Accouting (Week 6) - Ch. 15 - 16

Ch.
15 – Adjustments to financial statements:

irrecoverable debts and allowances for irrecoverable
debts.
15.1 – The nature of, and ledger entries for, irrecoverable

debts.
 When goods are sold on credit, it sometimes transpires that the
customers are unwilling or unable to pay the amount owed. This is
referred to as a bad debt [when goods are sold on credit, it sometimes
transpired that the customer is unwilling or unable to pay the amount
owed. It is also called an irrecoverable receivable or debt.] or
irrecoverable debt [debts that cannot be collected as the credit
customers is bankrupt or missing, or the entity takes the decision not to
pursue the debt any further as the cost of pursuing it outweighs the
benefit from receiving it. It is also called bad debt.], the decision to treat
a debt as irrecoverable is a matter of judgment.
 A debt may be regarded as irrecoverable for several reasons, such as
being unable to trace the credit customer, it not being worthwhile
financially to take the credit customer to court, or the credit customer
being bankrupt. However, if a credit customer is bankrupt, this does not
necessarily mean that the whole of the debt is irrecoverable. When a
person is bankrupt, his or her possessions are seized and sold to pay the
creditors. Such payments are often made in installments know as
‘dividends. Thus, when the ‘financial dividend’ is received, the remainder
of the debt is irrecoverable.
15.2 – The nature of, and ledger entries for, allowances for
irrecoverable debts.
 An allowance for debts/doubtful debts [when goods sold and recognized
as sales revenue in one accounting year may not become known to be
irrecoverable until the following accounting year, then a provision in
respect of probable irrecoverable debts is created in the year of sale.] is
required to ensure that the trade receivable assets and profits for the
period are not overstated. It is an example of the prudence concept,
wherein losses are recognized when they are likely to happen.
 Also, providing for a potential irrecoverable debt is an example of the
matching concept as the accounting treatment matches the relevant
irrecoverable expense to the revenue to which it is related.
 An allowance for irrecoverable debt may consist of either a specific
allowance [involves asserting which particular credit customers at the
year-end are unlikely to pay their debts and providing a specific
allowance relating to the specific credit customers.] or a general
allowance [an estimate of the total amount of irrecoverable debts
computed using a percentage (based a previous years’ figures) of the
trade receivable at the end of the current year.], or both. A specific
allowance involved ascertaining which particular credit customer at the
year-end is unlikely to pay their debts. An irrecoverable debt computed
using a percentage (based on previous years’ figures) of the trade
receivables at the end of the current year. Where both specific and
general allowances are made, the two amounts are added together, and
the total is entered in the general ledger.
 The accounting entries in respect of an allowance for irrecoverable debts
are made after the trial balance has been extracted the statement of
profit or loss is being prepared. It is important to appreciate that any
balance on an allowance for irrecoverable debts accounts shown in a trial
balance is typically related to the balance at the end of the previous
year. A charge ( or credit) is made to the statement of profit or loss in
each year that consists of an amount necessary to increase (or decrease)
2
the allowance at the end of the previous year to the amount required at
the end of the current year.
 An increase in an allowance always consists of:
 A decrease in an allowance is entered thus:
 The balance in the allowance for irrecoverable debts account at the end
of the year is deducted from trade receivables in the statement of
financial position to give the net amount that is expected to be received

