Advanced-Level
Prepayment and Accruals
1.)Expenses
A)Payment in arrear – accruals/accrued expenses/expenses owing
Example:
For the first year of operation, electricity expense amounts to $10 per month. It is paid on the first day of the following month. In the second year, the expense doubles. Show the Electricity Account for two years.
ElectricityYear 1 / $ / Year 1 / $
1/2-1/12 / Bank / 110 / 31/12 / P&L / 120
31/12 / Accrued c/d / 10
120 / 120
1/2-1/12 / Bank / 230 / 1/1 / Accrued b/d (liability) / 10
31/12 / Accrued / 20 / 31/12 / P&L / 240
250 / 250
Journal Entries at the end of first year:
Dr. Electricity 10
Cr. Accruals – Electricity 10
Entered the year end adjustment for the electricity expense.
B)Payment in advance – prepayments/prepaid expenses/payments in advance
Example:
The first month’s insurance of $10 was paid in advance at the commencement of the business. Then it was paid one month in advance on the last day of each month. Show the Insurance Account for two years.
InsuranceYear 1 / $ / Year 1 / $
1/1-31/12 / Bank / 130 / 31/12 / P&L / 120
31/12 /
Prepaid c/d
/ 10130 / 130
Year 2 / ↓(Current Assets) / Year 2
1/1 / Prepaid b/d / 10 / 31/12 / P&L / 120
31/12 / Bank / 120 / 31/12 / Prepaid c/d / 10
130 / 130
Journal Entries at the end of first year:
Dr. Prepayment – Insurance 10
Cr. Insurance 10
Entered the year end adjustment for the insurance expense.
C)Prepaid and Accrued in the same account
Example One
The company rented two flats for many years. The arrangements are:
Rent for Flat A is paid one month in arrear at $10 per month.
Rent for Flat B is paid one month in advance at $20 per month.
Show the Rent Account for the current year.
RentYear 1 / $ / Year 1 / $
1/1 / Prepaid b/d / 20 / 1/1 / Accrued b/d / 10
31/12 / Bank: Flat A / 120 / 31/12 / P&L / 360
Flat B / 240 / 31/12 / Prepaid c/d / 20
31/12 / Accrued c/d / 10
390 / 390
Journal Entries at the end of first year:
Dr. Prepayment – Rent 20
Cr. Accruals – Rent 10
Cr. Rent 10
Entered the year end adjustment for the rent expense.
Example Two
All data are same as above except that the rent will increase by 50% next year. Show the Rent Account for the current year.
RentYear 1 / $ / Year 1 / $
1/1 / Prepaid b/d / 20 / 1/1 / Accrued b/d / 10
31/12 / Bank: Flat A / 120 / 31/12 / P&L / 360
31/12 / Flat B / 250 / 31/12 / Prepaid c/d / 30
31/12 / Accrued c/d / 10
400 / 400
D)Materials or Office supplies – minor stock
Example:
Stationary stock that has not been used on 1.1.1992 amounts to $200. Cash paid to purchase stationery in 1992 amounts to $1 000. At year end:
Stock unused - $50
Owing for purchase of stationery - $170
Show the Stationery Account for the current year.
StationeryYear 1 / $ / Year 1 / $
1/1 / Stock b/d / 200 / 31/12 / P&L / 1320
31/12 / Bank / 1000 / 31/12 / Stock c/d / 50
31/12 / Accrued c/d / 170
1370 / 1370
Journal Entries at the end of first year:
Dr. Stationery Stock 50
Dr. Stationery 120
Cr. Accrual – Stationery 170
Entered the year end adjustment for the stationery expense.
2.)Revenue
A) Payment in arrear - receivable
The tenant pays rent of $100 per month in arrear on the first date of the following month. He moved in on 1.1.1998 and there would be a 10% increase of rent in 1999. Show the Rent Received/Rental Income Account for 1998 and 1999.
