# Example Of Accounting For Bad Debts Accounting Essay

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Here is an example that shows depreciation: The diagram has shows the lorry has been sold out after three years. The reduction in the value of lorry after 3 years it sold shows depreciation. The loss of RM 35,000 is the depreciation value. The only time to calculate depreciation accurately is during selling the asset. Or else while the non-current asset continues to be used it can only be estimated in each year.

There are some factors that caused reduction in the value of a tangible non-current asset. First, depreciation is caused by physical deterioration which is occurs from wears and tear while the tangible non-current asset is in use and from the action of weather. Depreciation also caused by the economic factors those effects an asset being out of use even though its productive life is still long. There are two main factors that are affected by the economic factor. Firstly is obsolescence which means the asset is out-of-date. Secondly is inadequacy which means the asset is no longer used because of the growth and changes in the size of business. Besides that, time and depletion are also the factors of depreciation occur.

Depreciation of an asset is measured based on cost, estimated useful life and estimated residual value.

Cost

Estimated useful life is the length of productive life expected from the asset. Useful life can be expressed in terms of time or units of output.

Estimated residual value is the cash value of an asset that is expected at the end of its useful life. Residual value also called as salvage value.

There are two general methods to compute depreciation to each period of accounting:

Straight line

Reducing balance

Straight line Method

In this method, an equal amount of depreciation expense is allocating to each year of the asset's useful productive life.

Example: Cost (RM 10,000) - Estimated disposal value (RM 2,000)

Number of expected years of use (2)

= RM 8,000 / 2

= RM 4,000 (depreciation expense each year for 2 years)

If there are no estimated disposal values:

Cost (RM 10,000)

Number of expected years of use (2)

= RM 10,000 / 2

= RM 5,000 (depreciation expense for each year for 2 years)

Reducing balance Method

This method is also called as diminishing balance method or diminishing debit balance method. It charged higher depreciation expense in the earlier years of the asset's useful life but charged lower depreciation expense in the later years.

Example: RM

Cost of asset 50,000

First year: depreciation (10%) (5,000)

45,000

Second year: depreciation (10% of RM 45,000) (4,500)

40,500

Third year: depreciation (10% of RM 40,500) (4,050)

Cost not yet apportioned, end of Year 3 36,450

This method show a fixed percentage for depreciation is deducted from the cost of first year. Then the same percentage is taken of the reduced balance in the second year and later years.

Provision for depreciation

Provision for depreciation is the liability of business. To show a true and fair value of tangible non-current assets, provision for depreciation has to be charged to each accounting period in which the asset is used. Provision for depreciation is accumulative. Accumulated provision for depreciation will get bigger while the time of asset being in used is getting longer.

By making provision for depreciation account, depreciation is not credit in tangible non-current account. Original purchased value of the asset is showed in the Statement of Financial Position at the end of each accounting year. Although depreciation is not credit in the fixed asset's account, it transfers to provision for depreciation account every year. When the asset is sold, the accumulated provision for depreciation will transfer to the credit side of that asset's account from provision for depreciation account. So that the profit or loss on the fixed asset can be calculating correctly and the profit or loss on sale of asset will be the debit or credit in Profit and Loss account.

Why do business, companies, etc. include depreciation expenses and its provision in their financial statements

The reason of depreciation and its provision include in financial statements is because of the depreciation is an expenses. It is a part of the original cost of a tangible non-current asset that is used during its productive life. It is an expense such as wages, rent or lighting expenses that needs to be charged to the Profit and Loss account every year and it will decreases net profit. If depreciation is not counted in the Profit and Loss account, additional capital will be raised when the net profit counted in the Statement of Financial Position.

Besides that, in the Statement of Financial Position, the asset will be overstated if depreciation is not occurring. In the Statement of Financial Position, the cost of tangible non-current asset must be in true value otherwise the financial statement will not reflect the true and fair value.

Bad debts mean 'HutangLapuk ' in Malay. It happens when the debtors couldn't pay for the amount which they owe to our business. This usually happen when our customers going to bankrupt, trade dispute, fraud or does not pay the amount owed to the business, it is said that the debt has gone bad. As this amount is not received by the business, it's counted as a loss and is subtracted from the debtor's account in the balance sheet.

Besides, bad debts are some amount which cannot be refund and considered to be irrecoverable. Therefore, many companies now make an estimate of bad debts expenses that might be incurred in the current time period based on past record.

We need to justify the need of bad debts in accounting. It will provide us a more realistic picture of financial performance and position. The owner of the business will want to know the accurate amount of profit because bad debt is an expense for a business. We will have a better management on sales if we write down the amount of bad debts in our accounting book. It is also a best way to remember how much does people owe us. Furthermore, we can expect to recover the debts with the concept of prudence.

Example of accounting for bad debts

Marry Ltd sells goods to Sanny Ltd for \$1000 on credit. Then, Marry Ltd finds out that Sanny Ltd is being liquidated and therefore the prospects of recovering its dues are very low.

