Account For The Provision Of Bad Debt example essay topic

Contents Page Page 3 ~ Section A - Trading, Profit and loss account for Mr. Stanley Page 4 ~ Section B - Balance Sheet for Mr. Stanley Page 5 ~ Section CPage 6 ~ Section Page 7 ~ Section Page 8 ~ Section Page 9 ~ Section Page 10 ~ Section Page 11 ~ Bibliography Trading, Profit & Loss account for Mr. Stanley relating to trading during January 1st 2002 to December 31st 2002 lb lb lb Sales 125000 Less Cost of Sales Opening Stock 10430 Add Purchases 67634 78064 Less returns outward 48 78016 Add Carriage Inward 2120 80136 Less Closing Stock 11250 68886 GROSS PROFIT 56114 Less Expenses Salaries 28400 Postage & Stationary 98 Rent & Rates (2900-860) 2040 Packaging 3217 Bad debt 126 Provision for Bad Debt 60 Insurance 1220 Electricity (953+263) 1216 Depreciation (3000 + 1680) 4680 41057 Carriage Outward 2850 43907 NET PROFIT 12207 This is a balance sheet for Mr. Stanley as at 31st December 2002. lb lb lb Fixed Assets Fixtures & Fittings (15,000 + 8,400) 23,400 Less Depreciation (3,000 + 1,680) 4,680 18,720 Current Assets Stock 11,250 Debtors 3,200 Less Prov. for bad debt 150 3,050 Bank 590 Add Prepayments 860 1,450 Cash 165 15,915 Less Current Liabilities Creditors 6,765 Accruals 263 Working Capital 7,028 8,887 27,607 Financed By Capital 25,000 Add Net Profit 12,027 Less Drawings 9,600 27,607 C. Give an explanation of the accounting treatment for invoices that have been unpaid and unrecorded at the date of the preparation of the final accounts. This is known as an accrual of expenses, an accrual occurs when expenses that have occurred during an accounting period are not included in the trial balance, they are unpaid and unrecorded. When this occurs the accounting treatment in the profit and loss account would be to add the outstanding amount to the expense in question showing the full amount of expense used up in that accounting period. In the balance sheet however an accrual is classed as a current liability. This is because the firm owes the outstanding amount and is expected to pay this debt in the short term. The outstanding amount will therefore appear under current liabilities in the Balance Sheet under the heading ACCRUALS.

The reasons for making these adjustments is to ensure that the profit and loss account records the cost that has been incurred for that particular accounting period instead of simply the amount that has been paid. An example of an accrual ~ during the accounting period of January 1st 2002 and December 31st 2002 a phone bill is incurred for the months June to September however it goes unpaid and is not incorporated into the telephone account. This means that adjustments have to be made so that it can be included in the final accounts for that accounting period. D. Mr. Stanley had paid a proportion of the rates for the following accounting period. Explain how this impacted on the preparation of the accounts for the current accounting period. A prepayment is when an amount is paid in advance of the accounting period in which it is actually due. It means that the company has made an overpayment, in this particular case Mr. Stanley has overpaid on his rates.

When this occurs within a companies account the amount in question is deducted from the expense account on the trial balance. The treatment for a prepayment in the profit and loss account would be to deduct the overpayment from the expense in question to show only the amount of that expense used up in the current accounting period. With the balance sheet aspect of the accounts the overpayment becomes a current asset as the money belongs to the firm. The overpayment will therefore appear within the current assets in the balance sheet under the heading PREPAYMENTS. An example of a prepayment ~ insurance is paid for in December 2002, which includes January payment of lb 200. This means that an overpayment of lb 200 has occurred and the profit and loss account and balance sheet need to be adjusted to show this.

This overpayment is then classed as a current asset within the balance sheet as it is the firms money. E. Mr. Stanley makes a 'provision for bad debt'. How does this differ from bad debt written off and how are the two accounted for? A provision for bad debt is where a company has set aside some money within their accounts to cover themselves against their debtors. It is so that they have covered themselves in case some of their debtors are unable to pay them back, there is no certainty with debtors that they will be able to repay their debts so by making a provision for this you are covering yourself against some losses. A provision for bad debt differs from bad debt written off because with a provision for bad debt although you are doubtful you will be repaid you are not certain that you won't whereas with bad debt written off you are certain that the money owed to you by your debtors is irrecoverable and you therefore have written it off. By writing off bad debt it is a way of reducing your debtors whereas making a provision for bad debt is a way of covering yourself against a loss, big or small.

The two are accounted for by having two accounts. The provision for bad debt has an adjustable account, which records the amount to create, increase or decrease the provision each year. The account for the provision of bad debt is there to record the accumulated total of the provision. When working with the balance sheet accounting adjustments are not necessary, the reason for this, the debtor accounts have been closed and removed from the total debtors figure before the trial balance. F. Making a 'provision for bad debt' follows one of the fundamental accounting concepts. Identify and give a full description of this concept. The fundamental accounting concept for the provision of bad debt is known as the prudence concept.

The prudence concept is also known as conservatism. The prudence concept is based around the job of an accountant, it is about them staying neutral and making sure that the facts they are supplying within a companies accounts are accurate and not misleading to people who may be intending on lending money to that company. The prudence concept requires that if there is any doubt over a figure such as profit then the accountant should try to be neutral and report it how it is so that the they can not be accused of hiding facts that could change a persons mind when they are thinking of investing their money. It also requires that profits are not anticipated, they should be recognised when it is reasonably certain that they are going to be achieved, also all liabilities have to be accounted for so that a false impression is not given off. In brief the prudence concept is about being as honest as possible when releasing financial information to do with a company. G. Give an explanation of the term 'depreciation' and include the main causes for it arising.

Depreciation is a measure of that portion of the cost (Less residual value) of a fixed asset that has been consumed during an accounting period. It is a measure of the wearing out, consumption of other reduction in the useful economic life of a fixed asset whether arising from use, efflux of town or obsolescence through technological or market changes. Depreciation is an expense to a business; the absolute accuracy of depreciation cannot be determined until the time of disposal of a fixed asset. This is when the difference between the cost to its owner and the amount received on disposal is then calculated. The main causes for depreciation arising are the wear and tear on a fixed asset through use, the length of time from when the item was originally bought, technological reasons such as a newer model has been launched and therefore the older model is then worth much less or an item could depreciate because of economic reasons. H. Mr. Stanley used the 'straight line' method of depreciation. Using a suitable example of your own, explain another method for depreciation that is widely practised.

A method that is widely practised other than the straight-line method is the reducing balance method. When using this method a fixed percentage for depreciation is deducted from the cost in the first year. In the following years the same percentage is taken off the reduced balance. Another name for this particular method is the 'diminishing balance' method. An example of the reducing balance method ~ A company at a cost of lb 20,000 purchases a new motor van and depreciation is charged at a rate of 10%.

If you were to calculate this for the first three years the outcome would be as follows: lb Cost 20,000 First year depreciation (10%) 2,000 18,000 Second year depreciation (10%xl b 18,000) 1,800 16,200 Third year depreciation (10%xl b 16,200) 1,620 14,580

Bibliography

1. A - Level Accounting ~ Geoff Black and Trevor Daff Published in 19942.
Accounting an Introduction ~ McLane y and A trill Published in 20023.
Business Accounting 1 ~ Woods & SangsterPublished in 20024.