Reporting business

transactions using financial

statements
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Accrual basis of accounting
• An entity shall prepare its financial statements, except for cash flow
information, using the accrual basis of accounting.

• When the accrual basis of accounting is used, an entity recognises

items as assets, liabilities, equity, income and expenses (the elements
of financial statements) when they satisfy the definitions and
recognition criteria for those elements in the Framework.

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Frequency of reporting
• An entity shall present a complete set of financial statements
(including comparative information) at least annually. When an entity
changes the end of its reporting period and presents financial
statements for a period longer or shorter than one year, an entity
shall disclose, in addition to the period covered by the financial
statements:
• the reason for using a longer or shorter period, and (b) the fact that
amounts presented in the financial statements are not entirely
comparable.

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Comparative information- Minimum
comparative information
• Except when SLFRSs permit or require otherwise, an entity shall
present comparative information in respect of the preceding period
for all amounts reported in the current period’s financial statements.
An entity shall include comparative information for narrative and
descriptive information if it is relevant to understanding the current
period’s financial statements.
• An entity shall present, as a minimum, two statements of financial
position, two statements of profit or loss and other comprehensive
income, two separate statements of profit or loss (if presented), two
statements of cash flows and two statements of changes in equity,
and related notes.
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What is the use of a financial statement?
• As a whole, financial statements fulfil the following purpose, which
makes them indispensable:
• First, to scrutinize the ability of a business to generate cash and the
sources and utilization of that cash.
• Second, to ascertain whether a business has the capability to pay back its
debts.
• Third, to help track financial results on a trend line to spot any looming
profitability issues.
• Next, to help derive financial ratios from the statements that can indicate
the condition of the business.
• Lastly, to investigate the particulars of certain business transactions, as
mentioned in the disclosures that accompany along with the statements.
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Other adjusting entries
• Depreciation

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• DEPRECIATION
• Depreciation is the allocation of the cost of PPE to expense over its useful (service)
life in a rational and systematic manner.
• Cost allocation provides for the proper matching of expenses with revenues in
accordance with the matching principle.
• Depreciation is a process of cost allocation, not a process of asset valuation.
• The change in an asset’s market value is not measured during the ownership
because plant assets are not held for resale. So the book value (cost less
accumulated depreciation) of a plant may be quite different from its market value.
• These assets are considered to be depreciable asset because the usefulness to the
company and revenue-producing ability of each asset will decline over the asset’s
useful life.
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• Three factors in computing depreciation:
• Cost: All expenditures necessary to acquire the asset and make it ready for
intended use. Explained earlier how to calculate the cost.
• Useful life: useful life is an estimate expressed in terms of time, units of
activity (such as machine hours), or units of output. Estimate depends on
intended use of the asset, expected repair and maintenance, and
vulnerability to obsolescence. Past experience with similar type of assets is
often helpful in deciding on expected useful life.
• Salvage value: It is an estimate of the asset’s value at the end of its useful
life.
• Cost
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• Depreciation methods:
• These methods are generally used to compute depreciation
• Straight-line
• Declining-balance
• Units- of- activity
• Management selects the method it believes to be appropriate.
• Once a method is chosen, it should be applied consistently over the
useful life of the asset.

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• A company purchased a factory machine at a cost of Rs. 18,000,000 on January 01, 2014. The
salvage value (residual value) of the machine is expected to be Rs. 2,000,000 at the end of its
4-year useful life.
• During its useful life, the machine is expected to be used 160,000 hours. Actual annual hourly
use is: 2014- 40,000 hrs; 2015- 60,000 hrs; 2016- 35,000 hrs; and 2017- 25,000 hrs.
Required:
Prepare depreciation schedules for the following methods:
• Units-of-activity method= 40+60+35+25 = 160,000
• 18-2 = 16,000,000 Cost/unit-of-activity = 16,000,000/160,000 = Rs. 100/hour
• 2014- depreciation exp = 40,000 hrs x 100/hr = 4,000,000
• 2015 - dep = 60,000 hrs x 100 = 6,000,000
• = 3,500,000
• = 2,500,000 10
th
 • Depreciation per year = 16,000,000/ 4years = Rs. 4,000,000/year
• Depreciation expense account Debit 4,000,000  P/L account
• Accumulated depreciation account Credit 4,000,000 Fin statement
• Factory machine - Rs. 18,000,000
• Less: Accumulated dep - Rs. 4,000,000 Rs. 14,000,000 (Carrying amount)
• Accumulated dep- 4 + 4 = 8
• 8 + 4 = 12
• 12 + 4 = 16
• End of 4th year – Machine 18
• Less: Accu 16 2 Carrying ammont = Residual value (Scrap value)

