Financial and Managerial
Accounting
Depreciation and Bad Debts and
Adjustments
Outline of Lecture
•
•
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•
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Depreciation
Bad Debts
Provision for Bad Debts
Exercises
Adjustments
Depreciation
• According to IAS 16 ‘Depreciation is the measure of the cost
of the tangible - fixed asset that has been consumed during
the period’ In other words is the cost of using a fixed asset.
Depreciation is recorded each year and has a dual effect:
1.Reduce the value of the fixed asset by the accumulative
depreciation (total depreciation) in the balance sheet to reflect the
wear and tear (damage, tiring, exhausting).
In accounting we use the definition ‘accumulated depreciation’ and we mean
by this the total amount of the loss of the fixed asset.
2.Record the depreciation charge as an expense in the income
statement (profit and loss account).
Lecturer: Chara Charalambous
3
Depreciation may arise from:
• Use
• Physical wear and tear
• Passing of time
• The fact that a fixed asset is old-fashion and imperfect
because of the technology and market changes for e.g. the
creation of a new machinery which is more specialized in a
sector
• Land has an unlimited life and so does not require depreciation, but
buildings should be depreciated.
• Depreciation of an asset begins when it is available for use.
Lecturer: Chara Charalambous
4
Methods of calculating depreciation
REDUCING BALANCE
STRAIGHT LINE
Depreciation charge is the same
each year and so assumes that
the benefit is consumed equally
Useful for assets which provide
equal benefit each year e.g.
machinery
A
reducing
amount
of
depreciation is charged each year
and so assumes that more benefit
is consumed in earlier years
Useful for assets which provide
more benefit in earlier years e.g.
cars, IT equipment
Lecturer: Chara Charalambous
5
Straight line method
Depreciation Charged = Cost - Residual Value
Useful life
Or Depreciation = Cost* X%
Straight line depreciation is often expressed as a percentage of original cost.
Residual Value: the estimated disposal (clearance/removal/scrap) value of
the asset at the end of its useful life. The residual value may be a second
hand value or a scrap value: not a significant amount and is often zero.
Useful Life: the estimated number of years during which the business will
use the asset. The useful life does not necessarily equal the physical life of
an asset.
For e.g. Many business use a three year useful life for computers. This does
not mean that the computer can no longer be used after three years, it means
that the business is possible to replace the computer after three years due to a
technological advancement.
Lecturer: Chara Charalambous
6
Reducing balance method
Depreciation Charged =Carrying value* X%
Carrying value (CV) is the original cost of the fixed asset less
the accumulated depreciation on the asset to date.
Example 1: (reducing balance method)
Chris, a trader, purchased a computer for € 1000 on August Y12 which he
depreciates on the reducing balance method at 20% per annum. What is the
depreciation charged for each of the first five years if the accounting year end
is 31 July?
Solution:
Depreciation Charge Cumulative Depen
1.1000*20%
200
200
2.(1000-200)*20%
160
360
3.(1000-360)*20%
128
488
4.(1000-488)*20%
102
590
5. (1000-590)*20%
82
672
Lecturer: Chara Charalambous
7
Bad Debts
•
If sales are made on credit, there may be problems
collecting the amounts owing from customers because
some may refuse to pay their debt or they may
declared bankrupt and unable to pay the amounts
owing. At this case the debt is known as an
irrecoverable debt or Bad Debt. As it will probably
never be received, it is written off by writing it out of
the ledger accounts completely.
• The Bad debts amount is deducted from Debtors
Lecturer: Chara Charalambous
8
Accounting for Bad Debts
The debtors account is credited so as to
reduce them, and an account named Bad
Debts expense is debited. This expense is
treated as all other expenses and for that
reason is included in the income statement
(profit and loss a/c) and is reducing the net
profit.
Provision for Bad Debts
If there is some doubt whether a customer can or will
pay his debt, a provision for bad debts is created, these
debts are not yet Bad Debts. However the creation of a
provision for bad debts means that the possible loss is
taking into consideration immediately.
The amount of the original debt will still remain the
same just in case the customer does eventually pay.
