Kato runs a business that sells goods on credit. The following information is available at 31 December 2024. Item $ Trade receivables at 31 December 2024 (b...
Question 1 Report
Kato runs a business that sells goods on credit. The following information is available at 31 December 2024.
| Item | $ |
|---|---|
| Trade receivables at 31 December 2024 (before writing off) | 48 000 |
| Irrecoverable debts to be written off | 3 000 |
| Allowance for irrecoverable debts at 1 January 2024 | 2 400 |
Kato maintains an allowance for irrecoverable debts at 5% of trade receivables (after writing off irrecoverable debts).
(a) