ASSOCIATION OF CHARTERED

CERTIFIED ACCOUNTANTS

F3 – FINANCIAL ACCOUNTING
Lecturing C – Meeting 01
Accruals & Prepayments and
Irrecoverable debts & Allowances
 ACCRUALS
AND PREPAYEMENTS
 Learning Objective
1. Accruals and Prepayments
a. Understand how the matching concept applies to
accruals and prepayments.
b. Identify and calculate the adjustments needed for
accruals and prepayments in preparing financial
statements.
c. Illustrate the process of adjusting for accruals and
prepayments in preparing the financial statements.
d. Prepare the journal entries and ledger entries for the
creation of an accrual or prepayment.
e. Understand and identify the impact on profit and net
assets of accruals and prepayments.

ACCA Paper F3 – Batch XV 3

Introduction
We have already seen that the gross profit for a period should be
calculated by matching sales and the cost of goods sold.

In the same way, the profit for the year for a period should be
calculated by charging the expenses which relate to that period.

For example, in preparing the statement of profit or loss of a business

for a period of, say, six months, it would be appropriate to charge six
months' expenses for rent and local taxes, insurance costs and
telephone costs, etc.

ACCA Paper F3 – Batch XV 4

Introduction
Accruals or accrued expenses are expenses which
are charged against the profit for a particular
period, even though they have not yet been paid
for.

Prepayments are payments which have been made

in one accounting period, but should not be
charged against profit until a later period, because
they relate to that later period.

ACCA Paper F3 – Batch XV 5

Examples 1: Accruals
Jhonson Co, ends his financial year on 28 February each year.
His telephone was installed on 1 April 20X6 and he receives his
telephone account quarterly at the end of each quarter. On the
basis of the following data, you are required to calculate the
telephone expense to be charged to the statement of profit or
loss for the year ended 28 February 20X7.

Jhonson Co – telephone expense for the three months ended:

$
30.6.20X6 23.50
30.9.20X6 27.20
31.12.20X6 33.40
31.3.20X7 36.00

ACCA Paper F3 – Batch XV 6

Examples 1: Accruals - Solution
Solution:

The telephone expenses for the year ended 28 February 20X7 are:
$
1 March – 31 March 20X6 (no telephone) 0.00
1 April – 30 June 20X6 23.50
1 July – 30 September 20X6 27.20
1 October – 31 December 20X6 33.40
1 January – 28 February 20X7 (two months) (2/3 × 36) 24.00
Total 108.10

ACCA Paper F3 – Batch XV 7

Examples 2: Accruals
Handy started in business as a paper plate and cup
manufacturer on 1 January 20X2, making up accounts to 31
December 20X2.

Electricity bills received were as follows.

20X2 20X3 20X4
$ $ $
31 January – 6,491.52 6,753.24
30 April 5,279.47 5,400.93 6,192.82
31 July 4,663.80 4,700.94 5,007.62
31 October 4,117.28 4,620.00 5,156.40

What should the electricity charge be for the year ended 31

December 20X2?

ACCA Paper F3 – Batch XV 8

Examples 2: Accruals - Solution
Solution:

The three invoices received during 20X2 totalled $14,060.55, but this
is not the full charge for the year: the November and December
electricity charge was not invoiced until the end of January.
To show the correct charge for the year, it is necessary to accrue the
charge for November and December based on January's bill. The
charge for 20X2 is:
$
Paid in year 14,060.55
Accrual (2/3 x $6,491.52) 4,327.68
Total 18,388.23

The double entry for the accrual (using the journal) will be:
DEBIT Electricity account $4,327.68
CREDIT Accruals (liability) $4,327.68

ACCA Paper F3 – Batch XV 9

Examples 3: Prepayments
A business opens on 1 January 20X4 in a shop which is on a 20
year lease. The rent is $20,000 per year and is payable
quarterly in advance.
Payments were made on what are known as the 'quarter-days'
(except the first payment) as follows.
$
1 January 20X4 5,000.00
25 March 20X4 5,000.00
24 June 20X4 5,000.00
29 September 20X4 5,000.00
25 December 20X4 5,000.00

What will the rental charge be for the year ended 31 December
20X4?

