Acca financial Accounting (FA) Study Text ac ca (FA)
Chapter 10 KAPLAN PUBLISHING
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KAPLAN PUBLISHING 185
Libby Farquar receives income from two rental units as follows: Unit 1 Unit 2 Period $
$
1.10.X4 – 31.12.X4 2,150 30.9.X4
1,300 2.1.X5 1.1.X5 – 31.3.X5 2,150 27.12.X4 1,300 4.4.X5 1.4.X5 – 30.6.X5 2,150 25.3.X5
1,300 1.7.X5 1.7.X5 – 30.9.X5 2,200 21.6.X5
1,400 6.10.X5 1.10.X5 – 31.12.X5 2,200 21.9.X5
1,400 2.1.X6 1.1.X6 – 31.3.X6 2,200 29.12.X5 1,400 4.4.X6 What is Libby’s rental income in the statement of profit or loss for the year ended 31 December 20X5? A $5,400 B $8,700 C $14,000 D $14,100
Accruals and prepayments 186 KAPLAN PUBLISHING Chapter summary
Chapter 10 KAPLAN PUBLISHING 187 Test your understanding answers
$ $
31 March cash 5,000
29 June cash 5,000
2 October cash 5,000
Accrual c/f 5,000 Profit or loss 20,000
–––––– ––––––
20,000 20,000
–––––– ––––––
Accrued
b/f 5,000
Test your understanding 2
Rental expense $
$ 1 January cash 1,200
3 March cash 1,200
14 June cash 1,200
25 September cash 1,400 Profit or loss 5,000
13 December cash 1,400 Prepayment c/f 1,400 –––––
––––– 6,400
6,400 ––––– –––––
Prepayment b/f 1,400
Accruals and prepayments 188 KAPLAN PUBLISHING
$
$ 6 February cash 2,800 Accrual b/f 2,000
8 May cash 3,000
5 August cash 2,750
10 November cash 3,100 Profit or loss 11,450
Accrual c/f 1,800
––––––
–––––– 13,450
13,450 ––––––
––––––
Accrual b/f 1,800
Test your understanding 4
Rental income (Unit 1) $
$
Prepaid income b/f
2,150
25.3.X5 cash 2,150
21.6.X5
cash 2,200
Profit or loss 8,700 21.9.X5 cash 2,200 Prepaid income c/f 2,200 29.12.X5 cash 2,200
––––– –––––
10,900 10,900
––––– –––––
Prepaid
income b/f
2,200
Chapter 10 KAPLAN PUBLISHING 189
$ $
Accrued income b/f 1,300 2.1.X5 cash 1,300
cash 1,300
1.7.X5
cash 1,300
Profit or loss 5,400 6.10.X5 cash 1,400
1,400 –––––
––––– 6,700
6,700 –––––
––––– Accrued income b/f 1,400
Total income: $8,700 + $5,400 = $14,100
Accruals and prepayments 190 KAPLAN PUBLISHING KAPLAN PUBLISHING 191 Receivables Chapter learning objectives Upon completion of this chapter you will be able to: •
•
understand the purpose of aged receivables analysis •
record the adjustments in the ledger accounts to write of an irrecoverable debt and one that is consequently recovered •
record the adjustments in the ledger accounts to adjust the allowance for receivables •
net assets.
One of the PER performance objectives (PO6) is to record and process transactions and events. Working through this chapter should help you understand how to demonstrate that objective.
Chapter 11 Receivables 192 KAPLAN PUBLISHING 1 Overview
Introduction
This chapter introduces the accounting requirements relating to irrecoverable debts and allowances for receivables that may not be fully recovered. Much of the content of this chapter is new. However, it is an important foundation for your future ACCA studies, in particular for Financial Reporting.
If a sale is for cash, the customer pays for the goods/services at the point of sale. The accounting entries for a cash sales are: Dr Cash
$X Cr Sales revenue $X If the sale is on credit terms the customer will pay for the goods/services after receiving them. Typically trading terms allow customers 30 – 60 days when purchasing goods and services on credit. Under the accruals concept, the sale is recorded in the ledger accounts when the right to the income is earned. That is usually the point at which the goods/services are delivered. Therefore when sales are made on credit the revenue is recorded with a corresponding asset that represents the customer's commitment to pay. The asset is referred to as a 'receivable'. The accounting entries to record the sale of goods on credit are: Dr Receivables $X
Cr Sales revenue $X
Chapter 11 KAPLAN PUBLISHING 193 When the customer eventually settles the debt the accounting entries will be: Dr Cash account $X
Cr Receivables $X
This then clears out the balance on the customer’s account.
