SPECIFIC ACCOUNTS
Introduction
When preparing a profit and loss and a balance sheet for an accounting period, the first step is the extraction of all the ledger account balance in the form of a trial balance. However these balances are invariably subject to the types of adjustment that are discussed in this section.
Accruals
Accruals are outstanding liabilities that arise due to the concept of matching revenue with the cost that produced that revenue. Examples of outstanding liabilities include telephone, electricity, gas and water charges not yet billed, and wages due but not yet paid. If a business is not charged for these incurred expenses until the end of the accounting period to which they relate, it must provide for those expenses, and for the outstanding liabilities at the period end.
Prepayments
The concept of matching costs and revenues applies also to prepayments or payments in advance. Where amounts are paid now for the financial year, these must be apportioned between the relevant accounting periods. This means that, at the end of the current financial year, there will be an un-expired benefit with certain expenses. These must be treated as an asset at the date of the balance sheet. Examples of some prepayments are: rent, rates, advertising, insurance.
Bad Debt Provisions
A bad debt arises when a proprietor considers a particular debt to be un-collectable, and writes it off to the profit-and-loss account, via a bad debts account:
Debtors - Nomoney Ltd
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| 3-4- | |
Sales | |
180 | |
16-9- | |
Cash | |
100 |
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13-12- | |
Bad Debts | |
80 |
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180 | |
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180 |
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Debtors - Nomoney Ltd
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| 31-12- | |
Nomoney Ltd | |
80 | |
31-12- | |
Profit & Loss | |
80 |
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A provision for doubtful debts is slightly different in concept, because a provision is made against current profits in anticipation of bad debts arising in following periods in respect of current debts. Unlike bad debts, the debtors accounts cannot be credited because when the provision is made it is not known which debts will become bad. Therefore, a doubtful debt provision account is opened.
The provision for doubtful debts is calculated on the outstanding debtors balances after writing off the bad debts for the year. The amount taken to the debit or credit of the profit-and-loss account is the amount necessary to adjust the balance on the provision account to the required percentage of outstanding debtors.
Depreciation
The economic life of all fixed assets (with the possible exception of land) is limited. The actual length of life is related to the type of asset, and the purpose for which it is used. Depreciation can be defined as distributing the cost of an asset - less any value remaining at its life's end - over its working life. This is then a process of allocation, rather than valuation.
Depreciation does not itself provide any cash for replacement. To provide cash, it is necessary to transfer some cash to a special fund (called a sinking fund), the amount of cash being related to the annual depreciation charge. Such a cash transfer will not necessarily provide sufficient cash to replace an asset, because in conventional accounts, the depreciation charge is based on the purchase - rather than the replacement - price. However, if the sum set aside for the replacement is invested so as to attract sufficient interest, there will be enough cash to replace the asset.
Suspense Accounts
A suspense account is a temporary account that is used to collect transaction is raised. For instance, if a bookkeeper receives cash from an unknown source, he will put it in a suspense account. The double entry would be a debit to cash, and a credit to suspense account. When the source of the cash is identified, the suspense account must be debited, the credit going to the appropriate account. Under no circumstances should there be a suspense account at the time that a year-end balance sheet is prepared.
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