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 Bad debts and Allowance for doubtful debts
• Accounts receivable/ debtors Rs. 50,000
• Bad debts Rs. 5,000  Bad debts account debit 5,000( P/L account) / Credit to Debtors 5,000
• Net bal Debtors = 50 – 5 = 45,000
• Expects that 5% (3%, 10%... ) of the net (45,000) = 2,250 will not be recovered during
• Bad debts account debit 2,250 (p/L account) / Credit to Allowance for doubtful debts 2,250
• Financial Position:
• Accounts receivable Rs. 45,000
• Less: Allowance for doubtful debts 2,250 42,250

• ALLOWANCE (PROVISION) METHOD

• The allowance method of accounting for likely bad debts involves estimating uncollectible accounts at the
end of each period. This provides better matching on the income statement.
• This means that companies make allowance at the end of the year for expected losses (likely bad debts)
which may happen during the next year when the accounts receivable are collected
• The simple reason for making Allowance:
• Out of credit sales made during a particular year, some sales are likely to become bad in the following year.
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• The proper accounting treatment would be to charge the likely bad debts in the same accounting year with such likely
• It also ensures that companies state receivables on the Financial Position at their cash (net)
realizable value. Cash (net) realizable value is the net amount the company expects to receive
in cash in the following year.
• In the Financial Position in the Assets’ side:
Fixed Assets Rs. 90,000,000
Less: Accumulated Depreciation Rs. 12,000,000 78,000,000

Current Assets:
Inventory Rs. 15,000,000
Accounts Receivable Rs. 30,000,000
Less: Allowance for Doubtful Accounts Rs. 3,000,000 27,000,000
Cash Rs. 15,000,000
• Thus, this method reduces accounts receivables by the amount of estimated uncollectible
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 Exercise
The following balances have been extracted from Trial Balance of a company as at December 31,
2020:
Accounts receivable Rs. 300,000
Bad debts Rs. 25,000
Additional information:
1. After preparing the Trial Balance, it is learnt that a debtor Renold has become insolvent and
therefore, the amount of Rs 10,000 due from him was irrecoverable.
2. Make 10% Allowance for doubtful debts for the year ended 31.12.2020.
Required:
i. Pass necessary adjusting entries Bad debts 10,000/ Accounts Receivable 10,
Bad debts Dr 29,000/ Allowance for doubtful debts 29,000
Net Accounts receivable = 300,000 - 10,000= 290,000x10% = 29,000
ii. Show how the items will appear in the financial statements
Accounts receivable 290,000
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 Exercise 2:
In 2020, Carlson Company had Account receivable of Rs.750,000. On January 1, 2020,
Allowance for Doubtful Accounts had a credit balance of Rs.18,000. During 2020, Rs. 30,000
were written off as bad debts but not recorded in the books. Past experience indicates that
3% of net Account receivable become uncollectible.
What should be the amount to be adjusted in the Allowance for Doubtful debts at
December 31, 2020?
a. Rs. 3,600
b. Rs.4,500.
c. Rs. 21,600
d. Rs. 22,500.
• Accounts receivable = 750,000 – 30,000 = 720,000x 3% = 21,600
• Allowance for doubtful debts = 21,600 – 18,000 = 3,600
• 18,000 + 3,600 = 21,600
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