ACCA F3 (INT) Financial Accounting - 2010 - Study text

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Chapter 7: Accruals and prepayments. Receivables and payables

Accounting for doubtful debts can be confusing. It might help to look separately at

what happens:

 when an allowance is created for the first time, or when it is increased at the end

of an accounting period, and

 when an allowance is reduced at the end of an accounting period.

2.6 Creating or increasing an allowance for irrecoverable debts

When an allowance for irrecoverable debts is created or when an allowance is

increased (from the end of the previous accounting period), the double entry in the

main ledger is as follows:

 Debit: Irrecoverable debts expense

 Credit: Allowance for irrecoverable debts (with the increase in the allowance).

The allowance for irrecoverable debts account is a liability account (as it is

effectively the reduction in value of an asset account – receivables). The increase

therefore must be credited to the allowance account.

The increase in the allowance is also an expense, which reduces profit therefore

debit to the irrecoverable debts account.

In the statement of financial position, the allowance for irrecoverable debts is not

shown separately as a liability under the heading for current liabilities. Instead, it is

deducted from total trade receivables.

Trade receivables A

Less: Allowance for irrecoverable debts (B)

Net receivables (shown in statement of financial position) A - B

The charge for irrecoverable debts expense in the income statement is the amount of

the irrecoverable debts written off, plus the increase during the year in the

allowance for irrecoverable debts.

Bad debts (irrecoverable debts written off) A

Plus: Increase in allowance for irrecoverable debts B

Total charge to profit and loss A + B

2.7 Reducing an allowance for irrecoverable debts

If the allowance for irrecoverable debts is reduced (compared with the end of the

previous accounting period), there is a ‘negative expense’. The double entry in the

main ledger is:

 Debit: Allowance for irrecoverable debts (with the amount of the decrease in the

allowance)

 Credit: Irrecoverable debts expense

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A decrease in the allowance for irrecoverable debts adds to profit in the period by

reducing the total expense for irrecoverable debts. It also reduces the credit balance

on the allowance account.

Example

A business has trade receivables of $75,000. It decides that $5,000 of these debts should

be written off as ‘bad’. In addition, an allowance for irrecoverable debts of $2,000

should be created. Until now, the business has not made any allowance for

irrecoverable debts. These transactions will be accounted for as follows:

Receivablesaccount

 $ $

Openingbalanceb/f 75,000 Irrecoverabledebts(baddebtwritten

off)

5,000

Closingbalancec/f 70,000

 75,000 75,000

Openingbalanceb/f 70,000 

Note: The balance on the trade receivables account is reduced by the bad debts

written off, but not by the allowance for doubtful debts.

Irrecoverabledebtsaccount(expense)

 $ $

Receivables(baddebts) 5,000 Incomestatement 7,000

Allowanceforirrecoverabledebts 2,000 

 7,000 7,000



Allowanceforirrecoverabledebtsaccount(liability)



$$

Irrecoverabledebts(expense) 2,000



In the statement of financial position, trade receivables will be reported as:



$

Tradereceivables 70,000

Less:Allowanceforirrecoverabledebts 2,000

 68,000

The charge for irrecoverable debts expense in the income statement is the amount of

the irrecoverable debts written off, minus the reduction during the year in the

allowance for irrecoverable debts.

Bad debts (irrecoverable debts written off) A

Minus: Reduction in allowance for irrecoverable debts (B)

Total charge to profit and loss A – B

Chapter 7: Accruals and prepayments. Receivables and payables

Example

Continuing the example, suppose that in the following year (Year 2), sales (all on

credit) were $200,000, receipts from customers were $185,000 and bad debts written

off were $8,000. It is decided to reduce the allowance for irrecoverable debts from

$2,000 to $1,500. These transactions can be summarised as follows:

Receivablesaccount



$ $

Openingbalanceb/f 70,000 Bank 185,000

Sales 200,000 Irrecoverabledebts(baddebtswritten

off)

8,000

Closingbalancec/f 77,000

 270,000 270,000

Openingbalanceb/f 77,000 

Note: The credit entry in the receivables account for irrecoverable debts is for the

amount of the bad debts written off.

Irrecoverable debtsaccount



$ $

Receivables(baddebts) 8,000 Allowanceforirrecoverable

debts

500

Incomestatement 7,500

 8,000 8,000

Note: The amount charged in this account as an expense for the period is the bad

debt written off minus the reduction in the allowance for irrecoverable debts.

