BAD DEBTS AND PROVISION FOR DOUBTFUL DEBTS

Bad debts

The amount of the debtors which cannot be recovered is known as bad debt. At the end the accounting year, the amount of bad debt is shown as an expense in the profit & loss account and deducted from the debtors. The double entry for recording the bad debt is:

                                Debit Bad debt account

                                Credit Debtors account

At the end of the year, while preparing the final accounts, the bad debt account is transferred to the profit & loss account by passing the following adjustment entry:

                                Debit Profit & loss account

                                Credit Bad debt account

Provision for bad debts (Provision for doubtful debts)

The provision created to cover the next year’s bad debt expense out of the current year’s debtors is known as provision for bad debts. This provision is created on the debtors after deducting the current year’s bad debt. The double entries required for creating the provision for bad debt are:

                First year               Debit      Profit & loss account and

                                                Credit     Provision for bad debts account.

               

Second year and subsequent years:

               

                For an increase in the provision for bad debt:

                                                Debit      Profit & loss account and  (with the amount increased)

                                                Credit     Provision for bad debts account.

                For a decrease in the provision for bad debt:

                                                Debit      Provision for bad debt account and

                                                Credit     Profit & loss account

The amount of decrease in the provision for bad debt is shown as an income in the profit and loss account

While preparing the balance sheet, always the new provision for bad debt is deducted from the amount of debtors.

Provision for discount on debtors

This is the provision created to cover the expense of discount that may be allowed to the debtors during the coming year when they pay their debt on time. The increase in the provision for discount on debtors is also shown as an expense in the profit & loss account and the new provision for discount on debtors is deducted from the debtors in the balance sheet.

The amount of provision for decrease in the provision for discount on debtors is shown as an income in the profit & loss account.

The double entries required for the provision for bad debt are:

                During the first year to create the provision for discount on debtors:

                                Profit & loss account                                                          Dr

                                Provision for discount on debtors account                     Cr

During the subsequent years, for an increase in the provision for discount on debtors:

                                Profit & loss account                                                          Dr.

                                Provisions for discount on debtors account                   Cr. 

                For a decrease in the provision for discount on debtors:

                                Provisions for discount on debtors account                   Dr.

                                Profit & loss account                                                          Cr.

Key points

• A debt written off is recorded in the books by debiting bad debts account and crediting debtors account.
• The provision for bad debt is calculated on the debtors’ balance obtained after deducting the bad debt written off.
• In the balance sheet, always the new provision for bad debt is deducted from the Debtors.
• Increase in the provision for bad debt is debited in the profit & loss account and credited in the provision for bad debt account.
• Decrease in the provision for bad debt is credited to profit & loss account and debited in the provision for bad debt account.
• Increase in the provision for bad debt is an expense and decrease in the provision for bad debt is an income to be shown to in the profit & loss account.
• The provision for discount on debtors is calculated on the debtors balance after deducting the bad debt and the provision for bad debt amount.
• Always new provision for discount on debtors is deducted from debtors, after deducting the provision for bad debt.
• Increase in the provision for discount on debtors is debited to profit & loss account and credited to provision for discount on debtors account.
• Decrease in the provision for bad debt is debited to provision for discount on debtors account and credited to profit & loss account.
• Increase in the provision for discount on debtors is an expense and decrease in the provision for discount on debtors is an income to be shown in the profit & loss account.

ACCOUNTING FOR NON TRADING CONCERNS

 

The business concerns are of two types: Trading concerns and non trading concerns.

Trading concerns are existing for the purpose of earning profit. But non trading concerns are existing for the purpose of rendering service to the public. E.g. of such concerns are clubs, societies, libraries etc. At the end of an accounting year the trading concerns prepare final accounts such as trading and profit and loss account and balance sheet. But non trading concerns prepare the following at the end of its accounting year:

1. Receipts and Payments accounts - it is summary of cash transactions of a non trading concern. It shows all receipts and payments during a year and the final balance of cash in hand or at bank or balance of bank overdraft. It is the cashbook prepared by a non trading concern.