Rent Received1991 / $ / 1991 / $
31/12 / P&L / 1200 / 1/2-1/12 / Bank / 1100
31/12 /
Receivable c/d
/ 1001200 / 1200
1992 / 1992
1/1 / Receivable b/d / 100 / 1/1-1/12 / Bank / 1310
31/12 / P&L / 1320 / 31/12 / Receivable / 110
1420 / 1420
Journal Entries at the end of first year:
Dr. Rent Receivable 100
Cr. Rent received 100
Entered the year end adjustment for the rent received.
B) Payment in advance - Unearned revenue/income
A new client agrees to buy an insurance policy on 1.10.1998. He pays insurance premium annually in advance ($1 200 per year) on Oct 1 each year. There will be a 10% increase of premium for the next payment. Show the Insurance Income Account for 1998 and 1999.
Insurance Premium Received1991 / $ / 1991 / $
31/12 / P&L / 300 / 1/10 / Bank / 1200
31/12 / Unearned c/d / 900 / (from 1/10 yr1to31/9 yr2)
1200 / 1200
1992 / 1992
31/12 / P&L / 1230 / 1/1 / Unearned b/d / 900
31/12 / Unearned c/d / 990 / 1/10 / Bank / 1320
2220 / 2220
Journal Entries at the end of first year:
Dr. Insurance premium received 900
Cr. Insurance income 900
Entered the year end adjustment for the insurance premium received.
Provision for bad debts and provision for discounts allowed
Illustrative example 1
31.12.91 / 31.12.92 / 31.12.93Debtors / $10 000 / $12 000 / $9 000
The company commenced business on 1.1.91 and its policy is to provide for bad debts on 5% of debtors. The bad debts written off during 1992 and 1993 were $200 and $300 respectively.
Required:
a)Prepare the Provision for bad debts Account for the three years.
b)Prepare the Profit and Loss Accounts (Extract) for the three years.
Provision for Bad Debts1991 / $ / 1991 / $
31/12 / Balance c/d / 500 / 31/12 / P&L / 500
1992 / 1992
31/12 / Balance c/d / 600 / 1/1 / Balance b/d / 500
31/12 / P&L / 100
600 / 600
1993 / 1993
31/12 / P&L / 150 / 1/1 / Balance b/d / 600
31/12 / Balance c/d / 450
600 / 600
Profit and Loss Account (Extract)
$ / $
1991 / Provision for Bad Debts / 500
1992 / Provision for Bad Debts / 100
Bad Debts / 200
1993 / Bad Debts / 300 / 1993 / Reduction in provision for Bad Debts / 150
Illustrative example 2
31.12.92 / 31.12.93Debtors / $116 000 / $123 600
Additional information:
1)A debtor of $600 was found to be uncollectible.
2)The company always made provisions according to past experience that 5% of debtors were bad and that 20% of the remaining debtors would accept a cash discount of 2.5%.
Prepare for the year ended 31.12.93:
a)the Provision Accounts for bad debts and discounts allowed.
c)the Profit and Loss Account (Extract) and Balance Sheet (Extract).
Provision for Bad Debts1993 / $ / 1993 / $
31/12 / Balance c/d / 6150 / 1/1 / Balance b/d / 5800
31/12 / Profit and Loss Account / 350
6150 / 6150
Provision for Discounts Allowed
1993 / $ / 1993 / $
31/12 / Balance c/d / 584 / 1/1 / Balance b/d / 551
31/12 / Profit and Loss Account / 33
584 / 584
Profit and Loss Account (Extract)
$
Provision for Bad Debts / 350
Bad Debts / 600
Provision for Discount Allowed / 33
Balance Sheet (Extract)
Current Assets
Debtors / 123000
Less: Provision for bad debts / 6150
Less: Provision for discounts allowed / 584 / 6734
116266
Bad Debts Recovered
Illustration
Mr. A who owed our company $100 declared bankrupt and the debt was writtenoff. Subsequently, a dividend of 90% was received. Show the journal entries for the transactions.
JournalParticular / Dr. / Cr.
$ / $
Bad Debts / 100
Mr. A – debtors / 100
Mr A / 90 / 90
Bad Debts Recovered / Bad Debts
Bank / 90
Mr. A – Debtors / 90
Depreciation
A.) Definition
Depreciation is the measure of the wearing out, consumption or other reduction in the useful economic life of a fixed whether arising from use, effluxion of time or obsolescence through technological or market changes.