Allowanceforirrecoverable debtsaccount



$ $

Irrecoverabledebts(2,000–

1,500)

500 Openingbalanceb/f 2,000

Closingbalancec/f 1,500 

 2,000 2,000

Openingbalanceb/f 1,500

In the statement of financial position, trade receivables will be:

 $

Tradereceivables 77,000

Less:Allowanceforirrecoverabledebts 1,500

 75,500

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Exercise 3

Continuing the same example above, the following year (Year 3) sales (all on credit)

were $250,000, receipts from customers were $252,000 and bad debts written off

were $7,000. It is decided to reduce the allowance for doubtful debts from $6,000 to

$4,500. Record these transactions in the following ledger accounts:

(a) trade receivables

(b) bad and doubtful debts

1.8 Aged receivables analysis

Preparing an aged receivables analysis is a method of attempting to assess the

likelihood of bad debts or to make an assessment of doubtful receivables. This is an

analysis for each individual credit customer of their total debtor balance, showing

how long each invoice has been outstanding. A typical format for an aged

receivables analysis is given below:

Customer Credit

limit

Total

owed

<30

days

30–60

days

60–90

days

Over90

days

 $ $ $ $ $ $

X 20,000 5,500 3,000 – 2,500 –

Y 15,000 2,700 – 1,000 1,000 700

If a customer has old amounts outstanding, these should be investigated and an

attempt should be made to collect payment. However the investigation may

indicate that the amount should either be written off as a bad debt, or that an

allowance should be made for an irrecoverable debt. (In other words, the debt is not

written off yet, but the chances of it being paid look doubtful.)

1.9 Bad debt recovered

On some rare occasions a debt that had been written off as bad in a previous year is

then subsequently received in a later period. The double entry for recording the

recovery of a bad debt is:

Debit Cash

Credit Income statement (other income)

1.10 Summary of the rules on bad and doubtful debts

The rules for dealing with bad debts and doubtful debts at the end of the financial

year can be summarised as follows.

Chapter 7: Accruals and prepayments. Receivables and payables

Income statement

Annual charge in the income statement =

 Bad debts written off

 plus Increase in allowance for irrecoverable (doubtful debts), or

 minus Reduction in allowance for irrecoverable (doubtful) debts

Statement of financial position

In the statement of financial position:

 Bad debts reduce the total trade receivables

 Doubtful debts do not reduce total trade receivables, but the allowance for

irrecoverable debts is a liability. Instead of showing it in the statement of

financial position together with the other current liabilities, the allowance

for irrecoverable debts is set off against (deducted from) total trade

receivables.

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Receivables ledger control account

 Introduction

 Basic rules: debit and credit entries in the receivables account

3 Receivables ledger control account

3.1 Introduction

For the purpose of this section, it is sufficient to understand that a receivables ledger

control account is the name given to the account in the main ledger for total

receivables. A control account is an account that records total amounts – in this case,

total amounts for receivables.

For your examination, you need to understand the rules of double-entry book-

keeping for the receivables control account. The basic rules were explained in the

earlier chapter on accounting for sales. This section introduces some additional

items.

A common form of examination question in the past has been a receivables ledger

control account that has been prepared incorrectly by a ‘trainee accountant’, with

some debit and credit entries on the wrong side of the account. You are then

required to correct the errors to find a balancing figure to complete the account

correctly. This missing figure is usually (but not necessarily) the closing balance for

receivables at the end of the period.

To deal with this question you must know which types of transaction are debit

entries in the receivables account, and which are credit entries.

3.2 Basic rules: debit and credit entries in the receivables account

Opening receivables balance

The opening balance in the receivables ledger control account is a debit balance,

because amounts receivable are an asset.

Occasionally there might also be a small credit balance in the receivables account, in

addition to a debit balance. Credit balances arise when customers have paid more

than they actually owe, so that the business entity owes its customers money.

Debit entries in the receivables control account

The receivables ledger control account records all transactions involving credit

customers.

Chapter 7: Accruals and prepayments. Receivables and payables

Debit entries in the receivables control account are transactions that add to the total

amount of receivables. These include:

(1) Credit sales

(2) Interest charged on overdue accounts (Debit Receivables, Credit Interest

income)

(3) Cheques received in payment from customers but subsequently dishonoured

(i.e. the bank refuses to make payment). The double entry is then Debit

Receivables, Credit Bank. The customer’s cheque is invalid and has ‘bounced’,

so the cheque payment received is ‘reversed’ in the receivables account.

Credit entries in the receivables ledger control account

Credit entries in the receivables ledger control account are transactions that reduce

the total amount of receivables. These include:

(1) Payments received from credit customers

(2) Sales returns (for credit sales)

(3) Discounts allowed to customers for early payment

(4) Contra entries, reducing balances in the payables ledger. Contra entries were

explained in the earlier chapter on sales and purchases

(5) Bad debts written off.