2. The income and expenditure account- this is similar to the profit and loss account prepared by a trading concern. It lists all the incomes and expenses of the non trading organization for a year. The result of this account is referred to as surplus or excess of income over expenditure or deficit or excess of expenditure over income. When the income is more than the expenditure the result is known as surplus. When the expenditure is more than the income, the result is known as deficit. It is prepared by considering all expenditures and incomes relating to the current year whether it is paid or not.

3. Balance sheet- the balance sheet is prepared as in the case of a trading concern. But the excess of assets over liabilities of a non trading concern is known as accumulated fund. The surplus from income and expenditure account is added to and the deficit is deducted from accumulated fund.

Difference between receipts and payments account and incomes and expenditure account.

	Receipts and payments account		Income and expenditure account
1	It is the cash book prepared by a non trading concern	1	It is the profit and loss account prepared by non trading concern
	It records all receipts and payments of cash and cheque only	2	It records only incomes and expenditures during the current year
3	It records receipts and payments  without considering whether for current year or previous year or for next year	3	It records incomes and expenditures relating to the current year only
4	The balance in this account is either cash in hand or cash at bank or balance of bank overdraft	4	The balance in this account represents surplus or deficit

          Trading account

Some non trading organizations do carry out regular trading activity, but this is not the main purpose of the organization. Many clubs and societies have a café, a shop, a bar and so on, where goods are bought and sold. A trading account should be prepared for each trading activity in order to calculate the gross profit or loss earned. The gross profit or loss of a trading activity of a non trading concern is transferred to the income and expenditure account. If it is gross profit, it is shown as income and if it is gross loss, shown as expenditure in the income and expenditure account.

 

Key points

• Accumulated fund on the opening date = total assets on the opening date – total liabilities on the opening date. It can be calculated by preparing an opening statement of affairs (balance sheet format) on the opening date, as a balancing figure.
• While preparing  the trading account of bar or any other trading activity, if the purchase figure is not given, it can be calculated as:-

Purchases = closing creditors + payments to creditors – opening creditors.

• The profit or loss as a result of sale of a fixed asset should be shown as income(if profit ) or  expenditure( if loss) in the income and expenditure account.
• Usually the depreciation on fixed assets will be calculated by comparing the opening and closing values.
• The surplus is added with accumulated fund and deficit is deducted from accumulated fund.
• The stock items from trading activity are shown as current assets in the balance sheet.
• The subscription is one of the most important incomes for a non trading concern. It may be given as a single amount or separately for three years(for last year, this year and  next year)

If it is given as a single amount, to find out the amount of subscription to be shown in the income and expenditure account, use the following formula:

	Subscription received during the year + this year’s arrear + last year’s advance – last year’s arrear received – this year’s advance received for the next year

 

Subscription =

If it is given separately for this year, last year and next year then use the following formula

	Subscription received for the current year + this year’s arrear + last year’s advance.

 

Subscription =

• Expense paid during the year + opening prepaid expense – closing prepaid expense

  The expense to be shown in the income and expenditure account when there is pre payment on the opening as well as on the closing date can be calculated as follows:-

Expenses =

• The calculation of expense when there is outstanding on the opening as well as on the closing date.

	Expenses paid during the year + outstanding on the closing date – outstanding on the opening date

 

Expenses =

TRADING AND PROFIT AND LOSS ACCOUNT

Final Accounts of sole Traders: show the calculation of profit earned or the loss incurred during the period and the financial position of the business at the end of the period.  Final accounts usually prepared from a trial balance.

1.  Trading Account:  deals with trading (buying and selling). The account shows the calculation of profit earned on goods sold.

Gross Profit  =  Sales – Cost of Goods Sold Cost of goods sold  =  opening stock + purchases + carriage inwards - closing stock

Drawings of goods for personal use is deducted from purchases Carriage inwards is added to the purchases

2.  Profit and Loss Account:  shows the calculation of final or true profit.  This is the profit after all running expenses and any other items of income.

