Fundamental of Accounting

ADJUSTMENT TO THE FINAL YEAR ACCOUNTS

a. BAD DEBTS AND ALLOWANCE FOR DOUBTFUL DEBTS

Accounts receivables

The term accounts receivables refer to the amounts due to a business following the sale of goods or services to
another company. It is a subcategory of Accounts Receivable. Trade receivables a/c considered a current asset
on a company's balance sheet as they can be readily converted into cash.

Bad Debts

Some debtors may not pay up their accounts for various reasons e.g. a debtor may go out of business. When a
debtor is not able -to pay up his/her account this becomes a bad debt. Therefore the business/firm should write
it off from the 'accounts and thus it becomes an expense that should be charged in the profit & loss account.

Provision for Bad-Debts

A provision for doubtful debts can either be for a specific or a general provision. A specific provision is where
a debtor is known and chances of recovering the debt are low.

The general provision is where a provision is made on the balance of the total debtors i.e. Debtors less Bad
debts and specific provision,

Accounting for Bad and Doubtful Debts Bad

debts
When a debt becomes bad the following entries will be made:
i. Debit bad debts account
Credit debtors account with the amount owing.
ii. Debit Profit and Loss Account.
Credit bad debts account to transfer the balance on the bad debts account to the income statement
account

Accounting treatment for provision of doubtful debts

The accounting treatment of provision for doubtful debts depends on the year of trading and the entries will be
st st
as follows. If it is the 1 year of trading (1 year of making provision)

i. Debit P&L a/c.

ii. Credit provision for doubtful debts (with total amount of the provision).
In the subsequent periods, it will depend on whether if it is an increase or decrease required on the provision.

If it is an increase:

iii. Debit P&L a/c.

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Fundamental of Accounting

iv. Credit provision for doubtful debts (with increase only). If it

is a decrease:

i. Debit provision for doubtful debts.

ii. Credit P&L a/c (with the decrease in provision only).

Illustration

Minim Ltd. started trading on 1 January 2018. It has been adjusting its doubtful debt provision at the end of each
year on percentage basis, but each year the percentage rate is adjusted in accordance with the economic
performance in the country.

The following details are available for the years ended 31 December 2018, 2019 and 2020.

Year Bad debts Witten Debtors at year end Provision for bad and
off at year end doubtful debts

2018 656,000 22,000,000 5%

2019 1,805,000 40,000,000 7%
2020 3,817,000 60,000,000 6%

Required;

i. Had debts account for the three years

ii. Provision for bad and doubtful debts for the years 2018, 2019 and 2020
iii. The balance sheet extracts for the years 2018, 2019 and 2020.

Solution

i. Bad debts account for the three years

Bad debts account

Sh. Sh.
31.12.2018 Debtors 656,000 31.12.2018 Profit and loss 656,000

31.12.2019 Debtors 1,805,000 31.12.2019 Profit and loss 1,805,000

31.12.2020 Debtor 3,847,000 31.12.2020 Profit and loss 3,847,000

ii. Provision for bad and doubtful debts for the years 2018, 2019 and 2020

Year Debtors at year end Provision for bad and doubtful debts
2018 22,000,000 5%x22,000,000 =1,100,000
2019 40,000,000 7%x40,000,000=2,800,000

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Fundamental of Accounting

2020 60,000,000 6%x60,000,000=3,600,000

Bad debts account Sh.

Sh.
31.12.2018 balance c/d 1,100,000 31.12.2018 Profit and loss 1,100,000

31.12.2019 balance c/d 2,800,000 1.1.2019 balance b/d 1,100,000

- 31.12.2019 P&L (Bal. figu) 1,700,000
2,800,000
2,800,000

31.12.2020 balance c/d 3,847,000 1.12020 Balance b/d 2,800,000

- 31.12.2020 P&L (Bal. figu) 800,000
3,600,000
3,600,000

iii. The balance sheet extracts for the years 2018, 2019 and 2020.

Sh. Sh.
31.12.2013 Debtors 22,000,000
Less Provisions for doubtful debts (1,100,000) 20,900,000

31.12.2014 Debtors 40,000,000

Less Provisions for doubtful debts (2,800,000) 37,200,000

31.12.2014 Debtors 60,000,000

Less Provisions for doubtful debts (3,600,000) 56,400,000

b. ACCRUALS AND PREPAYMENTS

Accrued income

Accrued income is an amount that has been

1. Earned,
2. There is a right to receive the amount, and
3. It has not yet been recorded in the general ledger accounts. One example of accrued income is the
interest earned on a bond investment.