## \$

1,000

Sanny Ltd

1,000

Show how Depreciation, Provision for depreciation, Bad debts and Allowance for doubtful debts would appear in the Financial Statements.

For depreciation and provision for depreciation, the depreciation is posted directly into the accumulated provision account. The fixed asset's account always is the original purchase value unless it has sold out. The double entry is:

Debit: Profit and Loss account

Credit: Accumulated Provision for Depreciation

When a non-current asset is sold, the cost of the asset needs to be taken out of the asset account and its accumulated depreciation also needs to be taken out of the accumulated provision. The profit and loss on sale of the non-current asset will have to be calculated and posted it to the Profit and Loss account at last.

Example:

Profit and Loss (extracts)

RM

2010

Acc Provn for Depn:

xxx

Lorry

2011

Loss on lorry sold

xxx

As provision for depreciation is an expense, it has to be deducted by gross profit in the Income Statement so that we can get the correct net profit. Show as below:

Income Statement (extracts) for the years ending 31 December

RM

Gross profit

xxx

Less Expenses

2010 Provision for depreciation: Lorry

xxx

2011 Loss on lorry sold

xxx

To have a true and fair value in the asset account, we need to less the non-current account on the Accumulated Provision for Depreciation account at the end of the year. Show as below:

Statement of Financial Position (extracts) as at 31 December

RM

RM

2010 Lorry at cost

xxx

Less Accumulated depreciation

xxx

xxx

2011 Lorry at cost

xxx

Less Accumulated depreciation

xxx

xxx

For bad debts and allowance for doubtful debts, both of these are expenses. So they need to be deducted in the Income Statement to calculate the correct net profit.

Example:

Income Statement (extract) for the year ending 31 December 2012

RM

Gross profit

xxx

Less Expenses:

xxx

Allowance for doubtful debts

xxx

Besides that, the allowance for doubtful debts needs to deduct from the current asset account in the Statement of Financial Position. Show as below:

Statement of Financial Position (extract) as at 31 December 2012

Current asset

RM

RM

Account receivable

xxx

Less Allowance for Doubtful Debts

xxx

xxx

Oppositely when the allowance had reduced, the reduction value in allowance for doubtful debts is as a gain to gross profit. So we need to add that value in Income Statement. Show as below:

Income Statement (extract) for the year ending 31 December 2012

RM

Gross profit

xxx

Add Reduction in Allowance for Doubtful Debts

xxx

Example of depreciation, provision for depreciation, bad debts and allowance for doubtful debts:

The following information was extracted from the books of ABC Trading as at 31 May 2012 :

RM

RM

Drawings / Capital

2,050

34,455

Sales

30,615

Purchases

12,600

Inventory, as at 1 April 2011

3,985

Cash in hand

182

Cash at bank

4,900

Salaries and Wages

5,770

Carriage inwards

750

Carriage outwards

350

Returns

1,350

2,183

Debtors / Creditors

10,200

15,500

General expenses

8,000

Insurances

7,500

1,500

Rent and Rates

3,096

Premises

30,500

Fixtures

3,600

622

Loan from bank (repayable on 1 Jan 2014)

10,800

Provision for doubtful debts

402

95,455

95,455

1. Closing inventory as at 31 March 2012 was valued at RM4,500.

2. Depreciation expense for premises for that year amounting to RM2,500 and depreciation

expense for fixtures was RM650.

3. Provision for doubtful debts is on 2% from the total net debtors.

Required : Prepare the Income Statement and Statement of Financial Position for the year ended 31 May 2012 for ABC Trading.

Income Statement for the year ended 31 May 2012

RM

RM

Sales

30,615

(-) Sales returns

1,350

29,265

Less : Cost of Goods Sold

Opening inventory

3,985

(+) Purchases

12,600

16,585

(-) Purchases returns

(2,183)

14,402

(+) Carriage inwards

750

15,152

(-) Closing inventory

(4,500)

Cost of Goods Sold

(10,652)

Gross Profit

18,613

Revenues

1,500

20,113

Less : Expenses

Salaries and wages

5,770

Carriage outwards

350

General expenses

8,000

Insurances

7,500

Rent and rates

3,096

622

Doubtful debt

204

Depreciation expenses : Premises

2,500

Fixtures

650

(28,692)

Net Loss

(8,579)

Statement of Financial Position as at 31 May 2012

RM

RM

RM

Non-Current Assets

Premises

30,500

(-) Provision for depreciation

(2,500)

28,000

Fixtures

3,600

(-) Provision for depreciation

(650)

2,950

30,950

Current Assets

Inventory

4,500

Debtors

10,200

(-) Provision for doubtful debts

(606)

9,594

Cash in hand

182

Cash at bank

4,900

19,176

Current Liabilities

Creditors

(15,500)

Working Capital

3,676

Non-Current Liabilities

Loan from bank (repayable on 1 Jan 2014)

(10,800)

23,826

Capital

Opening Capital

34,455

(-) Net Loss

(8,579)

25,876

(-) Drawings

(2,050)

Total capital

23,826