B.) Accounting concept of depreciation
The need to depreciate fixed assets arises from the matching concept. As depreciation represents that part of the cost of fixed asset which is not recoverable when the asset is finally put out of use, the amount expended must at some time be charged against profits. If the asset is one which contributes to an enterprise’s revenue over a number of accounting periods, it would be inappropriate to charge any single period with the whole of the expenditure. Instead, the procedure of matching periodic revenues with the cost of earning those revenues over the economic life of the asset must be adopted.
In a nutshell, providing for depreciation is a process for the ALLOCATION OF COST. It doesn’t aim at the valuation of assets or providing for replacement cost.
C.)Determining the cost of fixed assets
Capital Expenditure is an outlay of funds used to obtain a fixed asset, to prepare a fixed asset for its productive life, or to add to the value of a fixed asset by way of improvement. In other words, the expenditure will be a carryover of beneficial services into future periods.
It includes all costs related to fixed asset acquisition, costs of addition, costs of improvement (substantially increase the efficiency, create new functions or larger capacity, substantially extend the economic useful life).
Revenue Expenditure is an outlay of funds designed to enable an asset to continue its productive life or represent the cost of running the business or expense charges. In other words, the expenditure will be entirely consumed and benefit only the current period. It includes expenses in day-to-day operations, repair and maintenance costs, replacement costs.
Capital/Revenue- Cost of painting firm’s name on new van
- Cost of repainting firm’s name on existing van
- Legal costs of collecting debts
- Legal charges on acquiring new office
- Cost of motor taxation licence for existing van
- Cost of motor taxation licence for new van (once in a year)
- Addition shop counter
- Fire insurance premium
- Renewing signwriting on shop
- New tyre for van (assume that it is an existing van)
- Installing extra toilet (have future benefit)
- Purchase of replacement engine for existing motor van
- Cost of altering interior of new van to increase carring capacity
- Cost of software for use with the computer
- Cost of training the staff to use the software (cost of preparation)
- Wages of computer operators
- Cost of adding extra memory to the computer
- Cost of floppy discs used during the year
D.)Depreciation Method
1)Straight Line Methods Basic formula:
Depreciation =
a) sometimes, the policy may be expressed as:
Depreciation = Cost x depreciation rate (in%) p.a.
QuizCost of the fixed asset is $120. Depreciation is provided at 20% p.a. on cost by straight line method
What is the economic useful life of the fixed assets? 5 years
b) For sake of convenience, some companies may adopt the depreciation policy as:
i)Depreciation = Cost x depreciation rate (in%) p.a.
and-full year depreciation charge at the year of purchase
-no depreciation charge at the year of disposal
OR
ii)Depreciation = depreciation rate (in%) on cost of assets held at yearend
OR
iii)Depreciation = Cost x depreciation rate (in%) p.a.
and depreciation in the year of purchase and year of disposal is charged at one half of the normal rate.
Exercise
Depreciation policy is same as above at 20% p.a.
Cost of machine brought down on 1.1.92$20 000
Accumulated depreciation on 1.1.92 4 500
Purchase of machine on 1.3.92 at cost 2 000
Disposal of machine on 1.9.92 at $200 which was purchased at cost of $3 200 on 1.2.88.
Show the above transactions in the relevant ledger accounts.
Machine1992 / $ / 1992 / $
1/1 / Balance b/d / 20,000 / 1/9 / Disposal of Machine / 3,200
1/3 / Bank / 2,000 / Balance c/d / 18,800
22,000 / 22,000
Provision for depreciation - Machine
1992 / $ / 1992 / $
1/9 / Disposal of machine / 2,560 / 1/1 / Balance b/d / 4,500
31/12 / Balance c/d / 5,820 / 31/12 / P&L / 3,880
8,380 / 8,380
Disposal – Machine
1992 / $ / 1992 / $
1/9 / Machine / 3,200 / 1/9 / Disposal of Machine / 2,560
1/9 / Bank / 200
31/12 / P&L / 440
3,200 / 3,200
Depreciation on extension/improvement
Exercise One
The club house at cost of $1 200 000 had been purchased on 1.1.73. Depreciation policy is 2.5 % p.a. on cost by the straight line method. An extension of the club premises was completed on 30.9.82 at a cost of $216 000 and depreciation is to be provided as from that date the total cost incurred.