ACCA Paper F3 – Batch XV 10

Examples 3: Prepayments - Solution
Solution:

The total amount paid in the year is $25,000. The yearly rental,
however, is only $20,000. The last payment was almost entirely
a prepayment (give or take a few days) as it is payment in
advance for the first three months of 20X5.
The charge for 20X4 is therefore:
$
Paid in year 25,000.00
Prepayment (5,000.00)
Total 20,000.00

The double entry for this prepayment is:

DEBIT Prepayments (asset) $5,000.00
CREDIT Rent account $5,000.00

ACCA Paper F3 – Batch XV 11

Double Entry for Accruals and Prepayments
You can see from the double entry shown for both these examples
that the other side of the entry is taken to an asset or a liability
account.

- Prepayments are included in receivables in current assets in the

statement of financial position. They are assets as they represent
money that has been paid out in advance of the expense being
incurred.

- Accruals are included in payables in current liabilities as they

represent liabilities which have been incurred but for which no invoice
has yet been received.

ACCA Paper F3 – Batch XV 12

Examples 4: Accruals
Miley is a business dealing in pest control. Its owner, Roy, employs a team of
eight who were paid $12,000 per annum each in the year to 31 December
20X5. At the start of 20X6 he raised salaries by 10% to $13,200 per annum
each.

On 1 July 20X6, he hired a trainee at a salary of $8,400 per annum. He pays

his work force on the first working day of every month, one month in arrears,
so that his employees receive their salary for January on the first working day
in February, etc.

Required
(a) Calculate the cost of salaries which would be charged in the statement of
profit or loss of Miley for the year ended 31 December 20X6.
(b) Calculate the amount actually paid in salaries during the year (ie the
amount of cash received by the work force).
(c) State the amount of accrued charges for salaries which would appear in the
statement of financial position of Miley as at 31 December 20X6.

ACCA Paper F3 – Batch XV 13

Examples 4: Accruals - Solution
Solution:

ACCA Paper F3 – Batch XV 14

Examples 5: Prepayments
The Connoe Print Shop rents a photocopying machine from a supplier for which it makes a
quarterly payment as follows:

(a) Three months' rental in advance.

(b) A further charge of 2 pence per copy made during the quarter just ended.

The rental agreement began on 1 August 20X4 and the first six quarterly bills were as
follows.
Bills dated and received Rental Costs of copies taken Total
$ $ $
1 August 20X4 2,100 0 2,100
1 November 20X4 2,100 1,500 3,600
1 February 20X5 2,100 1,400 3,500
1 May 20X5 2,100 1,800 3,900
1 August 20X5 2,700 1,650 4,350
1 November 20X5 2,700 1,950 4,650
The bills are paid promptly, as soon as they are received.
(a) Calculate the charge for photocopying expenses for the year to 31 August 20X4 and
the amount of prepayments and/or accrued charges as at that date.
(b) Calculate the charge for photocopying expenses for the following year to 31 August
20X5, and the amount of prepayments and/or accrued charges as at that date.

ACCA Paper F3 – Batch XV 15

Examples 5: Prepayments - Solution
Solution:

ACCA Paper F3 – Batch XV 16

Examples 5: Prepayments - Solution
Solution:

ACCA Paper F3 – Batch XV 17

Effects on profit and net assets
You may find the following table a useful summary of the
effects of accruals and prepayments.

ACCA Paper F3 – Batch XV 18

 IRRECOVERABLE
DEBTS AND ALLOWANCES
 Learning Objective
2. Irrecoverable debts and allowances
a. Identify the benefits and costs of offering credit facilities to
customers.
b. Understand the purpose of an aged receivable analysis.
c. Understand the purpose of credit limits.
d. Prepare the bookkeeping entries to write off an irrecoverable
debt.
e. Record an irrecoverable debt recovered.
f. Identify the impact of irrecoverable debts on the statement of
profit or loss and statement of financial position.
g. Prepare the bookkeeping entries to create and adjust an
allowance for receivables.
h. Illustrate how to include movements in the allowance for
receivables in the statement of profit or loss and how the closing
balance of the allowance should appear in the statement of
financial position.

