CIMA - C2 Fundamentals of Financial Accounting
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150 9: Non-current assets – depreciation, revaluation and disposal ⏐ Part B Accounting systems and accounts preparation
Chapter roundup
•
The cost of a non-current asset, less its estimated residual value, is allocated fairly between accounting periods by
means of depreciation. The provision for depreciation is charged against profit and deducted from the value of the non-
current asset in the statement of financial position.
•
There are several different methods of depreciation, but the straight line method and the reducing balance method are
most commonly used in practice.
•
When a non-current asset is revalued, depreciation is charged on the revised amount.
•
When a non-current asset is sold, there is likely to be a profit or loss on disposal. This is the difference between the net
sale price of the asset and its net book value at the time of disposal.
•
Most organisations keep a non-current assets register. This is a listing of all non-current assets owned by the
organisation. This must be kept up to date.
•
Discrepancies between the non-current assets register and the physical assets or the nominal ledger must be
investigated.
Quick quiz
1 Fill in the blanks. Net book value is _______________ less _________________________________,
2 Two common depreciation methods are:
1) _______________________
2) _______________________
3 A non-current asset (cost $10,000, depreciation $7,500) is given in part exchange for a new asset costing $20,500. The
agreed trade-in value was $3,500. The income statement will include?
A A loss on disposal $1,000
B A profit on disposal $1,000
C A loss on purchase of a new asset $3,500
D A profit on disposal $3,500
4 The details about a non-current asset that would be included in a non-current assets register are:
(1) _______________________ (4) _______________________
(2) _______________________ (5) _______________________
(3) _______________________ (6) _______________________
5 A non-current asset originally cost $120,000. At 31 December 20X5, its net book value is $90,000 and the asset is now
revalued to $150,000. Its remaining useful life is 10 years. What is the annual depreciation for the year ended 31
December 20X5?
A $30,000
B $6,000
C $15,000
D $12,000
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Part B Accounting systems and accounts preparation ⏐ 9: Non-current assets – depreciation, revaluation and disposal 151
Answers to quick quiz
1 Net book value is cost less accumulated depreciation.
2 (1) Straight-line
(2) Reducing balance
3 B Correct. $
Net book value at disposal 2,500
Trade-in allowance
3,500
Profit
1,000
4 (1) Date of purchase
(2) Description and location
(3) Original cost
(4) Depreciation rate and method
(5) Accumulated depreciation to date
(6) Date and amount of any revaluation
5 C The new rate of depreciation is
$150,000
10
ie $15,000 pa.
Now try the questions below from the Question Bank
Question numbers Page
33–40 398
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152 9: Non-current assets – depreciation, revaluation and disposal ⏐ Part B Accounting systems and accounts preparation
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153
Topic list Syllabus references
1 Bad debts D (2)
2 Allowance for receivables D (2)
Bad debts and
allowances for
receivables
Introduction
The accounting problems discussed in this chapter are concerned with sales on credit. With
credit transactions, the time when a sale is recognised in the accounts is not the same as the
time when cash is eventually received or paid. There is a gap, during which something might
happen which results in the amount of cash eventually paid (if any) being different from the
original value of the sale on the invoice.
We shall consider two such events.
• Bad debts, which arise when a credit customer does not pay the money he owes
• Allowance for receivables, a provision for credit customers who may not pay
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154 10: Bad debts and allowances for receivables ⏐ Part B Accounting systems and accounts preparation
1 Bad debts
A bad debt is one that is no longer expected to be paid. For instance, the customer may have gone into liquidation. This
debt will be written off.
1.1 Bad debts
Credit customers may fail to pay for goods, out of dishonesty or because they have gone bankrupt and cannot pay.
Customers in another country may be prevented from paying by the unexpected introduction of foreign exchange control
during the credit period. For whatever reason, a business may decide to write the debt off as uncollectable.
1.2 Writing off bad debts
Bad debts written off are accounted for as follows.
(a) Sales are shown at their invoice value in the income statement. The sale has been made, and gross profit
earned. The failure to collect the debt is a separate matter.
(b) Bad debts written off are shown as an expense in the income statement.
If a sale of $300 became a bad debt:
$
Sale
300
Cost of sales, say
200
Gross profit
100
Bad debt written off
300
Net loss on this transaction (= cost of sales)
(200
)
When a debt is written off, the value of the receivable as a current asset falls to zero.
1.3 Bad debts written off: ledger accounting entries
Bad debts written off are posted to a bad debts account.
(a) When a particular debt will not be paid, the customer is no longer a receivable.
