
    Consequences of a petition for Bankruptcy
    The consequences of a petition for bankruptcy against receivables
    If the customer pays money to any other suppliers or disposes of any property 
    then these transactions are void.
    Any other legal proceedings relating to the customer’s property or debts are 
    suspended. 
    An interim receiver is appointed to protect the estate.
    Consequences of a bankruptcy order
    The following are among others:

    The official receiver takes control of assets

    Accounting Management | Student Book | Senior Six

    A statement of the assets and liabilities is drawn up-this is known as statement 
    of affairs.
    The receiver summons a meeting of creditors of the individual within 12 weeks 
    of the bankruptcy order.
    The creditors of the individual appoint a trustee in bankruptcy.
    The assets are realized and a distribution is made to the various creditors.
    The creditor who presented the petition does not gain any priority for payment 

    over other creditors.

    Order of distribution of assets

    The assets of the bankrupt will be distributed in the following order:
    Secured creditors
    Bankruptcy costs
    Preferential creditors such as employees, pension schemes, government taxes 
    payable
    Unsecured creditors, such as trade payables
    The bankrupt’s spouse
     The bankrupt
     Insolvency
    The process of insolvency for a company that cannot pay its debts as they 
    fall due is similar to that of a bankrupt individual; there are 2 main options for 
    companies
    Liquidation
    Administration
     Liquidation
    In liquidation the company is dissolved and the assets are realized, within 
    debts being paid from the proceeds and any excess being returned to their 
    shareholders. This process is carried out by a liquidator on behalf of shareholders 
    and/or creditors. The liquidator’s job is simply to ensure that the creditors are 
    paid and once this is done the company can be wound up. Again, unsecured 
    creditors are a long way down the list of who is paid first, therefore there may 

    be little left in the pot.

    Management Accounting | Experimental Version | Student Book | Senior Six

    Administrative receivership

    An alternative to liquidation is that the shareholders, directors or creditors can 
    present a petition to the court for an administration order. The effect of this is that 
    the company continues to operate but an insolvency practitioner (administrator) 
    is put in control of it, with the purpose of trying to save the company from 
    insolvency, as going concern - or at least achieve a better result than liquidation.
    Administrative receivership is a process whereby a creditor can enforce security 
    against a company’s assets in an effort to obtain repayment of the secured 
    debt. It used to be the most popular method of obtaining payment by secured 
    creditors, but legislative reforms have reduced its significance.
    Administrative receivership differs from liquidation in that an administrative 
    receiver is appointed over all of the assets and undertakings of the company. 
    This means that an administrative receiver can normally only be appointed by 
    the holder of a floating charge. Usually an administrative receiver will be an 
    accountant with considerable experience of insolvency matters.

    Retention of title clause

    A ‘retention of title’ clause can be written into agreements with customers. 
    Such a clause expressly states that the buyer doesn’t obtain ownership of the 
    goods unless and until payment is made. Accordingly, if the buyer goes out of 
    business before paying for the goods, the supplier can retrieve them. If payment 
    is not made goods can be stopped in transit and a lien secured on the goods 
    by the seller.
    Official receivers do not need the authority of an insolvency practitioner to 
    determine if a claim is valid. If an official receiver sells goods that are subject to 
    a valid retention of title claim then the supplier can sue the official receiver for 

    damages as ownership of the goods still belong to the supplier

    Application activity 6.2

    1. Describe the role of a contract in law legislating the credit
    2. Discuss on Terms and conditions associated with granting credit

    3. Enumerate Legal and administrative procedures for debt collection

    Skills Lab 6

    Student will visit a bank operating nearest the school especially in the 
    credit department and ask questions related to the credit with the aim of 
    knowing the procedure or the process of offering the credit and the low 

    legislating the credit.

    End of unit assessment 6

    Question :

    Discuss on Importance of liquidity management 
    What is the purpose of analyzing the financial statements evaluating credit 
    worthiness?
    It is known that the relationship between a seller of goods and a buyer of 
    goods is a contract what is a contract and what is its importance in Law 
    legislating the credit and remedies for breaches?

    Discuss on Bankruptcy and insolvency in




     

    UNIT5:VARIANCE ANALYSISUNIT7:CREDIT MONITORING SERVICES