Bad Debts, Depreciation, Pre-payments

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Bad Debts, Depreciation, Pre-payments Accruals

• AS Accountancy

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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.

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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

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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.

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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
• Debtors business has failed and is unable to pay
  any of the debt

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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.

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Double Entry
Smith Smith Smith Smith Smith Smith Smith Smith
2011 2011
Jan 8 Sales 200 Dec 31 Bad Debts 200

Bad Debts Bad Debts Bad Debts Bad Debts Bad Debts Bad Debts Bad Debts Bad Debts
2011 2011
Dec 31 Smith 200

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Income Statement

• Gross Profit 10,000
• Less
• Bad Debts (200)
• Profit 9,800

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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

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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

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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

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Double Entry
Profit Loss Profit Loss Profit Loss Profit Loss Profit Loss Profit Loss Profit Loss Profit Loss
2011 2011
Dec 31 Allowance for Doubtful Debts 200

Allowance for Doubtful Debts Allowance for Doubtful Debts Allowance for Doubtful Debts Allowance for Doubtful Debts Allowance for Doubtful Debts Allowance for Doubtful Debts Allowance for Doubtful Debts Allowance for Doubtful Debts
2011 2011
Dec 31 Profit Loss 200
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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

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Statement of Financial Position

• Current Assets
• Stock 6,000
• Debtors 1,900
• Less
• Provision for Doubtful Debt (95)
• 1,805
• 7,805

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Question

• Why arent BAD DEBTS shown in the Statement of
  Financial Position?

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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.

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What assets can depreciate?

• Non-current assets (fixed assets) that are long
  term but dont last forever
• Machinery
• Motor vehicles
• Fixtures
• Buildings (in rare circumstances)

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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

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Causes of Depreciation

• Physical Deterioration
• Wear Teat
• Erosion, rust, decay, rot etc
• Economic Factors
• Obsolescence
• Inadequacy
• Time (amortisation)
• Depletion

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Methods of Calculation

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

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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

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Recording depreciation

• Income statement
• Add expense provision for depreciation
• Statement of Financial Position
• Less the Accumulated Depreciation from the
  Non-current Asset

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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

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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

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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

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Working example

• Van
• 22,000 initial cost
• 5,500 each year depreciation
• over 4 years (straight line)

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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

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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

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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

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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)

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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)

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Accruals

• Payments that you know you have accrued in the
  accounting period but you havent 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

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Pre-payments

• Payments made in one accounting period although
  the expense isnt incurred until the next
  accounting period
• Example
• Rental for the telephone is charged in November
  for the next 3 months (Nov, Dec Jan)

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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

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Recording in the Statement of Financial Position

• Accruals
• Current Liabilities
• Accruals x
• Prepayments
• Current Assets
• Inventory x
• Debtors x
• Pre-payments x