Net Profit  =  Gross profit + other incomes - Expenses

                                                   Specimen of Profit and Loss Account

		Amount
Sales – Sales Returns Less: Cost of goods sold:                Opening stock of goods        Add: Purchases        Add: Carriage inwards/Carriage on purchases        Less: Closing stock                            Gross Profit        Add:  Rent received        Add:  Discount received        Add:  Commission received       Add :  Decrease in provision for bad debts       Less:  Expenses:                  Rent paid + Accrued/unpaid                  Salary paid + Accrued/ unpaid                  Bad debt                  General expenses                  Office expenses                  Insurance – prepaid/ paid in advance                  Increase in provision for bad debts                  Depreciation of fixed assets                  Bank charges                  Loan interest paid                  Repairs to building                  Delivery van expenses Net profit for the year transferred to capital a/c in the balance sheet	X X X X X X X X X X X X X X X x	X (-) Xx                    Xx Xx     Xx Xx xxx (-) xxx xxx

3.  Balance Sheet:  is a statement of the financial position of the business on a certain date.  It shows what the business          owns, and amounts owing to the business- the assets and what the business owes, the liabilities and the capital.

                                                       Specimen of Balance Sheet

		Amount
FIXED ASSETS:  Freehold Premises / Land and Buildings  Equipment less depreciation  Furniture – (depreciation of current year+ previous years)  Motor van / Motor vehicle – depreciation  Goodwill CURRENT ASSETS:   Cash in hand/ cash at bank   Debtors less provision for bad debts   Closing stock   Prepaid rent/insurance etc. LESS: CURRENT LIABILITIES   Creditors for goods                                                                                    xx   Creditors for expenses such as accrued rent, delivery van expenses           x   Bank overdraft                                                                                             x                  WORKING CAPITAL FINANCED BY:     Capital Add:  Net profit from P&L account Less: (Drawings of cash + goods) LONG TERM LIABILITIES         Bank Loan	X X X X xx Xx X X X	X X X X X   (+) Xx Xxx Xx (+) x xxx

                Adjustment of items in Final accounts

Items	Trading, Profit and Loss a/c	Balance Sheet
1.  unpaid expenses 2.  Prepaid expenses 3.  Drawings of goods 4.  Bank charges 5.  Provision for bad debts 6.  Provision for depreciation on fixed assets 7.  Accrued income 8.  Purchases, purchase returns, sales,      sales  returns 9.  Discount/commission/rent received 10. Discount allowed, commission paid, rent,       bad debt, wages, salaries, bank charges,       general expenses, office expenses,       repairs to building 11. Machinery, equipment, furniture,       premises, land and buildings 12. Cash in hand, debtors, cash at bank 13. Creditors, bank overdraft      Club Accounts 1.  subscription received in advance at start 2.  subscription received in advance at end 3.  subscription in arrear in the beginning 4.  subscription in arrear at the end	+ to the expenses - from the expenses - from purchases in trading a/c Expenses in profit and loss a/c Expenses Expenses Add to the g/p Trading a/c Added to gross profit Expenses in p&l a/c ……….. ………. ……….. Added to subscriptions in I&E a/c Deducted from subscription Deducted from subscriptions Added to subscriptions	Current liability Current assets Added to drawings Deducted from cash at bank Deducted from debtors Deducted from fixed assets Current asset …………….. ……………… …………….. Fixed asset Current asset Current liability Current liability in the opening b/s Current liability in the closing b/s Current asset in the opening b/s Current asset in the closing b/s

