ACCOUNTANCY

Provisions for Depreciation, Bad Debts and Discounts

(a) Depreciation

Under typical circumstances, depreciation is not addressed until the Trial Balance has been extracted. Thus, it is usually not considered before preparing the final accounts. In examination scenarios, a note is provided indicating the rate of depreciation to be applied. Although a detailed discussion on depreciation adjustments is covered in Chapter 07, it is important to give students a basic understanding of its concept here. Depreciation refers to the inherent decline in the value of an asset due to various factors. A common and straightforward example is the wear and tear of a machine, but there are many other causes.

ACCOUNTANCY Provisions for Depreciation, Bad Debts and Discounts

As with all other accounting entries, depreciation requires a complete double-entry. The necessary entry involves debiting the Trading and Profit and Loss Account and crediting the asset account for the asset being depreciated. This approach aligns with the fundamental accounting principles: the debit to the Trading and Profit and Loss Account is essential because the depreciation expense needs to be recorded, and the credit to the asset account is required to reflect the reduction in the asset's value.

As there are usually several assets which must be treated in a similar manner it is not unusual to make the transfer for depreciation to a Depreciation Account and transfer the whole of that account representing the depreciation of several assets to the Trading and Profit and Loss Account. The following would be the Journal entries for Depreciation, assuming that an amount of £100 is to be written off Plant. JOURNAL 19. Dec. 31 Trading and Profit and Loss Account 100 38 £ Plant. 100 Being Depreciation for the year ended this date. If the Depreciation Account is employed in preference to the direct transfer as above, the entries would be: 19. Dec. 31 Depreciation Plant JOURNAL D Being Depreciation for the year ended this date. Trading and Profit and Loss Account' Depreciation Being Depreciation transferred 'See p. 0519 tend of first paragraphi 100 71 £ 100 100 100

TRADING, PROFIT LOSS ACCOUNT BALANCE SHEET

Depreciation dealt with before extracting the Trial Balance will appear among the accounts therein. The asset will already have been credited with the amount of depreciation and the necessary debit to depreciation made, so that only the formal transfer to Trading and Profit and Loss Account is required. Reverting to the above example the only entry required will be that marked (').

These points may be further illustrated by an example:

Illustration 9

Fixtures Account at 1st January 19.., appears in the books at £500 and 5 per cent Depreciation is to be written off. If no depreciation has been written off for the year prior to the extraction of the Trial Balance, the amount standing in the books against Fixtures of £500 will appear in the Trial Balance at 31st December 19... In order to write off depreciation an entry to the debit of Trading and Profit and Loss Account and to the credit of Fixtures Account will be required; or, the depreciation may be first debited to Depreciation Account and credited to Fixtures, and then. Shifted to the Trading and Profit & Loss Account.

On the other hand, if depreciation has been dealt with prior to the extraction of the Trial Balance, the Trial Balance will not show Fixtures Account as £500 (for £25 has already been credited to it by way of depreciation), but as £475, and Depreciation Account will be part of the Trial Balance at the figure of £25. Hence, instead of Fixtures £500 there will be Fixtures £475 and Depreciation Account £25. Upon preparing the Trading and Profit and Loss Account the amount of £25 debited in the Depreciation Account will be transferred to the former account by the following entry: debit Trading and Profit and Loss Account, credit Depre- ciation Account.

If the asset is to stay in the books at cost, the entries are:

Debit Depreciation Account (or Profit and Loss Account). Credit Depreciation Provision or Fund Account.'

Where cash is invested outside the business to ensure that when replacement is required, the necessary CASH will be available, the follow- ing additional entries will be made:

Debit Depreciation 'Investment Fund.

Credit Bank.

Depreciation is usually computed at a certain rate per annum, e.g. 10 per cent per annum. The student must exercise great care in the calcula- tion, when the period covered by the accounts is not a year, for when the accounts are prepared half-yearly the depreciation would be 5 per cent actual. Examiners often omit the term 'per annum,' so that if the actual rate is given, the amount to be calculated for depreciation will require

This may also be referred to as 'Depreciation Reserve.' The difference between the terms Prosion and Reserve is dealt with in Chapter 07. The distinction is important in Limited Company accounts, but the student may find it useful to accustom himself to the terms by using them also in the accounts of sole traders and partnerships.