Accrued income will be presented in an income statement as follows;-

Income
account
Date Details Amount Balance to income statement xx
1.1 Accrued at start xx 31.1 Prepaid at end(to statement of financial
position as a liability) x

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Fundamental of Accounting

Prepaid expenses
Prepaid expenses are assets that become expenses as they expire or get used up. For example, office supplies
are considered an asset until they are used in the course of doing business, they become an expense. At the end
of each accounting period, adjusting entries are necessary to recognize the part of prepaid expenses that have
become actual expenses through use or the passage of time.

Prepaid expenses in one company's accounting records are often—but not always—unearned revenues in
another company's accounting records. Office supplies provide an example of a prepaid expense that does not
appear on another company's books as unearned revenue.

Accounting records that do not include adjusting entries to show the expiration or consumption of prepaid
expenses overstate assets and net income and understate expenses.
Let us consider a situation where a business pays an annual insurance premium on April l of Shs.10.000, If at
December 31 we transferred the balance of Shs.10,000 to the profit and loss account. It would not reflect the
true expense of the accounting period, since Shs.2,500 (3/12 x 10,000) relates to the next accounting period.

In order that the profit and loss account show the true expense of Shs.7,500, we need to carry down a debit
balance on the account for the Shs.2,500 prepaid.

The insurance account would then appear as:

Insurance Account
2010 Details Sh. 2019 Details Sh.
April1 Bank 10,000 Dec.31 Profit &Loss a/c 7,500
- Dec.31 Balance c/d 2.500
2011 10000 10.000
Jan 1 Bal. b/d 2,500

The balance of Shs.2, 500 brought down into 2020 will then be transferred to the profit and loss account at end
of 2020 together with any further expense paid, and after adjusting for any accrual or prepayment at December
31, 2020.

In the balance sheet at December 31, 2019 the debit balance of Shs.2, 500 will appear under current assets as a
prepayment.

The reason for this is that it represents value due to the business at that date.

Prepaid expenses will be presented in an expense account statement as follows;-

Expenses
account
Date Details Amount
1.1 Prepaid at start xx
Balance to income statement xx
31.1 Accrued at end(to statement of
financial position as a liability) xx
xx

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Fundamental of Accounting

Prepaid income

Prepaid Income is an accounting concept that refers to a payment that has been received, but the asset has not
yet been fully delivered. The company receives a one-off payment for the asset, but delivers its full value
either in the future or over time. Prepaid Income is found on the statement of financial position of a company
as a liability (as it is something which is owed), either with its own section or under Other Current Liabilities.

Accrued expenses

Money spent or cost incurred in an organization's efforts to generate revenue, representing the cost of doing
business.

Expenses may be in the form of actual cash payments (such as wages and salaries), a computed expired
portion (depreciation) of an asset, or an amount taken out of earnings (such as bad debts). Expenses are
summarized and charged in the income statement as deductions from the income before assessing income tax.
Whereas all expenses are costs, not all costs (such as those incurred in acquisition of income generating assets)
are expenses.

Most expenses are recorded during the accounting period at the time they are paid. However, when a period
ends there may be a few expenses that have been incurred but not paid and recorded because, payment is not
due.

These unpaid and unrecorded expenses for which payment is not due are called accrued expenses. Similar
terms are amounts due, unpaid and outstanding. Examples of accrued expenses are accrued wages and accrued
rental expenses.

Illustration

a) The following cashbook was extracted from the books of Fwamba Enterprises as at 31 December 2020.

Cash Book Sh
‘000’ Sh ‘000’
Balance b/d 100,000 Purchases 300,000
Sales 500,000 Rent and rates 65,000
Commission 10,000 Insurance 32,000
Salaries and wages 150,000
_ Balance 63,000
610,000 610,000

The following additional information is available:

i. On July 1 2020 insurance amounting to Sh 15,000 had been paid for 12 months ending 30 June
2021.
ii. Commission earned but not yet received as at 31 December 2020 was Sh5.000.
iii. On 1 January 2020:
• Rent amounting to Sh. 13,000 was owing

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Fundamental of Accounting

• Rates totaling to Sh. 4,500 had been paid in advance.

iv. December 2019 salaries of Sh. 30,000 were paid on 5 January 2021 and wages amounting to Sh.
35,000 had been paid
v. On 31 December 2020, rent outstanding amounted to Sh. 16,000 and rates paid in advance were Sh.
2,500

Required:
i) Insurance account.
ii) Rent and rates account.
iii) Salaries and wages account.

Insurance a/c

Sh ‘000’ Sh ‘000’
Bank 32,000 P&L 24,500
Balance 7,500
32,000 32,000

Rent and rates a/c

Sh ‘000’ Sh ‘000’
Balance 4,500 Balance b/d 13,000
Bank 65,000 P&L 70,000
Balance c/d 16,000 Balance c/d 2,500
85,500 85,500

Salaries and wages a/c

Sh ‘000’ Sh ‘000’
Bank 65,000 Balance b/d 30,000
P&L 85,000
_ Balance c/d 35,000
150,000 150,000

c. DEPRECIATION, PROVISION FOR DEPRECIATION AND DISPOSAL OF NON CURRENT ASSETS

Meaning of depreciation

Depreciation is the diminution in the value of assets due to wear and tear or due to just passage of time. In
actual practice, both of these factors operate. True profits of a business cannot be ascertained unless
depreciation has been allowed for.