ACCA Paper F3 – Batch XV 20

Introduction
Very few businesses expect to be paid immediately in cash, unless they are retail
businesses on the high street. Most businesses buy and sell to one another on credit
terms. This has the benefit of allowing businesses to keep trading without having to
provide cash 'up front'. So a business will allow credit terms to customers and receive
credit terms from its suppliers. Ideally a business wants to receive money from its
customers as quickly as possible, but delay paying its suppliers for as long as possible.

This can lead to problems. Customers might fail to pay, perhaps out of dishonesty or
because they have gone bankrupt and cannot pay.

Therefore, the costs of offering credit facilities to customers can include:

Interest costs of an overdraft, if customers do not pay promptly
Costs of trying to obtain payment
Court costs

For one reason or another, a business might decide to give up expecting payment and to
write the debt off.
An irrecoverable (or ‘bad’) debt is a debt which is definitely not expected to be
paid. An irrecoverable debt could occur when, for example, a customer has gone
bankrupt.

ACCA Paper F3 – Batch XV 21

Writing off Irrecoverable Debts
To begin with, lets recap the ledger entries when a sale on credit is made to a customer:
DEBIT Trade receivables
CREDIT Sales

All being well, a few weeks later, the customer will pay the debt and cash will be received,
at which point the double entry is:
DEBIT Cash account
CREDIT Trade receivables

But what happens if, instead, the customer goes bankrupt and then can’t pay? Remember
that according to the Conceptual framework an asset is a resource controlled by an entity
from which future economic benefits are expected to flow. If the customer can’t pay, then
no economic benefits are expected to flow from the trade receivable. So the trade
receivable no longer meets the definition of an asset and it must be removed from the
statement of financial position and is charged as an expense in the statement of profit or
loss.

The ledger entries to write off an irrecoverable debt are:

DEBIT Irrecoverable debts expense (statement of profit or loss)
CREDIT Trade receivables (statement of financial position)

ACCA Paper F3 – Batch XV 22

Example
Design Co has a total balance for trade receivables of $25,000 at the year end. A review of
the receivables balances highlights that one of its customers, Mann Co, has gone bankrupt.
Design Co is owed $4,000 by Mann Co for design work done during the year. This debt is
now considered irrecoverable.

Required
(a) What is the balance for trade receivables to be shown in the statement of financial
position at the year end?
(b) What is the irrecoverable debts expense to be shown in the statement of profit or loss
at the year end?

ACCA Paper F3 – Batch XV 23

Irrecoverable debts written off and subsequently paid
An irrecoverable debt which has been written off might
occasionally be unexpectedly paid. Because the debt has
already been written off, it no longer exists in the statement of
financial position and so the cash received cannot be offset
against it in the usual way.

Instead, the cash received is offset against the irrecoverable

debts expense. Regardless of when the payment is received,
the ledger entries are as follows:

DEBIT Cash account

CREDIT Irrecoverable debts expense

ACCA Paper F3 – Batch XV 24

Allowances for Receivables
Understand the differences between ‘irrecoverable debts’ and ‘doubtful debts’.

Irrecoverable debts are specific debts which are definitely not expected to be paid.
However, there may be some debts which the business thinks might not be paid, these
are known as doubtful debts. A doubtful debt is a debt which is possibly irrecoverable.

Doubtful debts may occur, for example, when an invoice is in dispute, or when a customer
is in financial difficulty.
In this situation, the debt is not written off, as it is not certain that the debt is
irrecoverable. But because there is doubt over whether the debt will be paid, a provision,
known as an allowance for receivables, is made against the doubtful debt.

Allowance for receivables. An amount in relation to receivables that reduces the

receivables asset to its prudent valuation in the statement of financial position. It is offset
against trade receivables, which are shown at the net amount.

An allowance for receivables provides for potential irrecoverable debts, as a prudent

precaution by the business. The business will thereby be more likely to avoid claiming
profits which subsequently fail to materialise because some specific debts turn out to be
irrecoverable.