ACCOUNTANCY

Adjusting accordingly. For example, if accounts are prepared half-yearly, depreciation at 15 per cent per annum will mean 7 per cent for the half year; but if the words 'per annum' are omitted, depreciation in that half-year will be 15 per cent instead of 72 per cent, that is at the rate of 30

per cent per annum.

Where assets have been acquired during the period covered by the accounts, depreciation should be charged upon the new assets from the date of acquisition to the end of the accounting period. In the examina tion, if no indication is given as to the date of acquisition, depreciation should be calculated on the closing balance, and an explanatory note made at the foot of the answer. The newly acquired asset may be an ADDITION to the existing assets, or may be merely a REPLACEMENT. In the latter case the book value of the old asset must be completely eliminated by crediting it with:

(i) Loss on Sale (if a profit the entry will be a debit).

(ii) Depreciation to the date the asset ceases to be used.

(iii) Proceeds of Sale,

If any costs should be incurred, for example on dismantling plant, these also will appear as debit to the old Asset Account. Thus:

PLANT

Balance.

b/d

Cost of Dismantling

150 22

Sale,

£172

Depreciation (to date of ceasing to be used) Profit and Loss Account (Loss on Sale)

If the sale realized, say £210 the account would be:

142

£172

PLANT

Balance

b/d

150

Cost of Dismantling

Profit and Loss Account

Sale Depreciation

210 20

(Profit on Sale)

£230

Illustration 10

Period of accounts 1st June 19.. to 31st December 19.. (i.e. seven

months).

Plant and Machinery Balance, 1st June 19... Plant and Machinery purchased 1st October 19...

Depreciation to be calculated at 6 per cent per annum.

8,000

2,000

TRADING, PROFIT, LOSS ACCOUNT-BALANCE SHEET

The amount of depreciation is:

6% on £8,000 for 7 months

6% on £2,000 for 3 months

[6% per annum = £0-05 (or 5p) per £10 per month.]

Plant and Machinery Account will appear as follows:

PLANT AND MACHINERY

280

£310

19.. June 1 Oct.

Balance Cash (or Creditor)

19.

b/d

8,000 Dec. 31 Depreciation 2,000 Balance.

310

c/d

9,690

£10,000

19.

Jan. 1 Balance."

b/d

9,690

Depreciation is dealt with in more detail in Chapter 07.

(b) Bad and Doubtful Debts. The provision for bad and doubtful debts is usually made by taking a suitable percentage on Sundry Debtors' and when computed the amount will be entered twice in the Bad and Doubtful Debts Account:

(i) On the debit side above the 'line,' and

(ii) On the credit side below the 'line.'

The latter figure will be shown either as a liability, or as a deduction from Debtors on the assets side of the Balance Sheet. The latter method is more frequently used in modern accounting.

Where separate accounts for Bad Debts and Provision for Bad and Doubtful Debts are kept, and it is required to carry forward to the next period a revised provision based upon a percentage of Sundry Debtors, the following steps must be taken:

1. The balance of Bad Debts Account, that is bad debts actually WRITTEN OFF, less bad debts that have been recouped, is transferred to the debit of Provision for Bad and Doubtful Debts, or to the credit of that account if recoveries exceed amounts written off.

2. The new Bad and Doubtful Debts Provision will be debited above the 'line' and credited below it in the Provision Account.

3. The balance will be dealt with thus:

(a) if DEBIT, the transfer will be-Debit Profit and Loss Account and Credit Provision for Bad and Doubtful Debts.

(b) if CREDIT, the transfer will be-Debit Provision for Bad and Doubtful Debts and Credit Profit and Loss Account.

Alternatively the Bad and Doubtful Debts Provision may be based on an estimate of the worth of each debt at the balance sheet date or be taken as a percentage on credit sales. (Usually the former is preferred, as it is more accurate, and being specific, will be allowed for

taxation purposes.)

ACCOUNTANCY

Illustration 11

Bad and Doubtful Debts Provision at 1st January 19..

