Bad Debts, Depreciation, Pre-payments & Accruals

AS Accountancy

Starter Activity

• Using the HEXAGONS to each represent one key term / idea– Link as many hexagons together to demonstrate the

main areas of consideration when drawing up the two main financial statements

• Income Statement• Statement of Financial Position

• You have 30 mins before you must present your links to the other groups.

Learning Objectives for Bad Debts

• Grade E – to be able to balance off Debtor accounts to allow for Bad Debts

• Grade C – to be able to incorporate the Bad Debt allowance & Allowance for Doubtful Debt into the Income Statement

• Grade A – to be able to evaluate the different reasons that bad debts may occur in a business and why you should make provision for them

What are Bad Debts?

• Bad Debts are when a customer may never pay for the goods that they bought on credit

• NORMAL business risk

• Bad Debt is a historical entry – the account has already proved to be bad.

Reasons for Bad Debts

• What do you think?

– Debtor may refuse to pay for one of their invoices (not all)

– Debtor may refuse to pay for part of an invoice– Debtor may indicate that business is failing

and can only pay some of the debt– Debtor’s business has failed and is unable to

pay any of the debt

How to record the bad debt

• Balance off the Debtors account to allow for the bad debt (Credit the account)

• Complete the double-entry with a Debit to the “Bad Debts” account

• Post the total Bad Debt to the ‘profit & loss’ section of the Income Statement as an Expense.

Double Entry

Smith

2011 £ 2011 £

Jan 8 Sales 200 Dec 31 Bad Debts 200

Bad Debts

2011 £ 2011 £

Dec 31 Smith 200

Income Statement

Gross Profit 10,000

Less:

Bad Debts (200)

Profit 9,800

Allowance for Doubtful Debt

• Prudence Concept– Accounts receivable & profit OVERSTATED if

provision not made

• Impossible to be accurate• Estimated Figures

– How much will be ‘bad’?– % of total amount due?– The longer owing the higher the chance

• Prediction of FUTURE

Accounting Entries for Doubtful Debts

• Debit the Income statement – Deduct from GROSS profit as an Expense

• Credit the Allowance for Doubtful Debts Account (double-entry)

• Deduct from Current Assets in the Statement of Financial Position

Increasing/Decreasing the provision

• Once calculated it remains in accounting system

• May need to increase/decrease in line with the increase/decrease in Debtors

• Record the CHANGE in provision

Double Entry

Profit & Loss

2011 £ 2011 £

Dec 31 Allowance for Doubtful Debts

200

Allowance for Doubtful Debts

2011 £ 2011 £

Dec 31 Profit & Loss 200

Income Statement

Gross Profit 21,000

Less: -Rent & Rates 3,800

Salaries 10,000

Bad Debts written off 100

Provision for Bad Debts 95

13,995

Profit 7,005

Statement of Financial Position

Current Assets

Stock 6,000

Debtors 1,900

Less:

Provision for Doubtful Debt (95)

1,805

7,805

Question

• Why aren’t BAD DEBTS shown in the Statement of Financial Position?

Learning Objectives for Depreciation

• Grade E – can calculate basis straight line depreciation

• Grade C – Can incorporate the depreciation into the Income Statement AND Statement of Financial Position

• Grade A – Can discuss the causes of depreciation and the need to make provision for it in business.

What assets can depreciate?

• Non-current assets (fixed assets) that are long term but don’t last forever– Machinery– Motor vehicles– Fixtures– Buildings (in rare circumstances)

Amounts of Depreciation

• Difference between initial cost and the disposal cost

• Bought for £10,000

• Sold 3 yrs later for £4,000

• Depreciation is £6,000

Causes of Depreciation

• Physical Deterioration– Wear & Teat– Erosion, rust, decay, rot etc

• Economic Factors– Obsolescence– Inadequacy

• Time (amortisation)

• Depletion

Methods of Calculation

• Straight Line Method

• Reducing Balance Method

• For the exam you only need to be able to use the Straight-Line Method

Straight Line Method

• Estimated numbers of years of use

• Initial Cost of Asset

• Initial Cost / number of years = yearly depreciation

• £22,000 / 4 years = £5,500 per year

Recording depreciation

• Income statement– Add expense “provision for depreciation”

• Statement of Financial Position– Less the Accumulated Depreciation from the

Non-current Asset

Straight Line Method

• Another way to calculate when you know of a disposal value

• (Initial Cost – disposal Value) / Number of years

• (£22000 – £2000)/4 = £5000 annual depreciation

Reducing Balance Method

• % is written off per year• Eg • Original Cost £12,000• Yr 1 25% of 12,000 £3,000• Value at end of year £9,000• Yr 2 25% of 9,000 £2,250• Value at end of year £6,750• Yr 3 25% of 6,750 £1,687• Value at end of year £5,063• etc

Recording the Depreciation

• Income Statement– Less Expense of Depreciation for year

• Statement of Financial Position– Show total (accumulated) depreciation to date

deducted from Non-Current Assets

Working example

• Van

• £22,000 initial cost

• £5,500 each year depreciation

• over 4 years (straight line)

Year 1

Income statement extract

Gross profit x

Less:

Depreciation £5,500

Extract from Statement of Financial position

Non-Current Assets

Van £22,000

Less Accumulated Depreciation (£5,500)

£16,500

Year 2

Income statement extract

Gross profit x

Less:

Depreciation £5,500

Extract from Statement of Financial position

Non-Current Assets

Van £22,000

Less Accumulated Depreciation (£11,000)

£11,000

Year 3

Income statement extract

Gross profit x

Less:

Depreciation £5,500

Extract from Statement of Financial position

Non-Current Assets

Van £22,000

Less Accumulated Depreciation (£16,500)

£5,500

Year 4

Income statement extract

Gross profit x

Less:

Depreciation £5,500

Extract from Statement of Financial position

Non-Current Assets

Van £22,000

Less Accumulated Depreciation (£22,000)

Prepayments & Accruals

Previously assumed all expenses were incurred in the period of the Income statement.

Assumed no expenses were outstanding at the beginning of the year and no expenses had been paid early for the next year (in advance)

Accruals

• Payments that you know you have accrued in the accounting period but you haven’t been asked to pay for yet.

• Example: -– Buying goods on the 30 Dec 2011 – Being sent your credit card statement with a

request for the payment on 15 Jan 2012

Pre-payments

• Payments made in one accounting period although the expense isn’t incurred until the next accounting period

• Example– Rental for the telephone is charged in

November for the next 3 months (Nov, Dec & Jan)

Recording Accruals &Pre-payments in the Income

Statement• Accruals

– Add the amount OWING to the original expense in the trial balance and enter into the INCOME STATEMENT

• Pre-payments– Take the pre-paid amount away from the

original expense in the trial balance and enter the new total into the INCOME STATEMENT

Recording in the Statement of Financial Position

• Accruals– Current Liabilities

• Accruals x

• Prepayments– Current Assets

• Inventory x• Debtors x• Pre-payments x