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The inclusion of a degree of caution in the exercise of the judgement needed in making the estimates required under conditions of uncertainty
Wood & Sangster, 2008
Non-current Assets Buildings and premises Fixtures and fittings Machineries and equipments Current Assets Inventories Debtors Cash at Bank Cash in hand
Non-current Assets Buildings and premises Fixtures and fittings Machineries and equipments Current Assets Inventories Debtors Cash at Bank Cash in hand
Why commercials offer sales on credit to their customers? To offer flexibilities in payment to customers. Encourage customers to buy (purchasing power). To gain advantage in business competition.
Businesses offer sales on credit to its customers. The business therefore taking risk that some of these customers (debtors) may never pay for the goods sold to them. In the events of uncollectible debts, these debts must be written-off from the assets accounts and charged to income statement. The uncollectible debts is called as bad debts.
On 31 August 2011, TCS Sdn Bhd was declared bankrupt and has to be written-off as bad debts.
TCS Sdn Bhd 2011 Aug 1o Sales 25,000
On 31 August 2011, TCS Sdn Bhd was declared bankrupt and has to be written-off as bad debts.
TCS Sdn Bhd 2011 Aug 1o Sales 25,000 Bad Debts 2011 Aug 31 TCS Sdn Bhd 2011 25,000 Dec 31 Profit & Loss 25,000 2011 25,000 Aug 31 Bad Debts 25,000 25,000
Sometimes, a debt written-off in previous years is recovered. When this happens, the debt must be reinstate in the accounts by making the following entries:
To show in the balance sheet a figure for accounts receivable as close as possible to the true value of accounts receivable at the balance sheet date. Thus, an estimation that some of the reported accounts receivable may be uncollectible in the future (become bad debts) must be incorporated in the account / financial statements prudence concept. This estimation is called as Allowance for Doubtful Debts
A debtor who owed RM500 to the company was declared bankrupt at the year end and this amount has to be written-off.
Accounts Receivable 2010 Dec 31 Balance b/d 2010 70,500 Dec 31 Bad debts Dec 31 Balance c/d 70,500 Bad Debts 2010 Dec 31 Acc. Receivable 500 500 70,000 70,500
The company has decided to provide 10% of the net debtors as allowance for doubtful debts.
Accounts Receivable 2010 Dec 31 Balance b/d 2010 70,500 Dec 31 Bad debts Dec 31 Balance c/d 70,500 500 70,000 70,500
The allowance for doubtful debts are as follows: 10% x RM70,000 = RM7,000
Net debtors
The double entries to record the increases in Allowance for doubtful debts: Debit Income Statement Credit Allowance for doubtful debts
Accounts Receivable 2010 Dec 31 Balance b/d 2010 70,500 Dec 31 Bad debts Dec 31 Balance c/d 70,500 500 70,000 70,500
Allowance for doubtful debts 2010 Dec 31 Balance c/d 7,000 7,000 2010 Dec 31 Income Statement 7,000 7,000
Income Statement (extract) for the year ended 31 Dec 2010 Expenses Increase in provision for doubtful debts
7,000
Balance Sheet (extract) as at 31 Dec 2010 Add Current Assets Accounts receivable / debtors less : Allowance for D. Debts
70,000 7,000
63,000
The balances in the account of Taza Sdn Bhd as at 31 December 2010 were as follows: Accounts receivable RM85,300
Additional Information 1. A debtor amounted RM800 was declared bankrupt and to be written-off. 2. An allowance for doubtful debts is to be provided at 5% of the net debtors. REQUIRED Show the following: i. Accounts receivable and allowance for doubtful debts ii. Income Statement and balance sheet as at 31 Dec 2010
Net debtors
Allowance for doubtful debts = 5% x 84,500 = 4,225 (increase in allowance for doubtful debts)
Accounts Receivable 2010 Dec 31 Balance b/d 2010 85,300 Dec 31 Bad debts Dec 31 Balance c/d 85,300 800 84,500 85,300
Allowance for doubtful debts 2010 Dec 31 Balance c/d 4,225 4,225 2010 Dec 31 Income Statement 4,225 4,225
Income Statement (extract) for the year ended 31 Dec 2010 Expenses Increase in provision for doubtful debts
4,225
Balance Sheet (extract) as at 31 Dec 2010 Add Current Assets Accounts receivable / debtors less : Allowance for D. Debts
84,500 4,225
80,275
When a company provide allowance for doubtful debts annually, the amount of provisions for doubtful debts would change as reflect to the amount of debtors at the year end or the rate of estimation. Example: Year 2001 2002 2003
Provisions for D. Debts 10% x 100,000 = 10,000 10% x 120,000 = 12,000 10% x 110,000 = 11,000
The account balances for Rahmad Trading as at 30 June 2011 were as follows: Accounts Receivables RM36,000 Provisions for Doubtful Debts 1,200 Bad Debts written-off 1,000 Additional information: 1. Bad debts to be written-off as at 30 June 2011 is RM600 2. Allowance for doubtful debts is to be provided at 5% on net debtors.