DEBIT Bad debts account (expense)
CREDIT Receivables account
(b) At the end of the accounting period, the balance on the bad debts account is transferred to the I/S ledger
account (like all other expense accounts).
DEBIT I/S account
CREDIT Bad debts account
1.4 Example: bad debts written off
At 1 October 20X5 a business had total outstanding debts of $8,600. During the year to 30 September 20X6.
(a) Credit sales amounted to $44,000
(b) Payments from various receivables amounted to $49,000
(c) Two debts, for $180 and $420, are declared bad and these are to be written off
FA
S
T F
O
RWAR
D
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Part B Accounting systems and accounts preparation ⏐ 10: Bad debts and allowances for receivables 155
Required
Prepare the receivables account and the bad debts account for the year.
Solution
RECEIVABLES
$
$
Opening balance b/f
8,600
Cash
49,000
Sales
44,000
Bad debts
180
Bad debts
420
Closing balance c/d
3,000
52,600
52,600
Opening balance b/d
3,000
BAD DEBTS
$
$
Receivables
180
I/S a/c: bad debts written off
600
Receivables
420
600
600
In the sales ledger, balances on the personal accounts of the customers whose debts are bad will be written off. The
business should ensure it does not sell goods on credit to those customers again.
1.5 Bad debts written off and subsequently paid
A bad debt which has been written off may be unexpectedly paid. The accounting entries are as follows.
DEBIT Cash account
CREDIT Bad debts account
1.6 Example: bad debts recovered
An income statement for the Blacksmith's Forge for the year to 31 December 20X5 is prepared from the following
information.
$
Inventories of goods in hand, 1 January 20X5 6,000
Purchases of goods 122,000
Inventories of goods in hand, 31 December 20X5 8,000
Cash sales 100,000
Credit sales 70,000
Bad debts written off 9,000
Debts paid in 20X5 which were previously written off as bad in 20X4 2,000
Other expenses 31,000
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156 10: Bad debts and allowances for receivables ⏐ Part B Accounting systems and accounts preparation
Solution
BLACKSMITH'S FORGE
INCOME STATEMENT FOR THE YEAR ENDED 31.12.20X5
$
$
Sales
170,000
Opening inventory
6,000
Purchases
122,000
128,000
Less closing inventory
8,000
Cost of goods sold
120,000
Gross profit
50,000
Expenses
Bad debts written off (9,000 – 2,000)
7,000
Other expenses
31,000
38,000
Net profit
12,000
(a) To write off a bad debt:
DEBIT Bad debts expense account
CREDIT Receivables account
(b) To record a receipt from a debt previously written off:
DEBIT Cash account
CREDIT Bad debts expense account
2 Allowance for receivables
An allowance for receivables occurs when there is uncertainty over whether a debt will be paid. The debt is not written
off, but an allowance is made against non-payment.
When bad debts are written off, specific debts owed to the business are identified as unlikely ever to be collected.
However, because of the risks involved in selling goods on credit, a certain percentage of outstanding debts at any time
are unlikely to be collected. Although it might be estimated that 5% of debts will be bad, the business will not know
which specific debts are bad.
When a business expects bad debts, it can make an allowance for receivables. The business is more likely to avoid
claiming profits which subsequently fail to materialise because of bad debts (the prudence concept).
2.1 Accounting for the allowance
(a) When an allowance is first made, the amount is charged as an expense in the income statement.
(b) When an allowance already exists, but is subsequently increased in size, the amount of the increase is charged
as an expense in the income statement.
(c) When an allowance already exists, but is subsequently reduced in size, the amount of the decrease is recorded as
an item of 'income' in the income statement.
FA
S
T F
O
RWAR
D
FA
S
T F
O
RWAR
D
Assessment
focus point
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Part B Accounting systems and accounts preparation ⏐ 10: Bad debts and allowances for receivables 157
The statement of financial position must also be adjusted to show an allowance for receivables. The value of
receivables in the statement of financial position must be shown after deducting the allowance. This is because the
net realisable value of all the receivables of the business is estimated to be less than their
'sales value'.
2.2 Example: allowance for receivables
A business has receivables of $50,000 and creates an allowance for receivables at 30 June 20X5 of 5% ($2,500).
Although total receivables are $50,000, eventual payment of only $47,500 is expected. What will be shown in the income
statement and statement of financial position?
Solution
(a) In the income statement, the increase in the allowance of $2,500 (from nil to $2,500) will be shown as an
expense.
(b) In the statement of financial position, receivables will be shown as
$
Total receivables at 30 June 20X5
50,000
Less allowance for receivables
2,500
47,500
2.3 Allowance for receivables: ledger accounting entries
The procedure is to leave the total receivables account in the nominal ledger and the receivables' personal balances in
the sales ledger completely untouched, and to open up an allowance account by the following entries.