Required:
Calculate the depreciation charge for the club house for year ended 31.12.82 and show the club house on the balance sheet.
a) Depreciation charges for the year:Depreciation charge:
$1,200,000 x 2.5% x 10 + $216,000 x 2.5% x
= $ 301,350
b)
Balance Sheet as at 31 December 1982
Cost / Accumulated Depreciation / Net Book Value
Fixed Assets / $ / $ / $
Club house / 1,416,000 / 301,350 / 1,114650
Exercise Two
The club house had been built on 1.1.1974 for a cost of $10 000 and its economic life would be 25 years. On 1.1.1980 improvements on the club house of $950 was incurred.
Required:
Calculate the depreciation charge for the club house for year ended 31.12.80 and show the club house on the balance sheet.
a) Depreciation charges for the year:Depreciation charge:
$10,000÷25+$950÷19
=$450
b)
Balance Sheet as at 31 December 1980
Cost / Accumulated Depreciation / Net Book Value
Fixed Assets / $ / $ / $
Club house / 10,9500 / 2,850 / 8,100
Trade-in Transaction
A car at cost of $100 and an accumulated depreciation of $80 is being traded in for a new car at a list price of $200. The trade-in-allowance is $30. Show all the relevant accounts in the transaction.
Car$ / $
Balance b/d / 100 / Disposal / 100
Bank / 170
Disposal – Trade in allowance / 30
300 / 300
Provision for depreciation – Car
$ / $
Disposal / 80 / Balance b/d / 80
Disposal - Car
$ / $
Car / 100 / Provision for depreciation / 80
Profit on disposal / 10 / Car - Trade in allowance / 30
110 / 110
2)Reducing/Diminishing Balance Method Basic Formula:
Depreciation = (Cost – Accumulated Depreciation) x depreciation rate= Net Book Value x depreciation rate
Example One
Cost of equipment = $1 000Residual Value = $64
Economic useful life = 3 yearsDepreciation rate = 60% p.a.
Calculate the depreciation charge for each of the 3 years.
Depreciation charges of year 1 / = $1000 x 60%= $600
Depreciation charges of year 2 / = $(1000-600) x 60%
= $240
Depreciation charges of year 3 / = $(1000-600-240) x 60%
= $96
Example Two
Cost of equipment = $1 200Residual Value = $75
Economic useful life = 3 yearsDepreciation rate = 60% p.a.
Calculate the depreciation charge for each of the 3 years.
Depreciation charges of year 1 / = $1200 x 60%= $720
Depreciation charges of year 2 / = $(1200-720) x 60%
= $288
Depreciation charges of year 3 / = $(1200-720-288) x 60%
= $117 (∵the rate is not accurate)
Example Three
Data same as example one but the date of purchase is 30 September while the financial year end is 31 December. Calculate the depreciation charge for each of the 4 years.
Depreciation charges of year 1 / = $1000 x 60% x= $150
Depreciation charges of year 2 / = $(1000-150) x 60%
= $510
Depreciation charges of year 3 / = $(1000-150-510) x 60%
= $204
Depreciation charges of year 4 / = $(1000-64-150-510-204)
= $72
General Formula for reducing balance method:
Cost = $1 000Rate = 60% p.a.Useful life = 3 years
Net Book Value of year 1 and 2:
NBV1 / = 1 000 – 1 000 x 60%= 1 000 x (1-60%)
= 400 / NBV2 / = 400 – 400 x 60%
= 400 x (1-60%)
= 1 000 x (1-60%) x (1-60%)
= 1 000 x (1-60%)2
= 160
Therefore, NBVn = Cost x (1-rate)n(It is useful for disposal calculation.)
When n = useful life, NBVn = residual value.