Net debtors
Allowance for doubtful debts = 5% x 35,400 = 1,770 Increase in allowance for doubtful debts = 1,770 1,200 = 570
Accounts Receivable
2011 June 30 Balance b/d 36,000 36,000 2011 June 30 Bad Debts June 30 Balance c/d 600 35,400 36,000
Income Statement (extract) for the year ended 30 June 2011 Expenses Bad debts Increase in provision for doubtful debts
1,600 570
Balance Sheet (extract) as at 30 June 2011 Add Current Assets Accounts receivable / debtors less : Allowance for D. Debts
35,400 1,770
33,630
The account balances for Rahmad Trading as at 30 June 2011 were as follows: Accounts Receivables RM35,000 Provisions for Doubtful Debts 2,200 Bad Debts written-off 1,000 Additional information: 1. Bad debts recovered as at 30 June 2011 is RM1,000 2. Allowance for doubtful debts is to be provided at 5% on net debtors.
Net debtors
Allowance for doubtful debts = 5% x 36,000 = 1,800 Decrease in allowance for doubtful debts = 2,200 1,800 = 400
Accounts Receivable
2011 June 30 Balance b/d 35,000 June 30 B. Debts Recovered 1,000 36,000 2011 June 30 Balance c/d 36,000 36,000
2,200
2,200
Income Statement (extract) for the year ended 30 June 2011 Revenues Bad debts recovered 1,000 Decreases in provision for doubtful debts 400 Expenses Bad debts
1,000
Add
36,000 1,800
34,200
There was a girl who was bald. She was wearing a yellow t-shirt, y. (y. = yellow) bracelet, and y. sandals. She went to her y. house using her y. car. She took a bath in her y. shower. After that she opened her y. drawer and found a green comb. She threw it away, why?
Do you think that all of the amount of your debtors will finally turned out as cash receipts?
Debtors RM100,000
RM100,000
RM85,000 RM100,000
Now, do you think that all remaining RM85,000 will become cash receipts in the end?
RM15,000
Bad Debts
RM75,000 RM85,000
Discount allowed
RM10,000
Provisions for discount allowed (PFDA) are more or less the same as PFDD, except, in arriving at this estimation, the amount of PFDD must be deducted from the Net Debtors (as we dont give discount to debts that we estimated to be bad).
Rolls company had the following balances as at 31 December 2010: Accounts receivable RM40,000 Provisions for doubtful debts 2,050 Provisions for discount allowed 930 Bad debts 1,000 Additional information: 1. Bad debts to be written-off is RM600 2. Bad debts recovered is RM200 3. The following provisions are to be made: Provisions for doubtful debts Provisions for discount allowed
8% 2%
Net debtors = debtors bad debts to be written off + bad debts recovered to be reinstate = 40,000 600 + 200 = 39,600 Provisions for doubtful debts = 8% x 39,600 = 3,168 (increase by 1,118)
Provisions for discount allowed = 2% x (39,600 3,168) = 728.64 729 (decrease by 201)
Part 2 Ledger / double entries Accounts Receivable 2010 Dec 31 Balance b/d 40,000 Dec 31 Bad debts Rec. 200 40,200 2010 Dec 31 Balance b/d Dec 31 Acc. Receivable 2010 Dec 31 Bad debts Dec 31 Balance c/d 600 39,600 40,200
Bad debts 1,000 600 Dec 31 Income statement 1,600 1,600 1,600 2010 Dec 31 Acc. Receivable 2010
200 200
200 200
2010 Dec 31 Balance b/d 2,050 3,168 Dec 31 Income statement 1,118
3,168 3,168
Provisions for Discount Allowed 2010 Dec 31 Income statement Dec 31 Balance c/d 2010 210 Dec 31 Balance b/d 729 930
930
930
Income Statement (extract) for the year ended 31 December 2010 Revenue Decrease in provision for discount allowed 201 Bad debts recovered 200 Expenses Increase in provision for doubtful debts 1,118 Bad debts 1,600
Balance Sheet (extract) as at 31 December 2010 Current Assets Accounts Receivable 39,600 Less : Provision for doubtful debts 3,168 Provision for discount allowed 729 35,703
Prudence concept requires financial reports to consider future possible losses and not future gains. This is to avoid assets or income being overstated and liabilities or losses being understated. Bad debts are actual losses incurs by businesses as these debtors are dead or become insolvent. Doubtful debts are estimation made by the businesses to consider future possible losses (of debtors which become uncollectible). Thus assets of debtors will be reduced to avoid for being overstated. Provisions for discount allowed is another estimation that made by businesses to consider future losses / expenses.
Bad debts = actual amount of uncollectible debts Net debtors = debtors bad debts to be written off + bad debts recovered to be reinstate PFDD = estimate % x Net debtors PFDA = estimate % x (Net debtors PFDD)
Bad debt is an expense Income statement (expenses) Bad debts recovered is a revenue Income statement (revenue) Increase in PFDD or PFDA Income statement (expenses) Decrease in PFDD or PFDA Income statement (revenue) Net debtors Balance sheet (current assets) Balance of PFDD and PFDA deduct from Account Receivables (in Balance Sheet under Current Assets)
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