ACCA Paper F3 – Batch XV 25

Specific and General Allowances for Receivables
There are two kinds of allowances for receivables that can be made:

(a) A specific allowance against a specific doubtful debt. The doubtful debt may be a
particular invoice or perhaps the whole balance outstanding from a particular customer.
(b) A general allowance against the remaining trade receivables balance.

A general allowance for receivables is an estimate of the percentage of remaining debts (ie
after deducting bad debts and specific doubtful debts) which are ultimately not expected to
be paid.

A general allowance is an allowance created to provide against the remaining trade

receivables balance, after writing off any bad debts and after accounting for any specific
doubtful debts. A general allowance is calculated based on experience of how many debts
usually turn out to be irrecoverable, and tends to be expressed as a percentage, eg ‘a
general allowance of 2% of trade receivables’.

The total allowance for receivables is the sum of any specific allowances plus the general
allowance.

ACCA Paper F3 – Batch XV 26

Accounting Treatment in the Financial Statements
When an allowance for receivables is first set up, the whole amount is debited to the statement of
profit or loss.
In subsequent years, only the movement on the receivables allowance is debited or credited to
irrecoverable debts expense in the statement of profit or loss.

When a business firsts sets up an allowance for receivables, the full amount of the allowance should
be debited to irrecoverable debts expense as follows:
DEBIT Irrecoverable debts expense (statement of profit or loss)
CREDIT Allowance for receivables (statement of financial position)

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 allowance is required now:

DEBIT Irrecoverable debts expense (statement of profit or loss)
CREDIT Allowance for receivables (statement of financial position)
with the amount of the increase.

(ii) If a lower allowance is needed now than before:

DEBIT Allowance for receivables (statement of financial position)
CREDIT Irrecoverable debts expense (statement of profit or loss)
with the amount of the decrease.
ACCA Paper F3 – Batch XV 27
Example:
Alex Gullible has total receivables 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 at all.
On 31 December 20X3 his trade accounts receivable 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 trade receivables will appear
in his statements of financial position as at those dates?

ACCA Paper F3 – Batch XV 28

Solution:

ACCA Paper F3 – Batch XV 29

Solution:

ACCA Paper F3 – Batch XV 30

Example & Solution:
QUESTION:

XY Co has a balance of receivables of $250,000. It wishes to provide a specific allowance

of 60% on a debt of $20,000. It also wishes to set up a general allowance of 2% of
receivables. What is the charge to the statement of profit or loss?

ANSWER

Specific allowance
60% × $20,000 = $12,000

General allowance
$
Total receivables 250,000
Specific provision (20,000)*
Balance 230,000
General allowance = 2% × $230,000 = $4,600

Total allowance charged in statement of profit or loss = $12,000 + $4,600= $16,600

*Note how the whole debt against which the specific provision is made is removed from
total receivables before the general provision is calculated.

ACCA Paper F3 – Batch XV 31

Example: irrecoverable debts and allowance for receivables
combined
QUESTION:

Consider the following example.

Fatima's receivables at 31 May 20X7 were $723,800. The balance on the

allowance for receivables account at 1 June 20X6 was $15,250. Fatima has
decided to change the allowance for receivables to 1.5% of receivables at 31
May 20X7.

On 14 May 20X7 Fatima received $540 in final settlement of an amount written

off during the year ended 31 May 20X6.

Required
What total amount should be recognised for receivables in the statement of
profit or loss for the year ended 31 May 20X7?

ACCA Paper F3 – Batch XV 32

Solution: irrecoverable debts and allowance for receivables
combined
SOLUTION:

First, note the requirement's wording 'recognised for receivables in the statement of profit
or loss'. This means the total charge (or recovery) for irrecoverable debts and the
allowance for receivables in the statement of profit or loss.

Secondly, consider the allowance for receivables.

$
Closing allowance required (723,800 × 1.5%) 10,857
Opening allowance (15,250)
Reduction needed in allowance (4,393)

Remember that a reduction to the allowance for receivables is a credit to the statement of
profit or loss.

Thirdly, the amount received of $540 had already been written off the previous year and
now needs to be credited to irrecoverable debts.

Therefore the total credit to the statement of profit or loss = 540 + 4,393 = $4,933

ACCA Paper F3 – Batch XV 33

THE END