ACCOUNTANCY FORM 5 – CORRECTION OF ACCOUNTING ERRORS

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RESERVES AND PROVISIONS

 INTRODUCTION:

• Any business firm must have an asset in conducting its activities.
  
• Assets are the possessions of the business.
  
• They are things of value that the firm utilizes in conducting business
  
• They are the actual resources that are in the business.
  
• Assets include land, building, machinery , stock of goods, debtors cash.
  
• Assets are financed by capital and liabilities or in technical terms are financed by equities.
  

 

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DEFINITION OF RESERVE:

It is an amount set aside out of profits (i.e. from the profit and loss account or any surpluses for unidentified or Unspecified purposes.

KIND OF RESERVES:

Reserved can be classified into the following major categories.

   1.  Revenue reserve
2.  Capital reserve

  1.REVENUE RESERVE

Is a fund / amount created by voluntary transferring part of the profit kind      normally becomes part of the name of that reserve.

           TYPES OF REVENUE RESERVE

1. Specific reserves: These reserves created out of revenues profit for a specific purpose.

 2. General reserve: These are reserves created out of revenue profit for
general purposes.

 2. CAPITAL RESERVES.

These are reserves which are created out of the capital profits. These  reserves are not available for nglish-swahili/distribution” target=”_blank”>distribution among shareholders as dividend in the case of companies.

Examples or sources of capital reserve:

1. Profit on sale of fixed assets: it should be noted that capital profit is only excess of sale price over the cost of fixed asset.
2. Profit prior to incorporation.
3. Premium on issue of shares of debentures.
4. Profits on redemption of debentures
5. Profit on for feature of shares.
6. Surplus on revaluation of fixed assets
7. Amount transferred out of profits to capital.

PROVISION

Provision usually means any amount written off or retained by way of providing
depreciation, renewals or diminution in the value of asset or retained by way of
providing for any known liability of which the amount cannot be determined with substantial accuracy.

Difference between reserve and provision

1. A reserve is an appropriation of profit while a provision is a charge against profits .in other words true profits cannot be determined without making adjustment for the provisions required.
2. Creation of reserves increases proprietor’s funds while creation of provisions decreases his funds in the business.
3. Provisions are created to meet some known contingency, the amount of which cannot be precisely determined .Reserves are created to meet some financial position of the business, while creation of previsions help in maintaining the exiting financial position.

 

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PROVISION FOR BAD AND DOUBTFUL DEBTS.

Bad debts:

 1. Accounting entries on bad debts.

     Dr; bad debts a/c

     Cr; debtors a/c

    Then at the end of accounting period.

       Dr: P&L

       Cr: bad debts

2.
Discount allowed

           Dr: P&L

            CR: Provision for discount allowed.

3.Treatment on provision for B.D D
i.In the first year:

     Dr: P&L

           Cr: provision for B. D.D

   ii. Decrease in provision for B.D.D

     Dr .Provision for B.D.D

           Cr: P&L
iii. Increase in provision
Dr: P&L
CR: Provision for B.D.D

EXAMPLE

List of debtors.

Rate of provision for B.D.D is 10% P.A

Draw Up:

  1. provision for B.D.D A/C

2. balance sheet as at 31. 12. 2000 – 2011

      2008: 100,000 x   10/100 = 10,000

      2009: 150,000 x 10/100 =   15,000

      2010: 145,000 x 10/100 = 14,500

      2011: 140,000 x 10/100   = 14,000

  DR               PROVISION FOR BAD AND DOUBTFUL DEBTS   A/C                                                                           CR

                   BALANCE     SHEET     AS     AT       31.12.2008

BAD DEBTS RECOVERED.

• when bad debts recorded
  

 

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     Dr: cash / bank

     Cr: bad debt recoverable a/c

Then at the end of accounting period:

           Dr: bad debts recoverable a/c

           Cr: P & L

QUESTIONS:
1. A business makes a provision for bad debts and discount allowed at a rate of 6% and 3% of debtors respectively

The debtors balance as at 31^st December were;

            1995               85,000

            1996               75,000

            1997               90,000

You are required to show the necessary entries in the provision accounts, profit and loss account and balance sheets for those years.
1. A trader makes a provision for discounts received at the rate of 4% of creditors at the end of the year. The creditors balance as at 31^st December were.

19 -2               12,000

                         19-3                15,000

                         19-4                10,000

                         19-5                13,000

You are required to show the necessary entries in the provision for discount received account, profit and loss account and balance sheet as at for these gears.

3. The following items appear in A white trial balance dated 31^st December 19-7

It is white’s policy to keep the provision for bad debts. Discount allowed and discount received at the rate of 5%, 2.5% and 6% on debtors.

You are required to show the entries in:-
1.The P & L account (extract) for the year ended 31 .12. 19-9
2. Balance sheet (extract) as at 31. 12. 19-9

      CALCULATION (1)

    Provision for bad debts at a rate of 6%

       1995:              85,000 x 6/100 = 5,100

       1996:              75,000 x 6/100 = 4500

       1997:              90,000 x 6/100 = 5400

 DR                                            PROVISION FOR BAD AND DOUBTFUL DEBTS   A/C                                CR

 DR                                                     PROFIT AND LOSS A/C                                                                 CR

4. E.C Commenced business on 1^st January 1997 and his account end to 31  December, every year. For the ended 31. 12. 1997, bad debts written off amounted to 1200/=, if was also found necessary to create the provision for doubt of 2,000/= in 1998, debts, amounting to 1600, proved bad and were w/o. Mrs Lema, whose debts of 350 was w/o as bad in 1997 settled her account in full on 30.11.1998. As at 31.12.1998 total debts outstanding were 56,000 it was decided to bring  provision up to 5% on this figure of that date.In 1999, 2,350 debts were w/o during the year, and another recovery of 150 was made in respect of debts w/o in 1997. As 31^st .12.1999, total debts outstanding were 42,000; the provision for doubtful debt is to be maintained at 5% of this figure.

You are required to prepare:-

    1. Bad debts a/c.
2. Provision for bad debts a/c.
3. Bad debts recovery a/c.

CALCULATION (4)

  DR                                                             BAD DEBTS A/C                                                                           CR

 DR                                                PROVISION FOR BAD AND DOUBTFUL DEBTS   A/C                                 CR

Workings:

31.12.1998: 56000 X 5/100 = 2800

31.12.1999: 42000 X 5/100 = 2100

 DR                                                 BAD   BEBTS   RECOVERY   A/C                                                               CR