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Maintaining Financial Record FA2

Chapter 7
Accruals, prepayments, receivables
and irrecoverable debts

Textbook Reading:
FA2 Maintaining Financial Records , 2020 Edition, BPP, Chapter 7
Practice:
FA2 Maintaining Financial Records Practice & Revision Kit, 2020 Edition, BPP
Question 7.1 to 7.16 & Question 8.1 to 8.13

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Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Section 1
Accruals and prepayments

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Learning objectives:
At the end of this section, you should be able to:
• Define accruals and prepayments.
• Apply the matching concept to accruals and prepayments.
• Identify and calculate the adjustments needed for accruals when preparing
financial statements.
• Prepare the journal entries and ledger entries for the creation of an accrual.
• Identify and calculate the adjustments needed for prepayments when preparing
financial statements.
• Prepare the journal entries and ledger entries for the creation of a prepayment.
• Identify the impact on profit, net assets and capital of accruals and
prepayments.
• Report accruals and prepayments in the final accounts.
• Explain the nature of provisions.
• Account for provisions.

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Accruals
• Accruals, or accrued expenses, are expenses charged against profits
which relate to (i.e. have been incurred during) a particular accounting
period, even though they have not yet been paid.
• Accrual adjustment at year end:
o Review accruals listing for previous year.
o Review every income and expenditure account.
o Review all invoices received after the year end.
o Calculate the relevant accruals.
• Accounting entries:
DEBIT Expenses
CREDIT Accruals

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Illustration 1
Cleverley started in business as a paper plate and cup manufacturer on 1
January 20X6, making up accounts to 31 December 20X6. The electricity bills
received were are follows.
30 April 20X6 $ 5,279.47
31 July 20X6 $ 4,663.80
31 October 20X6 $ 4,117.28
31 January 20X7 $ 6,491.54
Required:
a) What should the electricity charge be for the year ended 31 December
20X6?
b) Prepare the ledger account for both electricity and accrual for the year
ended 31 December 20X6 ?

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Illustration 2
Suppose that Willie Walker opens a shop on 1 May 20X6 to sell hiking and
camping equipment. The rent of the shop is $12,000 per annum, payable
quarterly in arrears (with the first payment on 31 July 20X6).
Willie decides that his accounting period should end on 31 December
each year.
Required:
a) What should rent charge be for the year ended 31 December 20X6?
b) Prepare the ledger account for rent for the year ended 31 December
20X6?
c) Prepare the ledger account for rent for the year ended 31 December
20X7, assuming no increase in rent?

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Prepayments
• Prepayments are payments which have been made in one accounting
period, but should not be wholly or partly charged against profit until a
later period, because they are related to that later period.
• Prepayments adjustment at year end:
o Review list of prepayments from previous year.
o Review all expense accounts for the year.
o Calculate and list all prepayments
• Accounting entries:
DEBIT Prepayments
CREDIT Expenses

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Illustration 3
Hillyard opened for business on 1 January 20X6 in a new shop which was on a 20 year
lease. The rent is payable quarterly in advance and amounts to $20,000 per year. The
payment was made on what are known as the ‘quarter-days’ (except for the first
payment) as follows.
1 January 20X6 $ 5,000
25 March 20X6 $ 5,000
24 June 20X6 $ 5,000
29 September 20X6 $ 5,000
25 December 20X6 $ 5,000
Required:
a) What will the rental charge be for the year ended 31 December 20X6?
b) Prepare the ledger account for both rent and prepayment for the year ended 31
December 20X6?

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Illustration 4
Suppose that Terry Trunk commences business as a landscape gardener on 1
September 20X6.
He immediately decides to join his local trade association, the Confederation of
Luton Gardeners, for which the annual membership subscription is $180,
payable annually in advance. He paid this amount on 1 September.
Terry decide that his accounts period should end on 30 June each year.
Required:
a) What will the subscription charge be for the year ended 30 June 20X6?
b) Prepare the ledger account for subscription for the year ended 30 June
20X6?
c) Prepare the ledger account for subscription for the year ended 30 June
20X7, assuming no increase in annual charge?

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Current assets and liabilities

• Current assets are:
o Items owned by business with the intention of turning them
into cash within one year
o Cash, including money in the bank, owned by the business
• Current liabilities are debts of the business that must be paid
within a fairly short period of the time
• Prepayments and receivables are part of the current assets.
• Trade and non-trade payables and accruals represents significant
proportion of current liabilities.

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Provision
• A provision is a liability of uncertain timing or amount.
• Features of provisions:
o Less certainty than with an accrual.
o Obligation to transfer economics benefits as a results of past transactions or
events
o Example including amounts likely to be paid as a results of a legal dispute or
estimates of amounts be paid in relation to warranties offered on goods sold
during the year.
o Amount included is the “best” estimate.
• Accounting for provision
DEBIT Expenses (SoPL)
CREDIT Provision (SoFP

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Section 2
Receivables and irrecoverable debts

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Learning objectives:
At the end of this section, you should be able to:
• Prepare the bookkeeping entries to write off an irrecoverable debt.
• Record an irrecoverable debt recovered.
• Identify the impact of irrecoverable debts on the statement of profit or
loss and on the statement of financial position.
• Calculate the movement in the allowance for receivables and the closing
balance.
• Prepare the bookkeeping entries to create and adjust an allowance for
receivables.
• Illustrate how to include movements in the allowance for receivables in
the statement of profit or loss and how the closing balance of the
allowance should be reported in the statement of financial position.

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Receivables and trade receivable

• A receivable is a balance owing to the business.