The provision of credit facilities
The majority of businesses will sell to their customers on credit and state a defined time within which they must pay (a credit period). The main benefits and costs of doing so are as follows: Benefits •
The business may be able to enter new markets. •
There is a possibility of increased sales. •
Customer loyalty may be encouraged. Costs •
Can be costly in terms of lost interest since the business is accepting payment later. •
•
There is a potential risk of irrecoverable debts. Aged receivables analysis Where credit facilities are offered, it is normal for a business to maintain an aged receivables analysis. •
Analysis is usually a list, ordered by name, showing how much each customer owes and how old their debts are. •
outstanding debts and follow up any that are overdue. •
Timely collection of debts improves cash flow and reduces the risk of them becoming irrecoverable. Credit limits It is also normal for a business to set a credit limit for each customer. This is the maximum amount of credit that the business is willing to provide. The use of credit limits may: •
on credit •
help build up the trust of a new customer •
be part of the credit control strategy of a business. Receivables 194 KAPLAN PUBLISHING 3 Irrecoverable debts and allowances The accruals concept dictates that when a sale is made, it is recognised in the accounts, regardless of whether or not the cash has been received. Occasionally customers either refuse to pay or cannot settle their outstanding debts. Not only does this lead to a loss of cash income for a business it also means that it may have an asset in its statement of financial position that it is unlikely to be able to collect. If it is highly unlikely that the amount owed by a customer will be received, then this debt is known as an irrecoverable debt. Irrecoverable debts are 'written off’ by removing them from the ledger accounts completely. This course of action would be necessary if a customer was in formal liquidation proceedings and it was known that the outstanding debt will not be recovered. If there is concern over whether a customer will pay but there is still hope that the amount (or at least some of it) can be recovered an 'allowance' is created. Unlike an irrecoverable debt, these items are left in the receivables’ ledger but a separate and opposite account (receivables are debits, the allowance is a credit) is set up that temporarily offsets the asset. If the balance is eventually paid the allowance can be easily removed. This course of action would be necessary if a customer was having cash flow difficulties but still considered they would be able to pay if given a little more time. 4 Accounting for irrecoverable debts An
irrecoverable debt is a debt which is, or is considered to be, uncollectable. With such debts it is prudent to remove them from the accounts and to charge the amount as an expense for irrecoverable debts to the statement of profit or loss. The original sale remains in the accounts as this did actually take place. The double entry required to achieve this is: Dr Irrecoverable debts expense $X Cr Receivables $X
Test your understanding 1
Araf & Co has total accounts receivable at the end of its accounting period of $45,000. Of these items, it is discovered that one, Mr Xiun who owes $790, has been declared bankrupt, and another who gave his name as Mr Jones has totally disappeared owing Araf & Co $1,240.
Chapter 11 KAPLAN PUBLISHING 195 5 Accounting for irrecoverable debts recovered There is a possible situation where a debt is written off as irrecoverable in one accounting period, perhaps because the customer has been declared bankrupt, and the money, or part of the money, due is then unexpectedly received in a subsequent accounting period. When a debt is written off the double entry is: Dr Irrecoverable debts expense $X Cr Receivables $X (removing the debt from the accounts) When cash is received from a customer the normal double entry is: Dr Cash $X
Cr Receivables $X
When an irrecoverable debt is recovered, the credit entry (above) cannot be taken to receivables as the debt has already been taken out of the receivables balance. Instead the accounting entry is: Dr Cash $X
Cr Irrecoverable debts expense $X Some businesses may wish to keep a separate ‘irrecoverable debts recovered’ account to separate the actual cost of irrecoverable debts in the period.
Test your understanding 2
Celia Jones had receivables of $3,655 at 31 December 20X7. At that date she wrote off a debt from Lenny Smith of $699. During the year to 31 December 20X8 Celia made credit sales of $17,832 and received cash from her customers totalling $16,936. She also received the $699 from Lenny Smith that had already been written off in 20X7. What is the final balance on the receivables account at 31 December 20X7 and 20X8?
$ $ A 2,956 3,852 B 2,956 3,153 C 3,655 4,551 D 3,655 3,852
Receivables 196 KAPLAN PUBLISHING 6 Allowance for receivables There may be some debts included in the accounts where there is some cause for concern but which are not yet definitely irrecoverable. It is prudent to recognise the possible expense of not collecting the debt in the statement of profit or loss, but the receivable must remain in the accounts in case the customer does, in fact, settle the amount outstanding. An allowance is set up which is a credit balance. This is netted off against trade receivables in the statement of financial position to give a net figure for receivables that are probably recoverable. The allowance should consist only of specific amounts where, for example, the customer is known to be in financial difficulty, or is disputing the invoice, or payment is already overdue, or is refusing to pay for some other reason (e.g. a faulty product), and therefore the amount owing may not be recovered. Therefore, an allowance can only be established where there is some objective evidence that a particular receivable may not be recovered in part or in full.
