Topic 3: Reserves And Provisions – Accountancy Notes Form 5 & 6
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, and debtors cash.
Assets are financed by capital and liabilities or in technical terms are financed by equities.
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
i. Specific reserves: These reserves created out of revenues profit for a specific purpose.
ii. 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 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.
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.
| YEAR | DEBTORS |
20082009 2010 2012 | 100,000150,000 145,000 140,000 |
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
| 31.12.2008 | Balance c/d | 10,000 | 31.12.2008 | P & L | 10,000 |
| 31.12.2009 | Balance c/d | 15,000 | 1.1.2009 | Balance b/d | 10,000 |
| 31.12.2009 | P & L | 5,000 | |||
| 15,000 | 15,000 | ||||
| 31.12.2010 | P & L | 500 | 1.1.2010 | Balance b/d | 15,000 |
| 31.12.2010 | Balance c/d | 14,500 | |||
| 15,000 | 15,000 | ||||
| 31.12.2011 | P & L | 500 | 1.1.2011 | Balance b/d | 14,500 |
| 31.12.2011 | Balance c/d | 14,000 | |||
| 14,500 | 14,500 | ||||
| 1.1.2012 | Balance b/d | 14,000 |
BALANCE SHEET AS AT 31.12.2008
| 2008 | Debtors | 100,000 | ||
| less: Provision for B.B.D | 10,000 | 90,000 | ||
| 2009 | Debtors | 150,000 | ||
| less: Provision for B.B.D | 15,000 | 135,000 | ||
| 2010 | Debtors | 145,000 | ||
| less: Provision for B.B.D | 14,500 | 130,500 | ||
| 2011 | Debtors | 140,000 | ||
| less: Provision for B.B.D | 14,000 | 126,000 | ||
BAD DEBTS RECOVERED.
- when bad debts recorded
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 31st 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 31st 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 31st December 19-7
| DR | CR | ||
| Tsh | Tsh | ||
| Bad debts | 3,000 | ||
| Discount allowed | 1,420 | ||
| Discount received | 3,000 | ||
| Trade debtors | 70,000 | ||
| Trade creditors | 110,000 |
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
| 31.12.1995 | Balance c/d | 5100 | 31.12.195 | p&L | 5100 |
| 31.12.1996 | p&l | 600 | 1.1.1996 | balance b/d | 5100 |
| 31.12.1996 | Balance c/d | 4500 | |||
| 5100 | 5100 | ||||
| 1.1.1997 | balance b/d | 4500 | |||
| 31.12.1997 | Balance c/d | 5400 | p&l | 900 | |
| 5400 | 5400 | ||||
| 1.1.1998 | balance b/d | 5400 |
DR PROFIT AND LOSS A/C CR
| 31.12.1995 | provision for B.D.Debts | 5100 | 31.12.1996 | provision for B.D.Debts | 600 |
| 31.12.1997 | provision for B.D.Debts | 900 | |||
4. E.C Commenced business on 1st 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 31st .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
| 31.12.1997 | Debtors | 1200 | 31.12.1997 | p&l | 1200 |
| 31.12.1998 | Debtors | 1600 | 31.12.1998 | p&l | 1600 |
| 31.12.1999 | Debtors | 2350 | 31.12.1999 | p&l | 2350 |
DR PROVISION FOR BAD AND DOUBTFUL DEBTS A/C CR
| 31.12.1997 | Balance c/d | 2,000 | 31.12.1997 | p&l | 2,000 |
| 31.12.1998 | Balance c/d | 2,800 | 1.1.1998 | balance b/d | 2,000 |
| 31.12.1998 | p&l | 800 | |||
| 2,800 | 2,800 | ||||
| 31.12.1999 | p&l | 700 | 1.1.1999 | balance b/d | 2,800 |
| 31.12.2000 | Balance c/d | 2,100 | |||
| 2,800 | 2,800 | ||||
| 1.1.2000 | balance b/d | 2,100 |
Workings:
31.12.1998: 56000 X 5/100 = 2800
31.12.1999: 42000 X 5/100 = 2100
DR BAD BEBTS RECOVERY A/C CR
| 31.12.1998 | p&l | 350 | 31.12.1998 | cash/bank | 350 |
| 31.12.1999 | p&l | 150 | 31.12.1999 | cash/bank | 150 |