EXERCISE 1 ANSWERS

Accruals & Prepayments

(a) Accruals
These include revenues not yet received nor recorded and expenses not yet paid nor
recorded. For example, interest expense on loan accrued in the current period but not yet
paid. Other examples of accruals include; an electricity bill or rent not yet paid,
commission which might have been earned, but the payment is received after the end of
the financial year to which it relates.

(b) Prepayments
These are revenues received in advance and recorded as liabilities, to be recorded as
revenue and expenses paid in advance and recorded as assets, to be recorded as expense.
For example, prepaid insurance, rent received account for this financial year could
include an advance payment received from a tenant in respect of the next financial year, a
law firm receiving a retainer fee from a new client, a web designer receiving a client’s
down payment for future work, a magazine publisher, receiving money from a subscriber
for magazines for the following year.

(c) In the double-entry accounts, the amount of the accrual and the transfer of the year’s
expense to the statement of profit and loss are shown. The Electricity account in the
records of Masha and the Bear Inc. will appear as follows:

Dr Cr
$

2018 2018 $
31-Dec Balance b\f 6,500 31-Dec Statement of profit or loss 7,000

1
 31-Dec Balance c\f 500
7,000 7,000
2019 $ 2019 $
1-Jan Balance b\f 500

As $500 was owing for the electricity expense at the end of 2018, the transfer to the statement of
profit or loss should be the expense of $7,000 that was incurred for the year 2018. The amount of
the accrual, $500 is carried down to the credit side of the electricity account. It is listed on the
Balance sheet at 31st December 2018 as a current liability.

The Water expense account in the records of Masha and the Bear Inc. will appear as follows:

Dr Cr
$

2018 2018 $
31-Dec Balance b\f 1,700 31-Dec Statement of profit or loss 2,000
31-Dec Balance c\f 300
2,000 2,000
2019 $ 2019 $
1-Jan Balance b\f 300

The water expense that was paid in January 2019 included an amount which was not paid in
2018. This means that $300 was owing for the water expense at the end of 2018 hence, the
transfer to the statement of profit or loss is the expense of $7,000 that was incurred for the year

2
2018. The amount of the accrual, $300 is carried down to the credit side of the electricity
account. It is listed on the Balance sheet at 31st December 2018 as a current liability.

The Salaries expense account in the records of Masha and the Bear Inc. will appear as follows:

Dr Cr
$

2018 2018 $
31-Dec Balance b\f 180,000 31-Dec Statement of profit or loss 178,500
31-Dec Balance c\f 1,500
180,000 180,000
2019 $ 2019 $
1-Jan Balance b\f 1,500

As $1,500 was prepaid for the expense at the end of 2018, the transfer to the statement of profit
or loss should be the expense of $178,500 that was incurred for the year 2018. The amount of the
prepayment, $1,500 is carried down to the debit side of the salaries account. It is listed on the
Balance sheet at 31st December 2018 as a current asset.

It is in February 2019 that the accountant has to make some final entries for the financial record
of 2018. It is given that for the past two years the Audit fee has been the same and has amounted
to $5,000. That is $2,500 for each year and if the fee is to be the same for 2018, then the amount
owing for the year 2018 is $2,500.

The Audit fees account in the records of Masha and the Bear Inc. will appear as follows:

Dr Cr

3
 $

2018 2018 $
31-Dec Statement of profit or loss 2,500
31-Dec Balance c\f 2,500
2,500 2,500
2019 $ 2019 $
1-Jan Balance b\f 2,500

Extracts of the profit/loss and the balance sheet will appear as follows:

Masha and the Bear Inc.

Profit and Loss Account for Year Ended 31 December 2018.

$ $

4
 Gross Profit xxxx
Expenses:
Electricity 7,000
Water 2,000
Salaries 178,500
Audit fees 2,500
Advertising xxxx
Total Expenses xxxx
Net Profit xxxx

Masha and the Bear Inc.

Balance Sheet Account for Year Ended 31 December 2018.

Cost Depn NBV

Fixed Assets
Motor Vehicle xxxx xxx xxxx
Office Equipment xxxx xxx xxxx
xxxx

Current Assets
Stocks xxxx
Prepaid Salary 1,500
Debtors xxxx

5
 xxxx

Less Current Liabilities

Creditors xxxx
Accrued Electricity Expense 500
Accrued water Expense 300
Accrued Audit fees 2,500
xxxx
Net Current Assets xxxx

EXERCISE 2 ANSWERS

Fixed Assets & Depreciation

(a) Straight line method

The straight-line method involves deducting a fixed percentage of the assets initial book
value, minus the estimated residual value each year. The estimated residual value means
the value at the end of the asset’s useful life within the business (which may be scrap
value).

