SYNOPSIS

Accounting-Knowledge Level

KNOWLEDGE LEVEL, ACCOUNTING

LECTURE-5 & 6, AUGUST 11, 2012

ACCOUNTING CONCEPTS & CONVENTIONS [CHAPTER-7]

&

ACCOUNTING FOR IRRECOVERABLE DEBT [CHAPTER-9]

Previously, several questions came from these
two Chapters.
For exam point of view, from Chapter 7 most
important part is short notes of the concepts
and identifying the concepts.
From Chapter 9, most important part is
mathematical type question on irrecoverable
debts.
LEARNING OBJECTIVES
After studying these Chapters, you shall be able
to understand:
Chapter-7:
 Short notes on Accounting principle
 Identifying principle in particular circumstances
 MATHS using Accounting principle
Chapter-9:
 How allowance is created
 How allowance is retired
 Accounting entry for written off and written-off
debt recovered
 Implication of treatment in income statement
and balance sheet
 Identify effect of irrecoverable debt in gross
profit and in net profit [admin exp]
 MATHS on calculation of bad debt allowance

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 SYNOPSIS
Accounting-Knowledge Level

ACCOUNTING CONCEPTS & CONVENTIONS

[CHAPTER-7]

Concepts and convention

Theory [Tricky question]

Accounting concepts:
Accounting concepts are ground rules and practices applied by an entity in preparing and presenting financial
statements.

As per the Framework:

1. Accrual basis
2. Going concern
3. Prudence
4. Substance over form
5. Neutrality
6. Completeness

As per the BAS-1:

1. Accrual basis
2. Going concern
3. Consistency of presentation
4. Materiality & Aggregation
5. Off-setting
6. Comparative information

Other important concepts and convention:

1. Business entity concept
2. Money measurement concept
3. Historical cost
4. Stable monetary unit
5. Realization concept
6. Duality concept
7. Timeliness

Some definition as per BAS-8:

1. Accounting policy
2. Accounting estimate
3. Prior year error
4. Retrospective application
5. Retrospective restatement
6. Prospective application
7. Impracticable

Prepared by Mohammad Shahidul Islam MBA, ACA

 SYNOPSIS
Accounting-Knowledge Level

ACCRUAL BASIS:
Under this basis, the effects of transactions and other events are recognized when they occur and nor as
cash or its equivalent is received or paid and they are recorded in the accounting records and reported in the
financial statement of the periods to which they relate.

Example:
 Costs only recognized for that part which is sold (COGS concept comes from accrual basis accounting)
 Provisions maintained
 Accruals of various expenses
 Depreciation

Linked with matching concept:

According to the matching concept, when computing profit, income earned must be matched against the
expenditure incurred in earning it

Linked with going concern assumption:

While it is assumed that company will not run in future, financial statements will be prepared on break-up
value i.e. net realizable value (sales price less selling expenses) basis rather than accrual basis of accounting.

Suggested Questions:
1. Short note on ‘Accrual basis’?
2. Identifying Accrual Basis concept from a given scenario.
3. During 2009, ABC Company has sales of Tk. 1,000,000, cost of which was Tk. 700,000.
Payment for such expenses was Tk. 650,000.
(a) Calculate profit for the year 2009 using cash basis accounting
(b) Calculate profit for the year 2009 using accrual basis accounting

Answer:
(a) Profit = [10,00,000-650,000] = 350,000
(b) Profit = [10,00,000-700,000] = 300,000

GOING CONCERN:
Under this assumption it is assumed that an entity will continue its operation for the foreseeable future (12
months from balance sheet date). It is also assumed that the enterprise has neither the intention nor the
necessity of liquidation or of curtailing materially the scale of its operations.

Accounting treatment, while going concern is not appropriate:

All items in the balance sheet and profit and loss accounts shall be recorded on break-up value basis i.e. net
realizable value (sales price less selling expenses).