Depreciation means a fall in the quality or value of an asset. The net result of an asset's depreciation is that
sooner or later, the asset will become useless. The factors that cause depreciation are:

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Fundamental of Accounting

1. Wear and tear due to actual use

2. Efflux of time — mere passage of time will cause a fall in the value of an asset even if it is not used,
3. Obsolescence — a new invention or a permanent change in demand may render the asset useless.
4. Accidents
5. Fall in market prices.

Methods for providing depreciation

The following are the various methods for providing depreciation —

(a) Fixed percentage on Original cost or Straight Line Method

(b) Fixed percentage on Diminishing Balance or Reducing Balance Method
(c) Revaluation Method
(a) Fixed Percentage on Original Cost/ Straight Line Method

Under this method, a suitable percentage of original cost is written off the asset every year. Thus, if an asset
costs Shs.20, 000 and ten percent depreciation is thought proper, Shs.2, 000 would be written off each year.

This method is useful when the service rendered by the asset is uniform from year to year. It is desirable,
when this method is in use, to estimate the amount to be spent by way of repairs during the whole life of the
asset and provide for repairs each year at the average, actual repairs being debited against the provision.
(b). Fixed Percentage on Diminishing Balance/ Reducing Balance Method

Under this method, the rate or percentage of depreciation is fixed, but it applies to the Value at which the
asset stands in the books in the beginning of the year.

In the first year, depreciation is written off proportionate to the actual period in use. The depreciation on Shs.20.
000 - the cost of the asset - at the rate of ten percent will be Shs.2, 000 in the first year.
This will reduce the book value of the asset to Shs.18, 000 (20,000-2,000). Depreciation in the second year will
be Shs.1, 800, i.e, ten percent of Shs.18, 000.

In the third year it will be Shs.1, 620. It should be noted that, taking the life of the asset to be the same, the
rate of depreciation in the second method will be roughly three times the rate under the first method.

(c). Revaluation Method

This method is used only in case of small items like cattle (livestock) or loose tools where it may be too much
to maintain an account of each single item. The amount of depreciation to be written off is determined by
comparing the value at the end of the year (valuation being done by someone having knowledge of the asset)
with the value in the beginning.

Suppose on first January, 2020 the value of loose tools was Shs. 1, 600 and during the year Shs.2,000 worth of
tools were purchased.

Now, if at the end of the year, the loose tools are considered to be worth only Shs.2, 400, the depreciation
comes to Shs.1, 200, i.e. Shs. 1,600 + 2,000 - 2,400

Accounting treatment on depreciation

When non-current assets are depreciated, a new account for each type of asset is opened; this account is

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Fundamental of Accounting

called a provision for depreciation whereby the following entries will be made;

Debit - P&L a/c

Credit — Provision for depreciation a/c
With the amount of depreciation charged for the period.

Illustration
A company starts a business on 1 January 2018, the financial year end being 31 December. You are to

show:

a) The plant account.

b) The provision for depreciation account.
c) The balance sheet extracts for each of the years 2018, 2019, 2020, 2021.

The machinery bought was:

2018 1 January 1 plant costing shs.8,000

2019 1 July 2 2 plant costing shs.5,000 each
1 October 1 plant costing shs.6,000
2021 1 April 1 plant costing shs.2,000
Depreciation is at the rate of 10 per cent per annum, using the straight-line method, plant being depreciated for
each proportion of a year.

Plant account

Date Sh. Date Sh,

2018
1/1 Cashbook 8,000 31/12 Balance c/d 8,000

2019
1/1 Balance b/d 8,000
Cashbook 10,000
Cashbook 6 ,000 31/12 Balance c/d 24,000
24,000 24,000
2020
1/1 Balance b/d 24,000 31/12 Balance c/d 24,000
2021 -
1/1 Balance b/d. 24,000
Cashbook 2,000 31/12 Balance old 26,000
26,000 26,000

Calculation for depreciation

2018 Shs Accumulated Depreciation

8,000 x 10/100 x 12/12 800 800

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Fundamental of Accounting

2019
10,000 x 10/100 x 6/12 500
6,000 x10/100 x3/12 150
8,000 x 10/100x12/12 800 1450

2020
24,000 x 10/100 x12/12 2400 2400

2021
24,000 x 10/100 x 12/12 2400
2,000 x 101100 x 9/12 150 2550
7200

Provision for Depreciation

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Fundamental of Accounting

Date Details Amount Date Details Amount

Shs Shs Balance Sheet
2018 2018 (Extract) as at
Balance c/d 800 Income statement 800 31/12/19 - 31/12/21
31/12 31/12