• The Debtors are not reduced but we multiply the
amount of Debtors with the percentage of the
provision. The debtors amount remain the same – we
are not reducing it as we did in the case of Bad Debts
– because the customer may finally pay.
Lecturer: Chara Charalambous
10
Accounting for Provision for Bad Debts
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•
•
The account ‘Provision fro Bad Debts’ has a credit
balance in contrast to the account ‘Bad Debts’ which
has debit b/ce.
The Provision for Bad Debts goes indirectly to the
profit and loss through the account Bad Debts. We
add the amount of provision for Bad Debts in the
amount of Bad Debts.
The balance, at the end of the year, of the a/c
‘Provision for Bad Debts’ goes to balance sheet
below Debtors and is deducted there from Debtors
to show the net Debtors.
Lecturer: Chara Charalambous
11
Example 1:
Stamp Ltd has opening balances at 1ST Jan Y12 Debtors
€68000. During the year the company made credit sales
€354000 and received cash later from the clients €340000.
At 31st Dec Y12 the company find out that €2000 of the
clients are Bad Debts and also believes that 5% of the
remaining clients will might not pay and since this is not sure
the accountant makes a provision for Bad Debts.
Required: 1. find the amount of Provision for Bad Debts that will
added to Bad Debts amount.
2.find the amount of Bad Debts which will go to Profit and
Loss
3. Show how Debtors will be presented in the Balance Sheet
Lecturer: Chara Charalambous
12
Provision for Bad Debts
• If
there is already an opening amount in the
account ‘Provision for Bad Debts’ then only the
movement (difference) in the provision is charged
to the Profit & Loss through ‘Bad Debts’ (closing
provision less opening provision)
Lecturer: Chara Charalambous
13
• If an exercise with trial balance is given to you and
you have the amount of Debtors and the amount of
Bad Debts in the trial balance it means that bad
debts have already been deducted from debtors and
so you should not deduct it.
• What you have to do is to find the new provision for
bad debts : 1 .Debtors* provision % and then
2 . deduct from the new provision the old and then
3 . add the difference in the bad debts amount.
Example 2:
Stamp Ltd has opening balances at 1ST Jan Y12 Debtors
€68000 and Provision for Bad Debts €3400. During the year
the company made credit sales €354000 and received cash
later from the clients €340000. At 31st Dec Y12 the company
find out that €2000 of the clients are Bad Debts and also
believes that 5% of the remaining clients will might not pay
and since this is not sure the accountant makes a provision
for Bad Debts.
Required: 1. find the amount of Provision for Bad Debts that will
added to Bad Debts amount
2.find the amount of Bad Debts which will go to Profit and
Loss
3. Show how Debtors will be presented in the Balance Sheet
Lecturer: Chara Charalambous
15
Accruals Basis of Accounting
The income statement for a period is prepared following the
accruals concept: the income and expenses are recorded as
they happened in the period regardless of whether cash has
been received or paid .
Therefore the profit of e.g. Y12 is calculated as following:
Sales Y12 ( not only cash sales but also credit sales)
Plus other income - e.g. from interests or rents (paid to the firm and
this not paid yet but third parties e.g. banks owe the income to the company because
It concerns the specific period)
Less Purchases Y12 (not only cash purchases but also credit purchases)
Less Expenses happened in Y12 ( rent, electricity ,telephone paid and
those not paid yet but they concern the period we study and the firm has debt on them)
RESULT : NET PROFIT/LOSS
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1. Accrued Expenditure
•
•
An accrual arises where expenses of the business, relating
to the year, have not been paid by the year end.
In this case the expense not paid it included in the total
expenses in the income statement, and therefore
deducted from the income so as to calculate the Net
Profit, and it also goes to Balance sheet in the current
liabilities side and is called Accrued Expenses.
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Example 1:
The electricity bill for the company A Ltd was for the year
end 31st Dec Y12 €12000. But in Y12 it was paid only €9000
and the rest €3000 was paid in Jan of Y13.
