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Bad Debts, Depreciation, Pre-payments & Accruals

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

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Bad Debts, Depreciation, Pre-payments & Accruals

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  1. Bad Debts, Depreciation, Pre-payments & Accruals AS Accountancy

  2. 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.

  3. 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 Learning Objectives for Bad Debts

  4. 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.

  5. 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

  6. 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.

  7. Double Entry

  8. Income Statement Gross Profit 10,000 Less: Bad Debts (200) Profit 9,800

  9. 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

  10. 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

  11. 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

  12. Double Entry

  13. 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

  14. Statement of Financial Position Current Assets Stock 6,000 Debtors 1,900 Less: Provision for Doubtful Debt (95) 1,805 7,805

  15. Question Why aren’t BAD DEBTS shown in the Statement of Financial Position?

  16. 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.

  17. 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)

  18. 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

  19. Causes of Depreciation • Physical Deterioration • Wear & Teat • Erosion, rust, decay, rot etc • Economic Factors • Obsolescence • Inadequacy • Time (amortisation) • Depletion

  20. Methods of Calculation Straight Line Method Reducing Balance Method For the exam you only need to be able to use the Straight-Line Method

  21. 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

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

  23. 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

  24. 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

  25. 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

  26. Working example Van £22,000 initial cost £5,500 each year depreciation over 4 years (straight line)

  27. 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

  28. 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

  29. 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

  30. 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)

  31. 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)

  32. 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

  33. 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)

  34. 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

  35. Recording in the Statement of Financial Position • Accruals • Current Liabilities • Accruals x • Prepayments • Current Assets • Inventory x • Debtors x • Pre-payments x

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