2019 2019
31/12 Balance c/d 2,250 1/1 Balance b/d 800
- 31/12 Income statement 1450
2.250 2250
2020 2020
31/12 Balance c/d 4,650 1/I Balance b/d 2,250
31/12 Income statement 2,400
4,650 4,650
2021 2021
31/12 Balance c/d 7,200 1/I Balance b/d 4,650
31/12 Income statement 2,550
7,200 7,200
Non-Current Cost Acc Depreciation NBV
Assets Sh. Sh. Sh,

2018
Plant 8,000 (800) 7.200
2019
Plant 24,000 (2,250) 21,750
2020
Plant 24,000 (4,650) 19,350
2021
Plant 26,00 (7,200) 18,800

Disposals of assets
When an asset is disposed and is no longer used by the firm, the appropriate entries should be made in the asset
account and the total depreciation provided to date on the asset removed from the books but this will depend on
the type of disposal.

When the asset is sold, the following entries will be made:

(a) Debit - asset disposal a/c

Credit asset a/c
With the cost of the asset being disposed

(b) Debit - provision for depreciation of asset a/c.

Credit - asset disposal a/c
With the total depreciation provided to date on the asset.

(c) Debit - cashbook.

Credit asset disposal a/c
With the cash received on disposal.
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Fundamental of Accounting

The balance in the disposal a/c after the above entries will either be a debit balance or a credit balance. A Credit
balance represents a profit on disposal, which is reported in the profit and loss a/c together with other incomes.
The entry will be:

Debit asset disposal ale

Credit - P&L a/c
With the balance in the account'

A debit balance in the asset disposal a/c is loss on disposal which is reported in the P&L a/c as an expense and
therefore the entry will be vice versa that of a gain on disposal.

Illustration
A company depreciates its plant at the rate of 20 per cent per annum, straight line method, for each year of
ownership. From the following details draw up the plant account and the provision for depreciation account for
each of the years 2017, 2018, 2019 and 2020.

2017 Bought plant costing Sh. 900 on 1 January.

Bought plant costing' sh. 600 on 1 October.
2019 Bought plant costing Sh. 550 on 1 July

2020 Sold plant which had been bought for Sh. 900 on 1 January 2017 for Sh. 275 on 30 September 2020
You are also required to draw up the plant disposal account and the extracts from the balance sheet as at the
end of each year.

Plant a/c

Date Sh. Date Sh,

2017 2017
1/1 Cashbook 900
Balance c/d 1,500
1/10 Cashbook 600 31/12
1,500 1,500

2018 2018
1/1 Balance b/d 1 ,500 31/12 Balance c/d 1,500

2019 2019
1/1 Balance b/d 1,500
1/7 Cashbook 550 31/12 Balance c/d 2,050
2,050 2,050

2020 2020
1/1 Balance b/d 2,050 30/9 Disposal 900
31/12 Balance b/d 1,150
2,050 2,050

Plant Provision for Depreciation a/c

Date Sh. Date Sh,

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Fundamental of Accounting

2017 2017
31/12 Balance c/d 210 31/12 Income Statement 210

2018 2018
1/1 Balance b/d 210
31/12 Balance c/d 510 Income Statement 300
510 510

2019 2019
1/1 Balance b/d 510
31/12 Balance c/d 865 Income Statement 355
865 865

2020 2020
31/12 Disposal 675 30/9 Balance b/d 865
Balance b/d 555 31/12 Income Statement 365
1,230 1,230

Calculation for Depreciation

Date Cost Months Depreciation charge Sh.

2017
1/1 900 12 20/100 x 900 x 12/12 180
1/10 600 3 20/100 x 600 x 3/12 30

2018
1/1 1,500 12 20/100 x 1,500 x 12/12 300

2019
1/1 1,500 12 20/100 x 1,500 x 12/12 300
½ 550 6 20/100 x 550 x 6/12 55
355
2020
30/9 900 9 20/100 x 900 x 9/12 135
31/12 550 12 20/100 x 550 x 12/12 110
31/12 600 12 20/100 x 600 x 12/12 120
365

Plant Disposal a/c

2020 Sh. 2020 Sh.

Plant a/c 900 30/9 Provision for depreciation 675
P&L 50 30/9 Cashbook 275
950 950

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Fundamental of Accounting

Balance Sheet (Extract

Non-Current Assets Cost Total Depreciation NBV

2017 Plant 1,500 (210) 1,290
2018 Plant 1,500 (510) 990
2019 Plant 2,050 (865) 1,185
2020 Plant 1,150 (555) 595

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Fundamental of Accounting

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