An allowance for receivables is set up with the following journal: Dr Irrecoverable debts expense $X Cr Allowance for receivables $X If there is already an allowance for receivables in the accounts (opening allowance), only the movement in the allowance is charged to the statement of profit or loss (closing allowance less opening allowance). As the allowance can increase or decrease, there may be a debit or a credit in the irrecoverable debts account so the above journal may be reversed. When calculating and accounting for a movement in the allowance for receivables, the following steps should be taken: 1 Write off irrecoverable debts. 2 Calculate the receivables balance as adjusted for the write-offs. 3 Ascertain the allowance for receivables required. 4 Compare to the brought forward allowance. 5 Account for the change in allowance to determine the expense or credit to the statement of profit or loss. 6 In the financial statements, deduct the closing allowance for receivables from the receivables balance.
Chapter 11 KAPLAN PUBLISHING 197
On 31 December 20X1 Jake Williams had receivables of $10,000. At that date, Jake estimated that there was evidence that amounts totalling $300 may not be recovered as those receivables were already overdue and he therefore wanted to make a specific allowance for this amount. During 20X2, Jake made sales on credit totalling $100,000 and received cash from his customers of $94,000. At 31 December 20X2, Jake now considered that there was doubt regarding the recoverability of amounts totalling $700 which were overdue and which may not be recovered. The allowance for receivables should therefore be increased from $300 to $700. During 20X3 Jake made sales of $95,000 and collected $96,000 from his receivables. At 31 December 20X3 Jake now considered that amounts totalling only $600 required an allowance for being overdue at that date. The allowance for receivables should therefore be adjusted from $700 to $600.
Calculate the allowance for receivables and the irrecoverable debt expense as well as the closing balance of receivables for each of the years 20X1, 20X2, 20X3. You should work through the information methodically, year-by-year. This will help you to understand the mechanics of how to account for trade receivables, irrecoverable debts and the allowance for receivables.
Receivables 198 KAPLAN PUBLISHING
$
$ At 31 December 10,000 Profit or loss (ß) 10,000
––––––
–––––– 10,000
10,000 ––––––
–––––– Balance b/f 10,000
Allowance required = $300
Allowance for receivables $
$ Balance c/f 300 31 Dec
Irrecoverable debts
300 ––––––
––––––
300
300 ––––––
–––––– Balance
b/f 300
Irrecoverable debts expense $
$ 31 Dec 31 Dec
Allowance for receivables 300 Profit or loss 300
––––––
–––––– 300
300 ––––––
–––––– Statement of financial position presentation $
$ Current assets
Less: Allowance for receivables (300)
9,700
Chapter 11 KAPLAN PUBLISHING 199
20X2 Receivables $
$ Balance b/f 10,000
Sales 100.000 Cash 94,000
Balance
c/f 16,000
––––––
–––––– 110,000
110,000 ––––––
–––––– Balance b/f 16,000
Allowance required $700
Allowance for receivables $
$
Balance b/f
31 Dec 300
Balance c/f 700 increase in allowance 400 ––––––
––––––
700
700 ––––––
–––––– Balance
b/f 700
Irrecoverable debts expense $
$ 31 Dec 31 Dec
Allowance for receivables 400 Profit or loss 400
––––––
–––––– 400
400 ––––––
–––––– Statement of financial position presentation $
$ Current assets
Less: Allowance for receivables (700)
15,300
Receivables 200 KAPLAN PUBLISHING
20X3 Receivables $
$ Balance b/f 16,000
Sales 95.000 Cash 96,000
Balance
c/f 15,000
––––––
–––––– 111,000
111,000 ––––––
–––––– Balance b/f 15,000
Allowance required $600
Allowance for receivables $
$ 31 Dec Balance b/f 700
Decrease in allowance 100
Balance b/f 600
––––––
700
700 ––––––
–––––– Balance
b/f 600
Irrecoverable debts expense $
$ 31 Dec 31 Dec
Profit or loss 100 Allowance for receivables 100 ––––––
––––––
100
100 ––––––
–––––– Statement of financial position presentation $
$ Current assets
Less: Allowance for receivables (600)
14,400
Chapter 11 KAPLAN PUBLISHING 201
John Stamp has opening balances at 1 January 20X6 on his trade receivables account and allowance for receivables account of $68,000 and $3,400 respectively. During the year to 31 December 20X6 John Stamp made credit sales of $354,000 and collected cash from his receivables of $340,000. At 31 December 20X6 John Stamp reviewed his receivables listing and acknowledged that he is unlikely ever to receive debts totalling $2,000. These are to be written off as irrecoverable. In addition, at that date he estimated that amounts totalling $4,000 were overdue and that an allowance for receivables was required to cover these amounts.