It is given that at 31st July 20x6, Apollon had non-current assets at the cost of $310, 000
and had not disposed of any non-current assets during the year to 31st July 20x7. Since
the depreciation charge of these assets is at 25% per annum, under straight line method;
the depreciation charge at the end of the year to 31st July 20x7 of these non-current assets
25
will be 100
×310, 000 = 77, 500.

However, during the year to 31st July 20x7, the company acquired an asset at a cost of
$79,200 on 1st January 20x7 and since the depreciation is charged from the first year of
acquisition with a full year’s charge, under straight line method; the depreciation charge
25
at the end of the year to 31st July 20x7 of this asset will be 100
×79, 200 = 19, 800.

Hence the company’s depreciation charge for the year to 31st July 20x7 under the
straight-line method will be $77, 500 + $19, 800 = $97300.

6
(b) Reducing balance method
This method also applies a fixed percentage, but it applies it to the diminishing value of
the asset each year—not to the initial value.
It is given that at 31st July 20x6, Apollon had non-current assets at the cost of $310, 000
and the accumulated depreciation of the assets at $120,000. The company had not
disposed of any non-current assets during the year to 31st July 20x7. Since the
depreciation charge of these assets is at 25% per annum, under reducing balance method;
the depreciation charge at the end of the year to 31st July 20x7 of these non-current assets
25
will be 100
×(310, 000 − 120, 000) = 47, 500.

During the year to 31st July 20x7, the company also acquired an asset at a cost of $79,200
on 1st January 20x7 and since the company allows a full year’s depreciation charge
from the first year of acquisition, under the reduced balance method; the depreciation
charge at the end of the year to 31st July 20x7 of this asset will be
25
100
×79, 200 = 19, 800.

Hence the company’s depreciation charge for the year to 31st July 20x7 under the
reduced balance method will be $47, 500 + $19, 800 = $67, 300.

7
EXERCISE 3 ANSWERS

Uncollectible accounts

(a) When a company goes to prepare its financial statements, it needs to determine what
portion of its receivables is collectible. The portion that a company believes is
uncollectible is what is called bad debt expense. There are two methods a company can
use to recognize bad debts: the direct write-off method and the allowance method.
The write-off of a bad debt usually refers to eliminating an account receivable due to the
customer’s inability to pay the amount owed. This method delays recognition of bad
debts until the specific customer accounts receivable is identified. Once this account is
identified as uncollectible, the journal entry to write off the account is; credit accounts
receivable (to remove the amount that will not be collected) and debit bad debts expense
(to report the amount of the loss on the company's income statement).
For example, a customer takes a $15,00 car loan on 1st August 2019 and is expected to
pay the amount in full before 1st December 2018. For the sake of this example, assume
that there was no interest charged to the buyer because of the short-term nature or life of
the loan. When the account defaults for nonpayment on 1st December 2019, the company
will record would record the following journal entry to recognize bad debt.

8
 Journal
Date Account Debit Credit
Dec. 1 Bad Debt Expense 15,000
Accounts Receivable 1500
To write-off Bad Debt

The allowance for bad debts account is used when bad debt expense is recorded prior to
knowing the specific accounts receivable that will be uncollectible. For example, a
company might have 500 customers purchasing on credit and they owe a company a total
of $1,000,000. The $1,000,000 is reported on the company’s balance sheet as accounts
receivable. The company doesn't know specifically which customer will not pay, but it
estimates that a few customers out of the 500 will not be paying the full amount they
owe. The company estimates that $10,000 will not be collected. Rather than waiting until
those specific customers are identified, the company makes an accounting entry that
debits bad debt expense and credits allowance for bad debts Account. When a specific
customer's account is identified as uncollectible, the journal entry to write off the account
is then initiated by a credit to accounts receivable (to remove the amount that will not be
collected) and a debit to allowance for bad debts account (to reduce the allowance
balance that was previously established).
The amount of the entry will be the amount necessary to get the ending balance in the
allowance account to be a credit of $10,000. When the balance sheet is prepared, it will
show accounts receivable of $1,000,000 less the allowance of $10,000 for a net realizable
value of $990,000—the amount that will likely be turned into cash. The entry also meant
that the income statement will be reporting $10,000 of bad debt Expense sooner than if
the company waited for the customers to admit they were not able to pay. This means that
the expense is matched more closely with the revenues—the goal of accounting's
matching principle.