Residual Value = Cost x (1-rate)n
64 = 1 000 x (1-rate) 3
Rate = 60% (What will the rate be if residual value = 0?)
Example Four
An asset which was bought on 1.1.85 at cost of $12 000 is sold at a salvage value of $1 000 on 31.12.91. The company adopts reducing balance method of depreciation at 40% p.a. Show the Disposal Account for the above transaction.
Disposal Account1991 / $ / 1991 / $
31/12 / Asset / 12 000 / 31/12 / Provision for Depreciation / 11 664
31/12 / P&L / 664 / Bank / 1 000
12 664 / 12 664
3)Sum-of-the-years-digits/Sum-of-digits Method
IF Cost = $1 600 Economic useful life = 3 years Residual value = $400
Year / Digit / Depreciation for the year1 / 3 / $(1 600 – 400) x 3/6 = $600
2 / 2 / $(1 600 – 400) x 2/6 = $400
3 / 1 / $(1 600 – 400) x 1/6 = $200
6 / 1 200
What will the depreciation charges be if the above asset is purchased on 1 October of year 1 while the financial year ends at 31 December?
Year / Digit /Depreciation for the year
1 / 4 / $600 x = $1502 / 3 / $600 x + $400 x = $550
3 / 2 / $400 x + $200 x = $350
4 / 1 / $200 x = $150
10 / $1 200
4)Revaluation Method
Loose tools which are used in the factory are either purchased from the suppliers or made in own factory. The information available is:
Value of loose tools at: / $1.1.1992 / 100
31.12.1992 / 50
Purchase of tools in cash / 150
Owing to suppliers at 31.12.1992 / 50
Expenses spent on producing tools:
Wages / 10
Materials / 20
Show the Loose Tools Account by using the revaluation method of depreciation.
Loose Tools Account1992 / $
1/1 / Bal b/d / 100 / Depreciation of loose tools / 280
Cash / 150
Wages / 10
Purchase of Materials / 20
Owing c/d / 50 / Bal c/d / 50
330 / 330
Owing b/d / 50
5)Units of Production Method
Machine hour method
A machine at cost of $1 000 can be used in production for 100 hours. After that, it will be scrapped at a value of $10. What will the depreciation charge be if the machine hours used in current year’s operation is 40 hours?
= $396
Depletion unit method
A quarry was bought for $5 000 and it was expected to contain 1 000 tons of saleable materials. This year the output was 200 tons and what would be the depreciation charge?
=$1 000
Exercise (Debtors, Provision for bad debts/discounts)
- George is a wholesale retailer, and the following information relates to the year ending 30 September 1982.
(a)Goods are sold on credit terms, but some cash sales are also transacted.
(b)At 1st October, 1981, George’s trade debtors amounted to ￡30,000 against which he had set aside a provision for doubtful debts of 5%.
(c)On 15thJanuary 1982, George was informed that Fall Limited had gone into liquidation, owing him ￡2,000. This debt was outstanding from the previous year.
(d)Cash sales during the year totaled￡46,800, whilst credit sales amounted to ￡187,800.
(e)￡182,500 was received from trade debtors.
(f)Cash discounts allowed to credit customers were ￡5,300.
(g)A part from Fall Limited’s bad debt, other certain bad debts amounted to ￡3,500.
(h)George intends to retain the provision for Doubtful Debts Account at 5% of outstanding trade debtors as at the end of the year, and the necessary entries are to be made.
Required:
Enter the above transactions in George’s ledger accounts, and apart from the cash and bank and profit and loss accounts, balance off the accounts and bring down the balances as at 1 October 1982.