A $2,700 B $6,100 C $2,600 D $6,000
Receivables 202 KAPLAN PUBLISHING Chapter summary
Chapter 11 KAPLAN PUBLISHING 203 Test your understanding answers
As the two debts are considered to be irrecoverable, they must be removed from receivables: Receivables $
$ Balance at period end 45,000 Irrecoverable debts
– Mr Xiun 790
Irrecoverable debts
– Mr Jones 1,240
Balance
c/f 42,970
––––––
–––––– 45,000
45,000 ––––––
–––––– Balance b/f 42,970
$
$ Receivables
– Mr Xiun 790
Receivables
1,240 Profit or loss 2,030
––––––
–––––– 2,030
2,030 ––––––
–––––– Note that the sales revenue account has not been altered and the original sales to Mr Xiun and Mr Jones remain. This is because these sales actually took place and it is only after the sale that the expense of not being able to collect these debts has occurred.
Receivables 204 KAPLAN PUBLISHING
$
$ Balance at period end 3,655 Irrecoverable debts
– Lenny Smith 699
Balance
c/f 2,956
––––––
–––––– 3,655
3,655 ––––––
–––––– Balance b/f 2,956
$
Receivables
– Lenny Smith 699 Profit or loss 699 ––––––
––––––
699
699 ––––––
–––––– 20X8 Receivables $
$ Receivables 2,956
Sales 17,832 Cash received 16,936
Balance c/f 3,852
––––––
–––––– 20,788
20,788 ––––––
–––––– Balance b/f 3,852
$
Profit or loss 699 Cash 699 ––––––
––––––
699
699 ––––––
––––––
Chapter 11 KAPLAN PUBLISHING 205
20X6 $
20X6 $ 1 Jan Balance b/f 68,000 31 Dec Cash 340,000
31 Dec Sales revenue 31 Dec Irrecoverable debts w/off 2,000
31 Dec Balance c/f 80,000 ––––––
––––––
422,000
422,000 ––––––
–––––– 20X7
1 Jan Balance b/f 80,000
Irrecoverable debts expense 20X6 $
20X6 $ 31 Dec Receivables 2,000
31 Dec Increase in allowance for receivables 600 31 Dec Profit or loss 2,600 ––––––
––––––
2,600
2,600 ––––––
–––––– Allowance for receivables 20X6 $
20X6 $
1 Jan Balance b/f 3,400
31 Dec Balance c/f 4,000 31 Dec Irrecoverable debts 600
––––––
–––––– 4,000
4,000 ––––––
–––––– 20X7
1 Jan Balance b/f 4,000
Receivables 206 KAPLAN PUBLISHING
Note that only the one irrecoverable debts expense account is used both to write off irrecoverable debts and to increase or decrease the allowance for receivables. There is no need to use separate accounts for each type of expense. Working – Allowance for receivables $4000 – b/f $3,400 = increase of $600 The
statement of financial position will show a receivables balance of 80,000. Underneath this separately the allowance for receivables c/f balance of $4,000 will be deducted to give a net receivables total of $76,000. The
statement of profit or loss will show the $2,600 as an expense. This expense will cause a decrease in overall profits.
KAPLAN PUBLISHING 207 Payables, provisions and contingent liabilities
Upon completion of this chapter you will be able to: •
•
identify and explain examples of payables •
define and illustrate the different accounting treatments of 'provisions,' 'contingent liabilities,' and 'contingent assets' •
calculate and record provisions and movements in provisions.
PER One of the PER performance objectives (PO6) is to record and process transactions and events. Working through this chapter should help you understand how to demonstrate that objective.
Chapter 12 Payables, provisions and contingent liabilities 208 KAPLAN PUBLISHING 1 Overview
Introduction
This chapter deals with the accounting requirements for payables, provisions and contingent liabilities. In particular, it draws upon the recognition and measurement criteria contained in IAS 37 Provisions, contingent liabilities and contingent assets. The chapter also considers classification of liabilities as either current liabilities or non-current liabilities. Much of the content of this chapter is new. However, it is an important foundation for your future ACCA studies for Financial Reporting and also Strategic Business Reporting.