Disclosure requirement in case of going concern problem:

 Basis on which financial statements have been prepared
 Reasons why the entity is not considered to be a going concern
 Nature of the uncertainty

Prepared by Mohammad Shahidul Islam MBA, ACA

 SYNOPSIS
Accounting-Knowledge Level

Example:
Indications of going concern assumption: (BSA-570: Going Concern)
Financial  Negative operating cash flows
 Adverse key financial ratios
 Substantial operating losses
 Arrears in discontinuance of operations
 Inability to pay creditors
 Change from credit to cash-on-delivery transaction with suppliers
 Withdrawal of financial support by debtor and creditor
 Negative current assets
Operating  Loss of key management without replacement
 Loss of major market
 Cancellation of license/franchise etc.
 Labor difficulties or shortage of important suppliers
Other  Non-compliance of capital or other statutory requirement
 Changes in legislation

Suggested Questions:
1. Short note on ‘Going Concern basis’
2. When break-up value of accounting is followed in preparing financial statements?
3. A retailer commences business on 1 January 2009 and buys 20 washing machines, each
costing Tk. 100. During the year he sells 17 machines at Tk. 150 each. How should the
remaining machines be valued at 31 December in the following circumstances? [May-
Jun’2010] [Q:8] [Marks-5]
(a) He forced to close down his business at the end of the year and the remaining
machines will realize only Tk. 60 each in a forced sale.
(b) He intends to continue his business into the next year.
Answer:
(a) Tk. 60*3= Tk. 180
(b)Tk. 100*3- Tk. 300
4. ABC Company has WDV of PPE of Tk. 200,000 (Tk. 180,000 recoverable), accounts
receivable of Tk. 150,000 (Tk. 120,000 realizable), cash & cash equivalent of tk. 50,000,
share capital of Tk. 250,000, retained earnings of Tk. 150,000.
(a) Prepare balance sheet of ABC using going concern assumption appropriate.
(b) Prepare balance sheet of ABC using going concern assumption in-appropriate.
Answer:
Self

Prepared by Mohammad Shahidul Islam MBA, ACA

 SYNOPSIS
Accounting-Knowledge Level

Consistency:
Items in the financial statements shall be presented and classified consistently year to year. However, in
some cases presentation/classification can be re-arranged.
a) Significant change in nature of operation
b) Change will result clear understanding to user
c) Change in presentation is required by any BAS

Disclosure requirement for inconsistency:

Reason for re-arrangement shall be disclosed by way of notes. Previous year’s figures shall also be re-
arranged.

Materiality & Aggregation:

Each material item should be presented separately in the financial statement. Immaterial amounts should be
aggregated with amount of similar nature or function.

Materiality depends on the size and nature of business. There is no specific rule for calculating materiality.
However, following rule for calculating materiality can be suggested:

Thumb rule 5% of profit before tax

Companies Act 1994 any amount exceeding 1% of total revenue or Tk. 5,000 whichever is higher,
shall be shown in distinct head in the financial statements

Off-setting:
 Assets and liabilities should not be off-set except when off-setting is required by another BAS
(Example: BAS-12);
 Income and expenses should only be off-set if standard permits and if the figure is immaterial.

Following items are permitted by BAS-1 for off-setting:

a) Gain or losses on disposal of non-current assets
b) Foreign currency translation gain or losses
c) Extraordinary items

Prudence:
Degree of caution in exercise of the judgments needed in making the management estimates. Examples of
estimates are:

 Estimate of useful life of assets to calculate depreciation

 Provision for doubtful loss (example: Receivable may not be collected)
 Inventory allowance/ obsolescence allowance
 Deferred tax
 Provision for warranty claim
 Accrued revenue
 Provision for loss from a lawsuit