Debtors1981 / 1982 / $
Oct 1 / Balance b/d / 30000 / Sept 30 / Cash / 182500
1982 / Sept 30 / Discount Allowed / 5300
Sept 30 / Sales / 187800 / Sept 30 / Bad Debts (2000+3500) / 5500
Sept 30 / Balance c/d / 24500
217800 / 217800
1982
Oct 1 / Balance b/d / 24500
Provision for bad debts
1982 / $ / 1981 / $
Sept 30 / Profit and Loss Account / 275 / Oct 1 / Balance b/d / 1500
Sept 30 / Balance c/d / 1225
1500 / 1500
1982
Oct 1 / Balance b/d / 1225
Bad Debts
1982 / $ / 1982 / $
Jan 15 / Fall Limited / 2000 / Sept 30 / Profit and Loss Account / 5500
Sept 30 / Debtors / 3500
5500 / 5500
Sales
1982 / $ / 1982 / $
Sept 30 / Trading a/c / 244600 / Sept 30 / Debtors / 187800
Sept 30 / Cash / 46800
244600 / 244600
Cash
1982 / D.A / Cash / Bank / 1982 / D.R. / Cash / Bank
Sept 30 / Debtors / 5300 / 182500
Sept 30 / Sales / 46800
Discounts Allowed
1982 / $ / 1982 / $
Sept 30 / Total for the year / 5300 / Sept 30 / Profit and Loss account / 5300
Profit and Loss Account
Bad debts / 5500 / Decrease in provision for bad debts / 275
Discounts allowed / 5300
- Theta Ltd is a business which acts as a distributor of washing machines entirely on credit terms to a wide range of customers. The following balances were extracted from its ledgers at 30th June 1980:
￡ / ￡
Sales / 723,869
Creditors-Balance at 30th June 1979 / 49,781
Debtors – Balance at 30th June 1979 / 84,611
Purchases of washing machines / 342,916
Discounts allowed / 8,214
Discounts received / 6,978
Cash received from debtors / 699,267
Cash paid to creditors / 321,853
Returns inwards / 36,925
Carriage outwards / 5,264
Overdraft interest / 12,748
Provision for Doubtful Debts as at 30th June 1979 / 4,813
Subsequent enquiries reveal the following information:
A cheque for ￡1,246 from A.Brown, a customer, has been returned by the bank marked “refer to drawer” Bad debts totaling￡6,854 are to be written off and the provision for doubtful debts is to be raised to 8% of the debtor balances at 30th June 1980.
On the last day of the year a cheque is received for ￡1,000 from the liquidator of J. Smith Ltd. This customer had owed Theta Ltd. ￡7,500 when it ceased to trade in March 1977, and the debt had been written off as a bad debts in the year ended 30th June 1977. No entry in respect of this cheque has yet been made in the books.
You are required to write up for the year ended 30th June 1980:
(a)The Debtors Ledger Control Account.
(b)The Bad and Doubtful Debts Account.
(c)Show the Balance Sheet entry for debtors as at that date.
Debtors Ledger Control Account1979 / $ / 1980 / $
July 1 / Balance b/d / 84611 / June 30 / Discounts allowed / 8214
1980 / June 30 / Cash / 699267
June 30 / Sales / 723869 / June 30 / Returns Inwards / 36925
June 30 / Bank – A. Brown / 1246 / June 30 / Cash – J Smith / 1000
June 30 / Bad Debts Recovered / 1000 / June 30 / Bad Debt / 6854
June 30 / Balance c/d / 58466
810726 / 810726
Bad and Doubtful Debts
1980 / $ / 1980 / $
June 30 / Debtors / 6854 / June 30 / Profit and Loss account / 6854
Balance Sheet as at 30.6.1980
Current Assets
Debtors / 58466
Less: Provision for bad debts / 4677
53789
- Certain balances in a company’s ledger at 30th June, 1980 were:
￡
Debtors / 20,000
Provision for bad debts / 1,000
Stock of coke / 630
Electricity accrued / 920
During the year to 30 June, 1981 the following transactions occurred:
￡Sales on credit / 200,000
Cash received from debtors / 193,000
Certain debtors became bankrupt, and their debts were written off against the provision / 3,000
Certain debts which had been written off as bad in previous years were recovered in cash and transferred to the provision / 1,000
Purchases of coke / 8,000
Payments for electricity for the year ended 30th April, 1981 / 6,000
At 30th June, 1981 the stock of coke was valued at ￡750, and the provision for bad debts was adjusted to be equal to 5% of the debtors. On 6th August, 1981 the company paid its electricity account of ￡1,010 for the quarter ended 31st July, 1981.