Bad debts written off during the year to 31st December 19.

Cr. £ROO

Dr. £900

The Provision is to be maintained at 5 per cent of Sundry Debtors, which at 31st December 19... is £20,000.

The Bad and Doubtful Debts Provision will be:

PROVISION FOR BAD AND DOUBTFUL DEBTS

900 Jan. 1 Balance

1,000 Dec. 31 Profit and Loss Account

Dec. 31 Bad Debts written off

Balance.

c/d

£1,900

19.. Jan. 1

Balance.

h/d

1.106

£1.94)

hid

1,000

BAD DEBTS

19.

Dec. 31 Debtors (detailed)

19.

900 Dec. 31 Transfer to Provision for Bad and Doubtful Debts

It will be apparent that the 'clearance' may be effected by transferring from Bad Debts Provision to Bad Debts Account and to this alternative no objection can legitimately be raised. Eliminating dates the accounts would appear:

Balance.

c/d

£ 1,000

Balance

800

Transfer to Bad Debts Account

200

£1,000

Balance.

1.000

BAD DEBIS

Debtors (detailed) Transfer from Bad and Doubtful Debts Pro- Viskon

200

Profit and Loss count

Alternative Treatment of Bad Debts. A consolidated account is frequently utilized in which the provision for bad debts is raised and adjusted.

TRADING PROFIT LOSS ACCOUNT BALANCE SHEFT

Account, thus dispensing with the separate account, as below

BAD DERIS

Proft and Law Accent

(c) Discounts. Where a Provision for Discounts is to be created on Sundry Debtors, the object is to charge against the current period the estimated cash discounts that will be ordinarily allowed to debtors on sales during the period, and which will involve a reduction in the Balance Sheet of the book value of debtors. Naturally, such a discount will be allowed only upon payment being made within the period stipulated expressly or impliedly in the contract, so that it is usually not necessary to provide for discounts on all the debtors, and further it is clear that if a debtor's account is written off as bad no provision for discount is required. It is therefore important that the discount provision be calculated on the proportion of debtors likely to be 'good', that is, not merely those who will pay 'sooner or later' but the prompt payers. As a matter of caution, it is the practice generally to assume that the proportion of debtors who are likely to pay will pay promptly and take advantage of the discount terms. Therefore, before making the Discount Provision the estimate of bad and doubtful debts must FIRST be made and provided for, and the Discount Provision created on the balance of debtors; in other words, on the estimated 'good' debtors, being the debtors according to the ledger less the Provision for Bad and Doubtful Debts."

It is usual to confine the creation and adjustment of the Discount Provision to the last method shown in relation to bad debts, i.e. the consolidated account.

Illustration 12

Debtors (none likely to be bad) at 31st December 19 Discount Provision to be 5%.

Discounts allowed during the year to 31st December 19. Discount Provision at 1st January 19...

1,200

270

6,000

DISCOUNTS ALLOWED

Dec 31 Sundres from Cash Book

1200 Jan 1 Provin

MN Dec 11 Proht and Los An

Provan

14 Jan

The same principle must be followed in respect of Goods out on Sale or Return we p

015241

ACCOUNTANCY

If, however, it is estimated that 20 per cent of the £6,000 are likely to be bad, the Bad and Doubtful Debts Provision would be adjusted to £1,200, leaving £4,800 as the BASIS of the Discount Provision; so that the Provision of £300 as computed above would be 5 per cent of £4,800 £240, the account being as follows:

19..

Dec. 31 Sundries from Cash Book Provision

DISCOUNTS ALLOWED

19..

1,200 Jan. 1

Provision

c/d

240 Dec. 31 Profit and Loss Account

£1,440

19.

Jan. 1 Provision

b/d

270

1.170

£1,440

b/d

240

The Balance Sheet at 31st December 19.., would, as far as Debtors are concerned, appear:

Sundry Debtors

6,000

Less Provision for Bad and Doubtful Debts' (20%)

1,200

4,800

240

4,560

Less Provision for Discounts' (5% of £4,800)

Illustration 13

The following figures appear in the books of Y:

19..