Prepared by Mohammad Shahidul Islam MBA, ACA

 SYNOPSIS
Accounting-Knowledge Level

Suggested Questions:
1. Identity accounting concepts from the following circumstances?
a) Only item which has monetary value is included in Accounts.
b) Application of degree of caution in exercising judgment under conditions of uncertainty.
c) Owner of the business takes goods from inventories for his own personal use.
d) The directors do not intend to liquidate the entity or to cease trading in foreseeable future.
e) When computing profit, income earned must be matched against the expenditure incurred in
earning it.
f) The presentation and classification of items in the financial statements should stay the same
from one period to the next
g) Financial statements are produced within a time interval that enables users to make relevant
economic decision.
h) In times of rising prices, tends to understate asset values and overstate profits.
i) Making allowance for receivables
Answer:
(a) Money measurement (b) Prudence (c) Business entity (d) Going concern (e) Accrual basis (f)
Consistency (g) Timeliness (h) Historical cost (i) Prudence
2. A company begins trading on 1 January 2005 and has sales of Tk. 100,000 during the year to 31
December. At 31 December there are trade receivables of Tk. 15,000. Of these it is uncertain
whether Tk. 6,000 will be paid. What is required to do if we follow prudence concept? [Dec-2011]
[Q:7(a)]
Answer:
Since there is uncertainty about Tk. 6,000 of receivables, prudence dictates that irrecoverable debt
of Tk. 6,000 should be written off.
3. Samson Feeble trades as a carpenter he makes kitchen furniture for customers. Cost of the
inventory at year end is Tk. 1,200 and Net realizable value is Tk. 600. What amount should be
recorded as inventory if you follow prudence concept?
Answer:
Lower of cost and net realizable value i.e. Tk. 600.
4. Your office equipment will be used, on average, for 5 years, so you depreciate it by 20% a year.
This year your business profitability is down and you think you can squeeze an extra year’s life out
of your equipment. Is it acceptable not to charge any depreciation this year?
Answer:
No. Consistency concept would be violated. Once you start charging depreciation cannot be
stopped without good cause.
5. You have recently paid Tk. 4.95 for a waste paper bin which should be used for about 5 years.
Should you treat it as non-current asset?
Answer:
No. Materiality concept would be violated. The cost of waste paper bin is very small, rather it
should be expensed.
6. Write short notes on (a) Prudence [June-2010] [Q:5] (b) Going concern [June-2010] [Q:8] (c)
Changes in accounting estimate [June-2010] [Q:5] (d) Materiality & aggregation [Dec-2010]
[Q:9] (e) Offsetting [Dec-2010] [Q:9] (f) Historical cost [Jun-2011] [Q:1] (g) Offsetting
[Jun-2011] [Q:1] (h) Going concern [Dec-2011] [Q:4] (i) Going concern [Jun-2012] [Q:5]
(j) Accrual basis of accounting [Jun-2012] [Q:5] (k) Materiality [Jun-2012] [Q:5].

Prepared by Mohammad Shahidul Islam MBA, ACA

 SYNOPSIS
Accounting-Knowledge Level

ACCOUNTING FOR IRRECOVERABLE DEBT

[CHAPTER-9]

Some important definition

Trade receivables:
Debtor arising from sale of goods or rendering of services.

Irrecoverable debt:
A debt which is not expected to be recovered or received.

Write off:
Write-off is the process of elimination of trade receivables from the books of accounts. Two important things
to do:
 Full bad amount to be charged as bad debt expense in Income Statement
 Full amount to be deducted from Trade Receivable in Balance Sheet

Bad debt expenses:

A head of expense through with irrecoverable debt charged against profit. Bad debt expense is shown under
the head ‘Administrative expenses’.

Allowance for Trade receivables:

A provision made in relation to receivables for the expectation that receivable may not be recovered.
Allowance for receivable is revised at each reporting period. Allowance for trade receivable is shown in the
balance sheet as liability.

Irrecoverable debt recovered:

Debt which was previously considered as irrecoverable may be recovered subsequently. This is an “Income
head” or reversal of “Bad debt expense”.

Direct write-off:
When it is confirmed that a receivable will not be recovered in 1st year and for which no allowance is created
yet that receivable is then directly written off from the books of accounts.

Making allowance:
When management estimates that there is possibility of non-recovery of receivables then management
make allowance for that receivable at an estimated rate (%). There is no hard and first rule for the rate of
allowance rather; this is the accounting policy of that particular company.