from credit customer – that is, their net realizable value. The treatment
of irrecoverable debts and allowances for irrecoverable debts is
illustrated In worked examples 15.1 and 15.2.
Accounting policy for allowance for irrecoverable debts:
 Most entities provide details of how they value their trade receivables
and how they calculate the allowance for irrecoverable debts in the
accounting policy.
 Like most accounting adjustments there is an element of subjectivity
about estimating the extent of general allowance that is required.
research has found that movements in the allowance for irrecoverable
debts are used to manipulate accounting profits (see smith, 1992 and
Phillips and Drew, 1992). An example is provided in Read World Example
15.2.
3
Ch. 16 – The nature of, and ledger entries for, accrued
expenses
16.1 – The Nature of, and ledger entries for, accrued expenses:
 An aural may comprise either or both of the following:
1. Invoices received (for expenses) that have been used but not
paid for a the ed of the accounting year.
2. The value of services received for which and invoice has not
been rendered at the end of the accounting year.
 In the case of the latter, this required an estimate to be made of the
amount for the services consumed during the period between the date
of the last invoice and the end of the accounting year. The estimate may
be based on any one of the following:
1. A meter reading taken at the end of the accounting year
(electricity).
2. The amount consumed over a corresponding period during the
current year.
3. The amount consumed during the same period of the previous
year as adjusted for any change in the unit price.
 However, in practice, final financial statements are often not prepared
until sometime after the end of the accounting year. By that time the
invoice covering the period in question is likely to have been received
and can this thus be used to ascertain the value of the services
consumed during the relevant period. The accrual convention has been
used in the past to manipulate reported earnings (profit) I a fraudulent
manner. It is for this reason that auditors afford special attention to
determination of accrual amounts and cut – off period.
 Although accrued expenses are essentially payables, rather than have a
separate accrual accounting it is usual to enter accruals in the relevant
4
expense account. This consists of debiting the amount owing at the end
of the current year to the expense account as a balance carried down
and crediting the same amount as a balance brought down in the next
period. Thus, the amount that will be transferred to the statement of
performance account consists of the amount paid during the current
year plus the accrual at the end of the current year (less the accrual at
the start of the year). This will reflect the total value of the services that
have been received during the current accounting year. The balance
brought down is entered on the statement of financial position as a
current liability. A pro forma ledger account showing typical entries is
not provided. This can be used to check that entries have been correctly
posted.
16.6 – The Nature of, and ledger entries for, prepaid expenses:
 The accruals concept also gives rise to prepaid expenses/ payments
[receivables in respect of services that have been paid for, but not
received at the end of the accounting period. Prepayments can only
occur where services are paid for the advance, such as rent local
government taxes, road tax and insurance.]
 The amount of the prepayment is ascertained by determining on a time
basis how much of the last payment made during the current accounting
period related to the services that will be received in the next accounting
period.
 Although prepaid expenses are essentially receivables, rather than have
a separate prepayment account, it is usual to enter the prepayments in
the relevant expense account. This consists of crediting the amount of
the prepayments to the expenses account as a balance carried down and
debiting the same account as a balance carried down and debiting the
same amount as a balance brought down. Thus, the amount that will be
transferred to the statement of performance account consists of the
amount paid during the current period minus the prepayment at the end
of the current period (plus the prepayment at the start of the period).
This will reflect the total value of the service that have been received
5
during the current accounting period. The balance brought down is
entered on the statement of financial position as a current asset. A pro
forma ledger account showing the relevant entries. This can be used to
check entries.
16.3 – Accruals and Prepayments and the Preparations of Final
Financials statements from the Trial Balance
 The statement of performance is usually prepared from the trial balance.
This involves adjusting the amounts shown for any accruals and
prepayments at the end of the accounting period. It is important to
appreciate that, because the trial balance is taken out at the end of the
current accounting period, the taken out at the end of the current
accounting period, the amount shown in it include any accruals.
 When preparing a statement of performance from the trial balance, it is
only necessary to add to the amount shown in the trial balance any
accrual at the end of the current accounting period and to subtract any
prepayment.
16.4 – Further year end adjustment (inventories of tools,

stationery and fuels)
 As explained in Chapter 14, adjustments to financial statements:
depreciation and non – current assets. Thus, any inventories for other
revenue items such as stationery and fuel are also treated as current
assets. However, irrespective of their classification, the accounting
adjustments in respect of these items are essentially the same. That is,
the value of the items in inventories at the end of the current accounting
period is entered in the relevant ledger account as a balance carried
down on the credit side and as a balance brought down on the debit side
and as a balance brought down on the debit side ( in exactly the same
way as with pre-paid expenses). The difference between the two sides of
the ledger account is the transferred to the statement of performance
account. In the case of loose tools this is described as ‘depreciation’,
6
which is referred to as having been computed using the relevant
method. The principle that is applied to each of these items is as follows:

Accouting (Week 6) - Ch. 15 - 16

Uploaded by

Copyright:

Available Formats

Accouting (Week 6) - Ch. 15 - 16

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Accouting (Week 6) - Ch. 15 - 16

Uploaded by

Copyright:

Available Formats

Ch.

15 – Adjustments to financial statements:

15.1 – The nature of, and ledger entries for, irrecoverable

of the year is deducted from trade receivables in the statement of

financial position to give the net amount that is expected to be received

16.4 – Further year end adjustment (inventories of tools,

You might also like