Jan. 1. Bad and Doubtful Debts Provision

Discounts Allowed Provision

Dec. 31. Discounts Allowed during year

Bad Debts written off

Bad Debts recovered Debtors (per Ledger)

Write off a further £240 (definitely bad).

Create a Discounts Allowed Provision of 3 per cent.

1,200

560

930

470

10,060

Create a provision for bad and doubtful debts amounting to 10%. Show Accounts: calculate to nearest £.

The accounts are:

PROVISION FOR BAD AND DOUBTFUL DEBTS

19 Dec. 31

Balance.

Bad Debts

19.

c/d

982 Jan. 1 Balance. 218

£1,200

19.

Jan. 1 Balance.

1.200

£1.200

These items are CREDITs in the books, and instead of being shown as liabilities are DEDUCTED

from the asset.

TRADING, PROFIT, LOSS ACCOUNT-BALANCE SHEET

Dec. 31 (details)

BAD DEBTS

470 Dec. 31 (details) Bad Debts Re-

Sundry Debtors written off Profit and Loss Account

240 25

£735

covered

Bad Debt Provision Profit and Loss Account

492

£ 735

The debit is to cash; or alternatively the treatment is:

Debit cash: Credit Personal Account.

Debit Personal Account; Credit Bad Debts Account.

DISCOUNTS ALLOWED

19.

Dec. 31 Sundries

19..

930 Jan. 1 Provision

bid

560

Provision

c/d

265 Dec. 31 Profit and Loss Account

635

£1,195

19.

Jan. 1 Provision

b/d

265

SUNDRY DEBTORS

19.

19..

Dec. 31 Detailed Ledger Accounts

10.060 Dec. 31 Bad Debts

Balances

£10060

19..

Jan. 1 Balances

b/d

9,820

£ 240

ૐ

c/d

9,820

£10,060

Notes. 1. The Bad and Doubtful Debts Provision would be created on the value of the debtors as shown in the books at 31st December 19.., ie 10% of £9,820. 2. The Discount Provision is 3% on:

Book Value of the Debtors

£ 9,820

Less Bad and Doubtful Debts Provision

982

£8,838

3% on £8,838 (taken to nearest £):

£265

These Provisions will then appear in the Balance Sheet in the following

manner:

ASSETS SIDE

£ £

Sundry Debtors

9,820

Less Provision for Bad and Doubtful Debis (10%)

982

8,838

Less Provision for Discounts (3% of £8,838)

265

8,573

ACCOUNTANCY

The tender of nones usually requires and fr the use by the borrower of the sum ioaned, the amount of which se with circumstances. Such a reward is termed Interest and it a sundur normal circumstances to stipulate for the payment of an intera stated periods, yearly or half-yearly. Hence, if accounts are drawn up a date other than that of the due date of the payment of the loan interes (assuming that the borrower pays promptly), an adjustment a required cover the loan interest accruing since the last due date.

The same principle applies in connexion with other expenses, viz shar charge may be required in respect of an amount ACCRUED (unless the should happen to be paid on the due date) and an amount wit respect of the period elapsing from the due date of the loan interest and the date to which the accounts are made up.

Illustration 14

Trial Balance at 31st January 19... shows (inter alia):

Loan Account (Cr) at 6% per annum Loan Interest (Dr.)

L 100.000

3.000

It is quite evident that, assuming the loan was made at least a year ago. there is accrued a half-year's interest and consequently the required adjustment is:

Debit Loan Interest Account above the "line" Credit Loan Interest Account below the "line"

3.0XK

3.000

The latter being a credit balance in the books will be shown in the Balance Sheet at 31st January 19.., as a liability, either as a separate item or with the loan, thus:

Loan Account

Add Interest to date.

£ 100,000

3,000

103,000

The Loan Interest of £6.000 for the year will be transferred in the usual way to the debit of Profit and Loss Account.

Illustration 15

A borrowed £5,000 on 30th April 19.1, agreeing to pay interest at the rate of 4 per cent per annum, on the 31st October and the 30th April in each year. He prepares his accounts yearly on 31st December. Show L Interest Account in A's books for the years ended 31st December 191 and 19.2. It may be assumed that the payments are made promptly on the

due dates.