Prepared by Mohammad Shahidul Islam MBA, ACA

 SYNOPSIS
Accounting-Knowledge Level

Accounting for irrecoverable debts

Direct write-off Making allowance

1. Allowance made initially:

1. Writing off an irrecoverable debt:
Bad debt expenses -----------------------------Dr.
Bad debt expenses -------------------------Dr.
Allowance for trade receivable ---------------Cr.
Trade receivable ----------------------------Cr.
2. Allowance revised at each reporting date:
2. If written off debt is recovered
subsequently: (a) If need to increase
Bad debt expenses ------------------------Dr.
Cash/Bank -----------------------------------Dr.
Allowance for trade receivable -----------Cr.
Bad debt expenses -------------------------Cr.
(b) If need to decrease
Allowance for trade receivable -----------Dr.
Bad debt expenses ------------------------Cr.

3. Writing off an irrecoverable debt:

Allowance for trade receivable ----------------Dr.
Trade receivable --------------------------------Cr.

4. If written off debt is recovered

subsequently:
Cash/Bank---------- -----------------------------Dr.
Bad debt expenses (Income)------------------Cr.
5. Amount recovered from receivable for
which provision is made earlier:
Cash/Bank---------- ---------------------------Dr.
Bad debt expenses (Income)----------------Cr.
Allowance for trade receivable -------------Cr.

Income statement and Balance

sheet presentation

Income statement Balance sheet

(Extract) (Extract)

Administration expenses Amount Current assets Amount

Bad debt expenses *** Trade receivables ***
*** Less: Allowance for receivables ***
***

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 SYNOPSIS
Accounting-Knowledge Level

Practical problem
[Provision on bad debt depends on accounting policy of a Company]

Accounting policy of ABC Company for provision for doubtful debts is as followings:
(a) Aged 6+ months – 1 year : 5%
(b) Aged 1+ year – 2 years : 20%
(c) Aged 2+ years – 5 years : 50%
(d) Aged over 5 years : 100%
Bad debts are written-off on consideration of the status of individual debtors. Ageing of Accounts receivables of
ABC company as on 31 December 2010 was as follows:

Sl. Subsidiary ledger (Details of receivables) Amount Ageing (years)

1 Unilever Bangladesh Ltd. 500,000 1.5

2 Zaman Traders 200,000 0.5

3 Social Islamic Bank Ltd. 100,000 6

4 Rupayan Builders Ltd. 600,000 3

5 Dhaka Club Ltd. 400,000 2

Total 18,00,000

Answer:

Sl Subsidiary ledger (Details Amount Ageing Rate Provision for

of receivables) (years) bad debt

1 Unilever Bangladesh Ltd. 500,000 1.5 20% 100,000

2 Zaman Traders 200,000 0.5 0% -

3 Social Islamic Bank Ltd. 100,000 6 100% 100,000

4 Rupayan Builders Ltd. 600,000 3 50% 300,000

5 Dhaka Club Ltd. 400,000 2 20% 80,000

Total 1,800,000 580,000

In 2010:
Bad debt expense-------------------------------Dr. 580,000
Allowance for trade receivable ---------------Cr. 580,000

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 SYNOPSIS
Accounting-Knowledge Level

Ageing of Accounts receivables of ABC company as on 31 December 2011 was as follows:

Sl. Subsidiary ledger (Details of receivables) Amount Ageing (years)

1 Unilever Bangladesh Ltd. 500,000 2.5

2 Zaman Traders 200,000 1.5

3 Social Islamic Bank Ltd. 100,000 7

4 Rupayan Builders Ltd. 600,000 4

5 Dhaka Club Ltd. 400,000 3

Total 18,00,000

Answer:

Sl Subsidiary ledger (Details Amount Ageing Rate Provision for

of receivables) (years) bad debt

1 Unilever Bangladesh Ltd. 500,000 2.5 50% 250,000

2 Zaman Traders 200,000 1.5 20% 40,000

3 Social Islamic Bank Ltd. 100,000 7 100% 100,000

4 Rupayan Builders Ltd. 600,000 4 50% 300,000

5 Dhaka Club Ltd. 400,000 3 50% 200,000

Total 1,800,000 890,000

In 2011:
Bad debt expense-------------------------------Dr. 310,000
Allowance for trade receivable ---------------Cr. 310,000

