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
Jan
8
Sales
£
2011
200
Dec
£
31 Bad Debts
200
Bad Debts
2011
Dec
£
31 Smith
200
2011
£
Income Statement
Gross Profit
Less:
Bad Debts
Profit
10,000
(200)
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
Dec
£
31 Allowance for
Doubtful
Debts
2011
£
200
Allowance for Doubtful Debts
2011
£
2011
Dec
£
31 Profit & Loss
200
Income Statement
Gross Profit
Less: Rent & Rates
Salaries
Bad Debts written off
Provision for Bad Debts
Profit
21,000
3,800
10,000
100
95
13,995
7,005
Statement of Financial
Position
Current Assets
Stock
Debtors
Less:
Provision for Doubtful Debt
6,000
1,900
(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
Yr 1 25% of 12,000
Value at end of year
Yr 2 25% of 9,000
Value at end of year
Yr 3 25% of 6,750
Value at end of year
etc
£12,000
£3,000
£9,000
£2,250
£6,750
£1,687
£5,063
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
Less:
Depreciation
£5,500
x
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
Less:
Depreciation
£5,500
x
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
Less:
Depreciation
£5,500
x
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
Less:
Depreciation
x
£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)
• Accruals
Recording Accruals &
Pre-payments in the Income
Statement
– 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
• Debtors
• Pre-payments
x
x
x