9
(b) When a specific customer's account is identified as uncollectible, the journal entry to
write off the account is done by a credit to accounts receivable (to remove the amount
that will not be collected) and a debit to allowance for bad debts account (to reduce the
allowance balance that was previously established).
Since during the year 2017 $740,000 in accounts receivable were written off as
uncollectible, the following journal entry would occur.

Journal
Date Account Debit Credit
Allowance for Doubtful
DD/MM/2017 Accounts 740,000
Accounts Receivable 740,000
To record known Bad Debts

(c) Since receivables totaling $24,000 were unexpectedly collected, the following journal
entries show the reinstatement of bad debt and the subsequent payment.

Journal
Date Account Debit Credit
DD/MM/201
7 Accounts Receivable 24,000
Allowance for Doubtful Debts 24,000
To reinstate previously written-off bad
debt
DD/MM/201
7 Cash 24,000
Accounts Receivable 24,000
To record bad debt for specific customer

10
 The first entry reverses the previous entry where bad debt was written off. This
reinstatement requires Accounts Receivable to increase (debit), and Allowance for
Doubtful Accounts to increase (credit). The second entry records the payment on the
account. Cash increases (debit) and Accounts Receivable decreases (credit) for the
amount received. However, the outstanding balance of $716,000 that was not repaid will
remain as bad debt.

(d) Since the company already had a credit balance from 2016 of $70,000, plus all accounts
that have been written off during 2017, and a current period estimated balance of
$80,000, the company would need to subtract the prior period’s credit balance from the
current period’s estimated credit balance in order to calculate the amount to be added to
the Allowance for Doubtful Accounts. That is, Allowance for Doubtful Accounts
= $80, 000 − $70, 000 = $10, 00.
Therefore, the adjusting journal entry would be as follows.

Journal
Date Account Debit Credit
Dec. 31 Bad Debt Expense 10,000
Allowance for Doubtful
Accounts 10,000
To record estimated Bad Debt

EXERCISE 4 ANSWERS

Capital & Revenue Expenditure

In a nutshell, non-recurring expenditures for high-value items are capital expenditures that have a
longer duration requirement. While in contrast, revenue expenditures are the routine recurring
expenditures that take place in the normal business.

A. Purchase of a motor car

11
 This is a capital expenditure as the motor car can be used for longer durations and can
help carry out services for customers and improve operational efficiency for instance, in
delivery companies.

B. Claim for a meal

This is a recurring expenditure that occurs fairly frequently. Hence, it will be classified as
revenue expenditure.

C. Purchase of shares in a supplier

Capital expenditures enhance the position of the business and trade. Expenditures made
to increase the revenue will certainly enhance the position of busines and trade hence
purchase of shares in a supplier will be classified as capital expenditure as this is also an
investment in a long-term financial health of the company.

D. Purchase of a new Computer

This is a capital expenditure since the computer purchased is likely to have a useful life
transcending a year and this will certainly result in an upgrade of the IT equipment and
improve the financial health of the company.

E. Payment of hotel accommodation

This falls under routine recurring expenditures. It a cost that will be an expense in the
accounting period and as such will be classified as revenue expenditure.

F. Installation cost of a sever

The sever being installed is likely to have a useful life of more than a year and this will
certainly result in an upgrade of the IT equipment and improve the financial health of the
company. Hence, it will be classified as capital expenditure.

12
G. Purchase of raw materials
This is a short-term recurring expense to meet the ongoing operational cost of running a
business hence, it will be classified as revenue expenditure.

H. Repair of motor vehicles

This falls under the routine expenditures that takes place in the normal
business. This kind of expenditure maintains fixed assets and hence, will be classified as
revenue expenditure.
I. Purchase of new stationary
This is a purchase of a long-term asset which will ultimately improve the company’s
ability to generate revenue and earnings and hence, will be classified as capital
expenditure.

J. Payment of an insurance premium

This is a recurring type of expenditure. It a cost that will be an expense in the accounting
period and as such will be classified as revenue expenditure.

K. Wages
This falls under the routine expenditures that takes place in the normal
business and help meet the ongoing operational cost of running a business hence, it will
be classified as revenue expenditure.

L. Purchase of a new plot of land

This is a capital expenditure as land can be used for longer durations and help undertake
new projects or investments by a company.

13