DEBIT Allowance account (expense in I/S)
CREDIT Allowance for receivables (SOFP)
The expense in the income statement is sometimes debited to the increase or decrease in the allowance for receivables
account or sometimes to bad debts. In the remainder of this section we will refer to the income statement posting as
being to the 'I/S account'.
Read questions carefully to decide where the increase or decrease in the allowance is posted. It is usually included in
with bad debts.
When preparing a statement of financial position, remember the credit balance on the allowance account is deducted
from the debit balance on the receivables account.
In subsequent years, adjustments may be needed to the amount of the allowance. The procedure to be followed then is
as follows.
(a) Calculate the new allowance required.
(b) Compare it with the existing balance on the allowance account (ie the balance b/f from the previous
accounting period).
(c) Calculate increase or decrease required.
(i) If a higher provision is required, post the increase as follows.
DEBIT I/S account
CREDIT Allowance for receivables
Assessment
focus point
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158 10: Bad debts and allowances for receivables ⏐ Part B Accounting systems and accounts preparation
(ii) If a lower provision is needed, post the decrease as follows.
DEBIT Allowance for receivables
CREDIT I/S account
If dealing with a movement on an allowance account, be careful to include in the income statement only the increase or
decrease in the allowance. A common error is to include the total allowance figure.
2.4 Example: accounting entries for allowance for receivables
Alex Gullible has total receivables' balances outstanding at 31 December 20X2 of $28,000. He believes that about 1% of
these balances will not be collected and wishes to make an appropriate allowance. Before now, he has not made any
allowance for receivables.
On 31 December 20X3 his receivables balances amount to $40,000. His experience during the year has convinced him
that an allowance of 5% should be made.
What accounting entries should Alex make on 31 December 20X2 and 31 December 20X3, and what figures for
receivables will appear in his statements of financial position as at those dates?
Solution
At 31 December 20X2
Provision required = 1% × $28,000 = $280
Alex will make the following entries.
DEBIT I/S account (allowance for receivables) $280
CREDIT Allowance for receivables $280
Receivables will appear as follows under current assets.
$
Sales ledger balances (= total receivables account)
28,000
Less allowance for receivables
280
27,720
At 31 December 20X3
Following the procedure described above, Alex will calculate as follows.
$
Allowance required now (5% × $40,000)
2,000
Existing allowance
(280
)
∴ Additional allowance required
1,720
He will make the following entries.
DEBIT I/S account $1,720
CREDIT Allowance for receivables $1,720
Assessment
focus point
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Part B Accounting systems and accounts preparation ⏐ 10: Bad debts and allowances for receivables 159
The allowance account will by now appear as follows.
ALLOWANCE FOR RECEIVABLES
20X2 $ 20X2 $
31 Dec
Balance c/d
280
31 Dec
I/S account
280
20X3
20X3
31 Dec
Balance c/d
2,000
1 Jan
Balance b/d
280
31 Dec
I/S account
1,720
2,000
2,000
20X4
1 Jan
Balance b/d
2,000
For the statement of financial position receivables will be valued as follows.
$
Sales ledger balances
40,000
Less allowance for receivables
2,000
38,000
In practice, it is unnecessary to show the total receivables balances and the allowance as separate items in the statement
of financial position. A statement of financial position would normally show only the net figure ($27,720 in 20X2,
$38,000 in 20X3).
Question
Bad debts and allowance for receivables
Corin Flakes owns and runs the Aerobic Health Foods Shop in Dundee. He commenced trading on 1 January 20X1.
Customers are allowed to purchase up to $200 of goods on credit but must repay a certain proportion of their
outstanding debt every month.
This credit system gives rise to a large number of bad debts, and Corin Flakes' results for his first three years of
operations are as follows.
Year to 31 December 20X1
Gross profit $27,000
Bad debts written off $8,000
Debts owed by customers as at 31 December 20X1 $40,000
Allowance for receivables 2½% of outstanding receivables
Other expenses $20,000
Year to 31 December 20X2
Gross profit $45,000
Bad debts written off $10,000
Debts owed by customers as at 31 December 20X2 $50,000
Allowance for receivables 2½% of outstanding receivables
Other expenses $28,750
Year to 31 December 20X3
Gross profit $60,000
Bad debts written off $11,000
Debts owed by customers as at 31 December 20X3 $30,000
Allowance for receivables 3% of outstanding receivables
Other expenses $32,850
Required
For each of these three years, prepare the income statement of the business, and state the value of receivables appearing
in the statement of financial position as at 31 December.
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