Chapter 12 KAPLAN PUBLISHING 209 2 Categorisation of liabilities It is important to consider the timing of settlement of a liability so that you can ensure you allocate it to the correct category of the statement of financial position. This can be significant to many multiple choice style questions, so take care when making adjustments for liabilities. Typically trade payables (liabilities for goods and services purchased), overdrafts and accruals are the main forms of current liability examined in Financial Accounting. Loans (not bank overdrafts) are the principal example of non-current liabilities. The Conceptual Framework defines a liability as
. The
obligation must be capable of being reliably measured. IAS 37 Provisions, contingent liabilities and contingent assets develops this principle by making reference to a legal obligation and a constructive obligation. According to IAS 37, a constructive obligation may be established by an entity having established or published policies and practices which creates a valid expectation on the part of others that it will act in a certain way.
Payables, provisions and contingent liabilities 210 KAPLAN PUBLISHING A good example of a constructive obligation is a retail store which allows customers to return unwanted goods, if the goods are of the wrong size, colour or specification, without being defective, if the minimum legal obligation is to only accept returned goods which have been returned because they are faulty or defective in some way. 3 Cash and credit purchases If a purchase is for cash, the business pays for the goods/services at the point of sale. The double entry for a cash purchase is: Dr Purchases/expenses $X Cr Cash
$X If the purchase was made on credit terms the business will pay for the goods and services following delivery. Typically trading terms allow 30 – 60 days to settle outstanding debts when purchasing goods and services on credit. Under the accruals concept, the purchase is recorded in the ledger accounts when the expense has been incurred. That is usually the point at which the goods/services are received/rendered. Therefore when purchases are made on credit the cost is recorded with a corresponding liability that represents the obligation to pay the supplier of the goods/services. The liability is referred to as a 'payable.' The double entry is recorded as follows: Dr Purchases/expenses $X Cr Payables $X When the payable liability is actually paid the double entry to reflect this is: Dr Payables $X
Cr Cash $X
4 Provisions A
is defined as
(IAS 37, para 10). For example, an entity may face a legal action for a breach of health and safety law. The likely repercussion is that it may be fined if the court judgement is made against them. The timing and severity of the fine will be decided by a court at some future date. The key question is: should the entity reflect this information in its financial statements? If we assume that the potential fine could be significant (it could even lead to the closure of the business) should the potential consequences be disclosed to the shareholders in some way? As owners of the business, they are entitled to know about this potentially significant issue that could damage the profits and reputation of the business and, therefore, the financial value of their investment in the entity. Chapter 12 KAPLAN PUBLISHING 211 Accounting for a provision The first potential course of action management can take is to recognise a provision in the accounts. This is done by estimating the potential cost of the uncertain event and recognising it immediately. As the amount would be settled at a future date, a corresponding liability is recorded, as follows: Dr Expenses $X Cr Provision $X The provision will need to be classified as either a current or non-current liability as befits the situation.
Given the uncertainty relating to provisions there is significant scope for accounting error, or even deliberate manipulation of provisions to alter profits. To reduce this risk IAS 37 specifies three criteria for recognition of a provision. A provision shall be recognised when: •
an entity has a present obligation (legal or constructive) as a result of a past event.
• it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and
• a reliable estimate can be made of the amount of the
(IAS 37, para 14).
The criteria referred to above mean that a provision can only be recorded in an accounting period if recognition of a liability has been triggered at the year-end. For example: Smith Co's year-end is 31 December 20X7. In November 20X7 Smith Co dismissed an employee. In February 20X8 a customer slipped whilst on Smith Co’s premises and broke her arm. In March 20X8 both the employee and the injured customer sue Smith Co the former for unfair dismissal and the latter for compensation for injuries suffered on Smith Co's premises. Should an obligation be recognised at 31 December 20X7 for either of these lawsuits?
Payables, provisions and contingent liabilities 212 KAPLAN PUBLISHING
There is a potential obligation at the year-end for the employee claiming unfair dismissal. This is because the triggering event happened in November 20X7, which is before the year-end. There is no obligation to the injured customer at 31 December 20X7. The event happened after the year-end date of 31 December 20X7. Therefore, any financial consequences resulting from the claim made by the customer will be reflected in the financial statements for the year ended 31 December 20X8.
Obligations
Should an obligation be recognised at 31 December 20X7 for either of these lawsuits? A legal obligation is an obligation that derives from: •
the terms of a contract,
• legislation, or
• other operation of law (IAS 37, para 10).
•
by an established pattern of past practice, published policies, or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities, and
• as a result, the entity has created a valid expectation on the Download 25,25 Mb. Do'stlaringiz bilan baham:
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