Prepared by Mohammad Shahidul Islam MBA, ACA

 SYNOPSIS
Accounting-Knowledge Level

MATH-1:
At 1 October 2005 a business had total outstanding debts of tk. 8,600. During the year to 30 September 2006
the following transaction took place: [May-June’ 2010] [Q: 17] [Marks-6]
(a) Credit sales amounted to tk. 44,000;
(b) Payments from various customers amounted to tk. 49,000;
(c) Two debts, for tk. 180 and tk. 420, were declared irrecoverable and the customers are no longer
purchasing goods from the company. These are to be written off.
You are required to prepare the Accounts receivable account and the irrecoverable debt account for the year.
Answer:
Accounts receivable account = [8,600+44,000-180-420] = 3,000
Irrecoverable debt account = [180+420] - 600

MATH-2:
A Business has total accounts receivable outstanding at 31 December 2002 of tk. 28,000. It believes that 1% of
these balances will not be collected and wishes to make an appropriate allowance. Before now, he has not
made any allowance for receivables at all.

On 31 December 2003 its accounts receivable amount to tk. 40,000. Its experience during the year has
convinced him that an allowance of 5% should be made.

What accounting entries should the company make on 31 December 2002 and 31 December 2003, and what
figures for trade accounts receivable will appear in his balance sheets as at those dates?

Answer:
In 2002: Journal entry:
Bad debt expenses--------------------Dr. [28,000 *1%] 280
Allowance for receivables------------Cr. 280
In 2002: Balance sheet:
Trade receivables-------------------- 28,000
Less: Allowance for receivables---- 280
27,720

In 2002: Journal entry:

Bad debt expenses--------------------Dr. [40,000 *5%] – [280] = 1,720
Allowance for receivables------------Cr. 1,720
In 2002: Balance sheet:
Trade receivables-------------------- 40,000
Less: Allowance for receivables---- 2,000
38,000

MATH-3:
An allowance for receivables of 2% is required. Trade accounts receivable at the period end are tk. 200,000
and the allowable for receivables brought forward from the previous period is tk. 2,000. What movement is
required this year?
Answer:
Journal entry:
Bad debt expenses--------------------Dr. [200,000 *2%] – [2,000] = 2,000
Allowance for receivables------------Cr. 2,000

Prepared by Mohammad Shahidul Islam MBA, ACA

 SYNOPSIS
Accounting-Knowledge Level

MATH-4:
Irrecoverable debts are Tk. 5,000. Accounts receivable at the year-end are Tk. 120,000. If an allowance for
receivables of 5% is required. What is the entry for irrecoverable debts and allowance for receivables in the
income statement?
Answer:

Journal entry:

Bad debt expenses--------------------Dr. [5,000] + [120,000-5,000] *5% = 10,750

Allowance for receivables------------Cr. 10,750

MATH-5:
On 1 January 2010 X had doubtful debts allowance of Tk. 1,000. During 2010 he wrote off debts of Tk. 600
and was paid Tk. 80 by the liquidator of a company whose debts had been written off completely in 2009. At
the end of 2010 it was decided to adjust the doubtful debts allowance to Tk. 900. What are the net expenses
for irrecoverable debts in the income statement for 2010? [Nov-Dec 2010] [Q:7] [Marks-4]
Answer:
[600-80+900]-[1000] = 420

MATH-6:
HG Company has realizes that his business will suffer an increase in customers not paying in the future and so
he decides to make an allowance against those who are at greater risk at each year end.
Year end Balance on Balance at risk of
receivables account default
28-Feb-2006 15,200 304
28-Feb-2007 17,100 342
28-Feb-2008 21,400 214
Requirements
For the each of the 3 years:
(a) What are the closing trade receivables and allowance for receivables balances?
(b) What charges is made to the income statement?
(c) How would receivable appear in the balance sheet?
Answer:
(a) Accounts receivables:
2006: 15,200
2007: 17,100
2008: 21,400
Allowance for receivables:
2006: 304
2007: 342
2008: 214
(b) Charges in income statement:
2006: 304
2007: [342-304]=38
2008: (128)
(c) Receivable to be shown in balance sheet:
Current assets 2006 2007 2008
Trade receivables 15,200 17,100 21,400
Less: Allowance for receivables (304) (342) (214)

Prepared by Mohammad Shahidul Islam MBA, ACA