Required: 1.Prepare the accounts in the General ledger affected
from the above transactions and 2.show where each amount
finally goes.3.Prepare the extract of B/ce Sheet and the Profit and
loss a/c
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Electricity
Cash
Cash
9000 Profit & Loss 12000
Accrued Exp c/d 3000
12000
Electricity 9000
12000
Accrued exp b/d 3000
Profit & Loss a/c
Gross Profit
x
Less Expenses
Electricity
12000
Balance Sheet as at 31st Dec Y12
Current Liabilities
Accrued Expenses
3000
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2. Prepaid Expenditure
•
•
A prepayment arises where some of the following
year’s expenses have been paid in the current year.
In this case, it is necessary to remove that part of the
expense which is not relevant to this year, and
therefore must not be deducted from the income of
this year, and create a corresponding account in the
Balance Sheet in the side of assets named Prepaid
expenses.
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Example 2:
The insurance bill for the company A Ltd was for the year end
31st Dec Y12 €24000. But in Y12 it was paid €30000 for
insurance expenses. The owner of the company wanted to
prepaid in this way future charges of insurance.
Required: 1.Prepare the accounts in the General ledger affected
from the above transactions and 2.show where each amount finally
goes.3.Prepare the extract of B/ce Sheet and the Profit and loss a/c
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Insurance
Cash
Cash
30000 Profit & Loss 24000
Insurance 30000
Prepaid Exp c/d 6000
30000
30000
Prepaid
B/ce b/d
6000
Profit & Loss a/c
Gross Profit
x
Less Expenses
Insurance
12000
Balance Sheet as at 31st Dec Y12
Current Assets
Prepaid Expenses
6000
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SUMMARY:
EXPENSE A/C
Prepaid exp b/d
Cash payments
Accrued exp c/d
x
Accrued exp b/d
x
x
Profit & Loss a/c
x
x
Prepaid exp c/d
x
x
x
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3. Accrued Income
•
Accrued income arises where income has been earned in the
accounting period but has not yet been received. In this case
we mean the income from other sources than the clients for e.g. the
bank interest, rents e.t.c)
•
In this case, it is necessary to record the whole (paid + unpaid)
income in the income statement and create a corresponding
asset in the statement of financial position (called accrued
income).
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Example 3:
• A business earns income in Y12 from bank interest €300
per month. However during Y12 the business received only
€3000 instead of €3600 (300*12).
Required: 1.Prepare the accounts in the General ledger affected
from the above transactions and 2.show where each amount
finally goes. 3.Prepare the extract of B/ce Sheet and the Profit and
loss a/c
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Bank Interest Income
Profit &Loss
3600
Bank
Bank
3000
Accrued Income c/d 600
3600
Bank
Interest 3000
3600
Accrued Income
B/ce b/d
600
Profit & Loss a/c
Gross Profit
x
Add Bank Interest 3600 X
Balance Sheet as at 31st Dec Y12
Current Assets
Debtors
X
Accrued Income
600
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4. Prepaid Income
• Prepaid income arises where income has been
received in the accounting period but which relates
to the next accounting period.
• In this case, it is necessary to remove the income not
relating to the year from the income statement and
create a corresponding/resulting current liability in
the statement of financial position (called prepaid
income).
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Example 4:
A business rents out a property at an income of € 4000 per
month. €64000 has been received in the year ended 31 Dec
Y12.
Required: What is the year-end liability and what is the rental
income for the year? Show the relevant entries in the ledger
accounts and the financial statements.
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Rent Income
Profit & Loss
48000 Bank
(4000*12)
Prepaid Income c/d 16000
64000
Bank
64000
Rent 64000
64000
Prepaid Income
b/d
16000
Profit & Loss a/c
Gross Profit
x
Add Rent
48000 X
Balance Sheet as at 31st Dec Y12
Current Liabilities
Creditors
X
Prepaid Income
600
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SUMMARY:
INCOME A/C
Accrued Income b/d
X
Prepaid Income b/d
Profit & Loss a/c
X
Cash payments
Prepaid Income c/d
X
Accrued Income c/d
x
X
X
X
x
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