List of some common Expenses, Income, Assets and Liabilities

EXPENSES. Carriage inwards,  carriage outwards Purchases, wages and salaries, Rent and insurance, electricity charges, advertising charges, bank charges, Discount allowed, bad debts, Depreciation of fixed assets, Provision for bad debts, office expenses, Provision for discount on debtors General expenses, motor expenses, Motor vehicle expenses Repairs to building or machinery Interest on loan	FIXED ASSETS Plant and Machinery Land and Buildings Premises Equipment Furniture and Fittings Fixtures and Fittings Lawn Mover Computers Motor van/Motor vehicle Motor car	CURRENT LIABILITY Creditors for goods Creditors for expenses:    Eg. Rent owing,           Salary accrued           Wages unpaid           General expenses unpaid           Commission outstanding Bank overdraft [ all unpaid amounts]
INCOMES: Sales, discount received, Commission received Interest received,  rent received, profit on sale of old fixed assets	CURRENT ASSETS Cash in hand Cash at bank Debtors Closing stock Prepaid rent, insurance, rates	LONG TERM LIABILITIES Loan from bank Mortgage loans Debenture

The trading and profit & loss account and balance sheet prepared at the end of a year is known as Final accounts. While preparing the final accounts, there may be some items so far not adjusted. These items are to be adjusted in the final accounts for calculating the correct profit or loss of the business. The usual adjustments in the final accounts are:

a. Expenses owing:  These are the expenses incurred during the year but not paid in cash. This amount will be paid in the near future (next year). The owing expense is to be added with the amount of same expense already paid given in the trial balance and it should be shown in the balance sheet as a current liability.

The double entry for recording the expenses owing is

                                Debit       Expenses account

                                Credit     Expenses owing account

This expense is also known as outstanding expenses, expenses payable or expense payable.

b. Prepaid expense. : This is the expense paid during the year for the benefit of the next year. The portion of the expense which is prepaid is to be deducted from the total expenses already paid during the year (given in the trial balance) and shown as current asset in the balance sheet.

The double entry for recording the prepaid expense is

                                Debit       Prepaid expense account and

                                Credit     Expense account                               

This expense is also known as expense paid in advance or unexpired expense

c. Accrued income: The income earned during the year but not received in cash is known as accrued income. The amount of accrued income is to be considered as current year’s income and added with the concerned income received during the year (given in the trial balance) and shown as a current asset in the balance sheet.

The double entry for recording the accrued income is:

                                Debit      Accrued income account and

                                Credit     Income account

The accrued income is also known as outstanding income.

d. Income received in advance: This is the income received during the year for the services to be rendered during the next year.  Since this income is not related to the current year, it should be deducted from the concerned income (given in the trial balance) and shown as a current liability in the balance sheet.

The double entry for recording the income received in advance is:

                                Debit      Income account and

                                Credit     Income received in advance

This is also known as unexpired income.

 e. Depreciation: The part of the cost of a fixed asset that is consumed by a business during the period of its use is known as depreciation. It is considered as an expense in the business therefore shown as an expense in the profit & loss account and deducted from the cost price of the concerned fixed asset in the balance sheet.

The double entry for recording depreciation is:

                                Debit      Profit & loss account and

                                Credit     Depreciation account                   

f. Bad debt: The part of the amount of debtors which cannot be recovered is known as bad debt. It is an expense to be shown in the profit & loss account. If the bad debt appears in the trial balance, it is known as bad debt written off and shown in the profit & loss account only. If bad debt information appears among the adjustment points below the trial balance, then it should be shown as an expense in the profit & loss account and shown as a deduction from the debtors in the balance sheet under the heading “current assets”.

The double entry for recording the bad debt is:

                                Debit      Bad debt account and

                                Credit     Debtors account

g. Goods drawings by the owner for his personal use:-

The amount of goods withdrawn by the owner for his personal use is to be considered as drawing.

The double entry for recording the goods drawings is:

                                Debit      Drawings account and

                                Credit     Purchase account or sales account

The amount of goods drawings should be deducted form purchases and capital in the balance sheet.