TRADING PROFIT LOSS ACCOUNT

BALANCE SHEET

IN 31

Cash Hall wats Interest

to date

Interest accruing. 2 months

LOAN INTEREST

191

De 1 Proht and Los Acount

133 33

4133 31

192

Apt

to date

Cash Half-year's Interest

(K 31/Cash do

Dec 31 Interest aruing. 2

192 Jan. 1 100-00 Dec. 31 100-00

Interest accruing

Proft and Loss Account

31 31 20000

months

33-33

4233-33

193 Jan 1

Interest accruing

4233-33

33-33

In practice. Income-tax is deducted from each payment of Interest. This does not affect the principle above outlined and treatment of Income-tax in this connection is dealt with in Chapter

21.

If in 19.3 the borrower pays only the half-year's interest to 30th April. 19.3. the half-yearly amount due on 31st October, 19.3, being paid on 10th January 19.4, the account for 19.3 and 19.4 (assuming the 19.4 payments are met promptly) would be:

19.3

Apl. 30 Cash: Half-year's Interest

to date

Dec. 31 Half-year's Interest to 31st

LOAN INTEREST

քր 19.3 Jan. 1 100-00 Dec. 31

Interest accruing Profit and Loss Account

b/d

33-33

200-00

October, 19.3.

ACCRUED

c/d

100-00

Interest accruing, 2

months

c/d

33-33

£233-33

19.4

Jan. 10

Cash: Half-year's Interest'

Jan. 1

Half-year's Interest to 31st

to 31st Oct., 19.3

100-00

Apl. 30

Cash: do. to date

100-00

Oct., 19.3, ACCRUED Interest accruing

b/d

100-00

b/d

33-33

Oct. 31

Dec. 31

Cash: do. to date

100-00 Dec. 31 Profit and Loss Account

200-00

Interest accruing. 2

months

c/d

33-33 £333-33

19.5

Jan. 1 Interest accruing

£333-33

իմ

33-33

Where repayments of the loan itself have taken place it will be neces sary to ascertain the date of repayment as the adjustment for loan interest accrued or accruing will be modified accordingly.

Illustration 16

Reverting to the preceding example, on 1st August 19.5, the borrower repays £1,000 and the interest payments are made promptly at due dates.

ACCOUNTANCY

The calculation of the accrual at 31st December 19.5, will be thus:

Two months' interest accruing on £4,000 at 4% per annum, viz.

£26-67

Moreover, the Loan Interest paid 31st October 19.5, will be:

Three months' Interest on £5,000 at 4% per annum, that is, for the period between 1st May, 19.5, and 31st July, 19.5

Three months' Interest on £4,000 at 4% per annum, that is, for the period between 1st August, 19.5, and 31st October, 19.5

Payment of Loan Interest on 31st October, 19.5

The account would be continued in 19.5, as follows:

LOAN INTEREST

£90

19.5

£p

19.5

Apl. 30

Cash: Half-year's Interest

Jan. 1

Interest accruing

b/d

33-33

to date

100-00 Dec. 31

Profit and Loss Account'

183-34

Oct. 31

Cash: do

90-00

Dec. 31 Interest accruing. 2

months

c/d

26-67

£216-67

19.6

£216-67

b/d 26-67

Jan. 1 Interest accruing

1i.e. Interest for 7 months on £5,000 (£116-67) plus Interest for 5 months on £4,000 (£66-67) at 4 per cent per annum.

The repayment of the principal would be debited to the Loan Account. In the books of the lender the entries will be exactly opposite to the above.

If an Expenses Day Book or Journal is used the interest accrued will have passed through the books; hence an adjustment is required only for items accruing.

6. Transfers

As the correction of errors requires detailed treatment (see Chapter 14) all that need be stated here is that the transfer required will conform to ordinary double-entry principles, a simple illustration sufficing for the

present.

Illustration 17

An amount of £10 is paid for decorations to the private house of a trader. such amount being paid by cheque on the business banking account and debited to General Expenses. The correcting entries are:

Debit Drawings (or Capital) Account

Credit General Expenses

10.

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