Receivables can be broken down into trade receivables and
non-trade receivables.
• A trade receivables is a balance arising in the course normal
trading operations.
• Non-trade receivables arise from many different types of
transactions, depending on the type of business, for
example there may be loans to employees for season travel
tickets.

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Irrevocable debt

• An irrevocable debt is a specific debt which is not expected

to be repaid.
• A receivable should be only be classed as an asset if it is
recoverable.
• If definitely irrecoverable, the debt should be written off to
the statement of profit or loss as an irrecoverable debt.
DEBIT Irrecoverable debts expense
CREDIT Receivables ledger control

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Illustration 5
At 1 October 20X6 a business had total outstanding debts of $8,600. During
the year to 30 September 20X7:
i. Credit revenue amounted to $44,000
ii. Payments from various receivables amounted to $49,000
iii. Two debts, for $180 and $420 were declared irrevocable. These are to be
written off.
Required:
Prepare the receivables accounts and the receivables expense account for the
year in following cases:
a) If both the debts written off were exclusive of sale tax.
b) If both the debts written off were inclusive of sale tax at the rate of 20%.

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Subsequent recovery of debts

• If the payment is received before the end of the period in which
the debt was written off, simply reverse the entry for the write off.
DEBIT Recoverable control account
CREDIT Recoverable expense
and then record the receipt in normal way.
• If the payment is received after the end of the period in which the
debt was written off, then it is treated as sundry income in the
statement of profit or loss.
DEBIT Bank account
CREDIT Sundry income
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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

An allowance for receivables

• An allowance for receivables is a general estimate of the

percentage of debts which are not expected to be repaid.
• If uncertainty exists as to the recoverability of the debt, an
allowance should be set up. This is offset against the
receivables balance on the statement of financial position.
DEBIT Irrecoverable debts expense
CREDIT Allowance for receivables

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 Chapter 7: Accruals, prepayments, receivables and
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An allowance for receivables

In subsequent years, adjustments may be needed to the amount of the allowance. The
procedure to be followed then is as follows.

• Step 1: Calculate the new allowance required

• Step 2: Compare it with the existing balance on the allowance account

• Step 3: Calculate the increase or decrease required.

(a) If a higher allowance is required:

DEBIT Receivable expenses

CREDIT Allowance for receivables

(b) If a lower allowance is needed:

DEBIT Allowance for receivables

CREDIT Receivable expenses

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 Chapter 7: Accruals, prepayments, receivables and
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Illustration 6
Andrew Carter has total receivables balances outstanding at 31
December 20X6 of $28,000. He believes that about 1% of these
balances will not be paid and wishes to make an appropriate
allowance. Before now, he has not made any allowance for
receivables at all.
On 31 December 20X7 his receivables balance amount to $40,000.
His experience during the year has convinces him that an
allowance of 5% should be made.
What accounting entries should Andrew make on 31 December
20X6 and 31 December 20X7, and what figure for receivables will
appear in his statement of financial position as at those dates?

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Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Practice Questions

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 Chapter 7: Accruals, prepayments, receivables and
irrecoverable debts

Question 1
Sandy wants to write off a debt due to him from a business that has
recently ceased trading.

What entries should Sandy make?

A. DEBIT Receivables control account

CREDIT Irrecoverable debt expense

B. DEBIT Revenue
CREDIT Irrecoverable debt expense

C. DEBIT Irrecoverable debt expense

CREDIT Receivables control account

D. DEBIT Irrecoverable debt expense

CREDIT Revenue

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 Chapter 7: Accruals, prepayments, receivables and
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Question 2
At 1 January 20Xl there was an allowance for receivables of $2,000.

During the year $1,000 of debt was written off and $800 of irrecoverable
debt was recovered.

At 31 December 20Xl, it was decided to adjust the receivables allowance to

10% of receivables, which were $30,000.

What was the irrecoverable debt expense in the statement of profit or loss
for the year?

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 Chapter 7: Accruals, prepayments, receivables and
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Question 3
Graham prepared his draft end of year accounts, however he has now
realised that he did not adjust these for a prepayment of $2,100 and an
accrual of $800.

How will Graham's profit and net assets be affected by including the
prepayment and accrual?

Net profit will: Net assets will

A. Increase by $2,900 Reduce by $2,900
B. Increase by $1,300 Increase by $1,300
C. Reduce by $1,300 Increase by $1,300
D. Reduce by $2,900 Reduce by $2,900

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 Chapter 7: Accruals, prepayments, receivables and
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Question 4
On 3 July 20X0 Alex paid rent of $18,000 for the period 1 July 20X0 to 30
June 20X1. He is drawing up accounts for the year to 31 January 20X1.

What entry does Alex need to make in respect of rent in order for the year
end figure to be correct?

Picklist: Picklist:
accrual $7,500
prepayment $10,500

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 Chapter 7: Accruals, prepayments, receivables and
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Question 5
Wendy is drawing up accounts for her toy store for the year ended 31
December 20X8. During that year one of the toys she sold was faulty and
resulted in an injury to a child. As a result the parents of the child have
taken legal action and are demanding a maximum of $6,000 in damages.

Wendy offered compensation of $1,200 which has been turned down. She
has now taken advice on the matter from her solicitor who thinks that,
although there is a slim chance she will be able to avoid paying damages
if the case goes to court, the sensible course of action is to settle out of
court. The solicitor has advised that a sum of around$4,500 is likely to be
accepted by the parents.

Calculate the amount of the provision to be included in Wendy’s accounts.

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