MANUFACTURING ACCOUNTS

The businesses which produce and sell the items prepare the following accounts at the end of its accounting year:-

                a. The Manufacturing account (to calculate the total cost of production)

                b. The Trading and profit & loss account (to find out the net profit or loss)

                c. The balance sheet.(to show the financial position of the business)

The total cost of production = Prime cost + Factory overhead

The Prime cost = Direct material + Direct labour + Direct expenses

Direct material cost = Opening stock of raw materials + purchase of raw materials +  carriage inwards – returns outwards – closing stock of raw materials.

Factory overhead expenses = All expenses related to the factory (indirect expenses)

The format of a manufacturing account

                Manufacturing account for the year ended . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Opening stock of raw materials	xxxx
Add purchase of raw materials	xxxxx
Add carriage inwards ( if any )	Xxxx
	Xxxxx
Less Returns outwards (of raw materials)	xxxx
	Xxxxx
Less Goods drawings ( if any )	xxxx
	xxxxx
Less Closing stock of raw materials	xxxx
Cost of Direct Materials		xxxxxxx
Add Direct labour		xxxxxxx
Add Direct expenses (Eg: royalties)		xxxxxxx
Prime Cost		xxxxxxx
Add Factory overhead expenses
Factory lighting	xxxxxx
Factory heating	xxxxxx
Factory insurance	xxxxxx
Factory rent	xxxxxx
Factory maintenance	xxxxxx
Factory indirect wages	xxxxxx
Factory supervisor’s wages	xxxxxx	( + )
Depreciation on plant & machinery	xxxxxx
Depreciation on factory building	xxxxxx
Depreciation on factory furniture	xxxxxx
Depreciation on factory motor van	xxxxxx
Depreciation on other factory fixedassets	xxxxxx	XXXXXXX
		XXXXXXX
Add Opening stock of work in progress		xxxxxx
		XXXXXXX
Less Closing stock of work in progress		xxxxxx
Cost of production		XXXXXXX

In a manufacturing concern, usually there are three kinds of stocks:

Stock of Raw materials (the materials which are mainly used for production of the item)

Stock of Work in progress (the materials on which some work process have been completed)

Stock of Finished goods (The materials on which all the production processes are completed and ready for sale to the customers)

In the examination questions, the stock figures will be given separately.

Format of trading account of a manufacturing concern

Sales of finished goods		xxxxx
Less Returns inwards		xxxxx
		xxxxxx
Less Production cost of goods sold
Opening stock of finished goods	xxxxx
Add Cost of production	xxxxxxx	(-)
	xxxxxx
Less closing stock of finished goods	xxxxx
	xxxxxxx
Less finished goods drawings by the owner	xxxxx	xxxxxxx
Gross profit or Gross loss		XXXXXX

The profit & loss account and the balance sheet preparations will be the same as that of a sole trader’s. So the students have to follow the previous method for the preparation of these.

Fixed expenses and Variable expenses

Some expenses will remain constant whether the level of activity increases or falls. These expenses are called fixed expenses E.g. rent of building

The expenses which change with changes in activity are called variable expenses

E.g: cost of materials.

  Key points:

·         Carriage on raw materials means carriage inwards and it is a part of prime cost.

·         Carriage outwards is shown in the profit & loss account as an expense.

·         Royalties paid is to be treated as direct expense.

·         Depreciation on Plant and Machinery or any other factory asset is to be treated as factory overhead expense.

·         Stocks of raw materials and work-in-progress are taken in the manufacturing account and stock of finished goods is taken in the trading account.

·         Stocks at the end of the year (raw materials, work-in-progress and finished goods) are shown in the balance sheet as current assets.

·         Owner’s raw materials drawings are shown in the manufacturing account while calculating the prime cost.

·         Finished goods drawings are shown in the trading account while calculating the cost of goods sold.

·         The purchase of finished goods is added with cost of production in the trading account.

·         The depreciation of any asset used in the office should be shown as an expense in the profit & loss account.

·         Cost of readymade items bought for the production of items manufactured should be treated as direct expense.

·         Unit cost of production =           Total cost of production 

No of units produced