Entries not recorded in the receivables ledger control account

Transactions are not recorded in the receivables ledger control account unless they

relate to credit sales and specific credit customers. Transactions NOT be recorded in

the ledger account are:

(1) Cash sales (Debit Bank, Credit Sales)

(2) Changes in the Allowance for irrecoverable debts account.

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Payables ledger control account

 Introduction

 Basic rules: debit and credit entries in the payables account

 Refunds from suppliers

4 Payables ledger control account

4.1 Introduction

The payables ledger control account is the name given to the account in the main

ledger for total trade payables.

For your examination, you need to understand the rules of double-entry book-

keeping for the payables ledger control account, as well as for the receivables

account. The basic rules were explained in the earlier chapter on accounting for

purchases.

4.2 Basic rules: debit and credit entries in the receivables account

Opening receivables balance

The opening balance in the payables ledger control account is a credit balance,

because amounts payable are a liability.

Occasionally there might also be a small debit balance in the payables account, in

addition to a credit balance. Debit balances arise when suppliers have been paid

more than they are actually owed, so that the supplier owes money. The supplier

might eventually pay back the over-payment in the form of a refund.

Credit entries in the payables control account

The payables ledger control account records all transactions involving credit

purchases. Since business entities make most of their purchases on credit (with the

exception of petty cash items), the control account records virtually all purchases.

Credit entries in the payables control account are transactions that add to the total

amount of payables. These include:

(1) Purchases (but not any cash purchases)

(2) Refunds from suppliers (see below).

Debit entries in the payables ledger control account

Debit entries in the payables ledger control account are transactions that reduce the

total amount of payables. These include:

(1) Payments made to suppliers

Chapter 7: Accruals and prepayments. Receivables and payables

(2) Purchases returns

(3) Discounts received from suppliers for early payment

(4) Contra entries, reducing balances in the receivables ledger. Contra entries were

explained in the earlier chapter on sales and purchases. Whenever there is a

contra entry on the debit side of the payables ledger control account, there must

be a matching credit entry in the receivables ledger control account.

4.3 Refunds from suppliers

Occasionally a supplier might make a refund. This occurs when the supplier has

been paid too much for the goods or services provided, and issuing a credit note is

not a suitable way of dealing with the problem because payment has already been

made. (Credit notes are issued when there are purchase returns, and the purchase

invoice is therefore for too much money. The credit note has the effect of reducing

the amount payable, before payment is actually made.)

When a supplier makes a refund, there is a debit balance in the account for the

individual supplier, rather than a credit balance. The refund removes the debit

balance.

The effect of a refund is therefore to increase the total amount of payables. For

example, suppose that a company is owed $1,000 by a supplier for an overpayment,

and owes its other suppliers $30,000. The net credit balance on the payables account

would be $29,000. If the supplier pays a refund of $1,000, the balance on the

payables ledger control account will increase to $30,000.

Refunds are therefore recorded in the main ledger as follows:

 Debit: Bank

 Credit: Payables ledger control account.

Paper F3: Financial accounting (International)

Practice multiple choice questions

1 At 1 July 2009 a company had an allowance for irrecoverable debts of $51,000.

At 30 June 2010, total trade receivables were $942,000. It was decided to write off

$86,000 of these debts and to adjust the allowance for irrecoverable debts to $65,000.

What amounts should be included in the company’s statement of financial position at

30 June 2010?

Trade

receivables

Allowance for

receivables

Net trade

receivables

$ $ $

942,000 65,000 877,000

856,000 65,000 791,000

856,000 116,000 740,000

942,000 116,000 826,000

(2 marks)

2 Details of a company’s insurance policy costs are as follows.

Premium for year ending 31 March 2010, paid April 2009: $27,600

Premium for year ending 31 March 2011, paid April 2010: $30,000

What figures should be included within profit or loss for the year to 30 June 2010 for

insurance costs, and what should be included in the statement of financial position as

at 30 June 2010?

Income

statement

Statement of financial position

$ $

28,200 22,500

prepayment (Dr)

29,400 22,500

prepayment (Dr)

28,200 22,500

accrual (Cr)

29,400 22,500

accrual (Cr)

(2 marks)

3 A company owns a number of office properties that it rents to tenants. The following

information is available for the year ended 30 June 2010.

Rent in advance Rent in arrears

$ $

30 June 2009 127,900 5,700

30 June 2010 138,100 9,400

Cash received from tenants during the year to 30 June 2010 was $948,300. All rental

income in arrears was subsequently received in full.

What figure should appear in profit or loss for the year to 30 June 2010 for rental

income?

A $954,800

B $1,199,200

C $697,400

D $941,800

(2 marks)

ACCA F3 (INT) Financial Accounting - 2010 - Study text - Emile Woolf Publishing

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