ADJUSTMENTS TO FINAL ACCOUNTS

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Presentation transcript:

ADJUSTMENTS TO FINAL ACCOUNTS There are different users of financial information. To meet the needs of these different users, the final accounts need to be objective. And to achieve this objectivity, necessary adjustments have to be made to the final accounts The major adjustments to final accounts are:

Bad debts and allowance for provision for doubtful debts Provision for discount allowed Expenses prepaid Expenses owing Income accrued Income prepaid Depreciation of non current assets Disposal of non current assets

Define bad debts, bad debts recovered and allowance for doubtful debts (a) BAD DEBTS AND ALLOWANCES FOR DOUBTFUL DEBTS INTRODUCTION This chapter covers how a business deals with bad debts, bad debts recovered and allowances for doubtful Learning objectives: Define bad debts, bad debts recovered and allowance for doubtful debts Describe and account for bad debts and the treatment in financial statements Explain why allowance for doubtful debts are provided Account for allowance for doubtful debts and how they are calculated.

Bad debts recovered, accounting and treatment in final accounts Allowances for doubtful debts Accounting for allowance for doubtful debts Treatment of allowance for doubtful debts in financial statements

BAD DEBTS As a business grows in size, some of its sales may be made on credit. Customers will be able to access the goods from the business and arrangement will be made when to settle the amount. By doing so the business is taking a risk because some customers may fail to pay for various reasons which may include:

Restrictions by a country to transfer cash (foreign exchange) to another country. The customers business may just close down (liquidated) The customer may refuse to pay one or part of the invoices Some customers may not be genuine and may just disappear without paying.

When a business fails to recover its money from credit customers, after making all efforts, the amount is written off as a bad debt. This is normal in business and should be accepted as a business expenses The bad debt written off will be charged to Income Statement as an expense when calculating net profit or loss for the period.

There is no entry for bad debts in the balance sheet unless a bad debt appears as an adjustment item below the trial balance. In that case the amount for bad debts in deducted from trade receivable figure in the balance sheet

When a business sells goods to a customer on credit, double entry will be: DR. – Customers account CR. – Sales account Example: on 1 January 2015 sold goods on credit to Bwalya for K276,000. So you Dr. Bwalya a/c K276,000 And Cr. Sales a/c K276,000

But when the customer fails to pay, the account will appear as: DR. – Bad debts account (in general ledger) CR. – Customers (in sales ledger) Example: The goods which were sold to Bwalya on 1 January 2015 for K276,000 had not yet been paid for by 31st December 2015. The supplier decided write this transaction as bad debt. Required: Show the Bad debts account, Bwalya account and Income Statement for the above transaction.

A debt previously written off may be recovered in full or partially. 4 BAD DEBTS RECOVERED A debt previously written off may be recovered in full or partially. Steps in recovery: The debt must first be reinstated to facilitate the recording of cash coming in. DR. – the receivable (Debtor) account CR. – Bad debts recovered account. When payment is received: DR. – Cash or Bank account CR. – Receivables (Debtors) account with amount received

Example: Bad debts recovered A debt previously written off for Bwalya K276,000 has now been fully recovered with a payment by cheque. Required: Show the Bad debts recovered, Bwalya Account and Income Statement for the above transaction

Bwalya account Dr. Cr. K Sales d 276,000 Bad debts _______ recovered Bank recovered account Income sta tement Bwalya NOTES: - The bad debts recovered account is closed off to income statement as Income and will be added to gross profit.

ALLOWANCE/PROVISION FOR DOUBTFUL DEBTS Because of past experiences where some debts become bad, some organizations find it more prudent to provide for future bad debts. The provision is an amount set aside to cover the money that may not be paid by the debtors

An allowance for doubtful debts is a general estimate of the percentage of debts which are not expected to be repaid. An aged schedule of receivables may help in estimating the allowance. It is well known that the longer a debt is owing, the more likely that it will become bad debt.

Example A Schedule of Allowance or Provision for doubtful debts on Receivables Period debt is owing Total amount owing Estimated % Doubtful Allowance for doubtful debts Less than 30 days 1 1,300,000 1% 113,000 30 days less than 60 days 7,400,000 4% 296,000 60 days less than 90 days 2,500,000 6% 150,000

Accounting for allowance for doubtful debts: (i) Upon creation:  Dr. – Income statement Cr. – Allowance for doubtful debts account (ii) On increasing the Provision: Dr. –Income statement with the amount of increase Cr.- Allowance for doubtful debts account (iii) On Decreasing the Provision: Dr.- Allowance for doubtful debts account Cr. – Income statement ( add to gross profit)

NOTE: In Income Statement the provision is deducted from gross profit as an expense and the same provision is deducted from Trade receivable figure in the balance sheet. Example: A trader decided to open allowance for doubtful debts account in 2013. The Provision was to be 5% of trade receivable figures outstanding each year ended.

Year Trade receivable estimated provision % 2013 K82,000 5 2014 K91,600 5 2015 K81,200 5 Required: Prepare Allowance for doubtful debts account three years, and show the entries in Income Statement and the Balance Sheet.

PREPAYMENTS OR PREPAID EXPENSES Prepayments are amount paid in advance before a service is provided. The amount prepaid by the business are brought down on the debit side expense account in the ledger are deducted from the respective expenses item in the Income Statement In the balance sheet the amount prepaid appears as a current asset.

Example On 31st December 2014, rent amounting K9,000 was prepaid. During the year to 31st December 2015, we paid K 98,000 for rent by cash. And as at 31st December 2015 amounts totaling K78,000 was prepaid. Required: Prepare the Rent account, and show adjustments in Income Statement and Balance Sheet

ACCRUED EXPENSES These are also known as amount due, amount outstanding, owing or arrears The accrued expenses are expenses incurred during the current trading period but not yet paid for at the end of financial year. The amount owing is has a credit balance in the respective expenses account In the income statement, the amount owing is added to the amount that was already in the respective expense item In the Balance Sheet, the amount owing appears as a Current Liability

Example On 31st 2014 December the Stationery of K200,000 was owing. During the year 2015 amount of K400,000 was paid by bank. And as at 31st December 2015, amount of K300,000 was owing. Required: Show Stationery account, Adjustments in Income Statement and Balance Sheet.

INCOME OWING OR RECEIPT DUE Just as expenses can be accrued, so can income be. The income owed is the amount we have earned but not yet received. For instance in a situation where a business sales goods on behalf of another business and the commission is not yet received by the business which has sold the goods

The income owing is brought down on the debit side of the income owing account in the ledger In the income statement, the amount is added to respective income amount already received. In the Balance Sheet the amount appears as current assets

Example Kazanga Enterprises earns a commission from the sale MTN products. Commission received in the year 2014 was K85,000 by cash, owing at 31st December 2014 was K14,500. Required: Prepare the Commission Received account and show the transfer to Income statement as well as the Balance Sheet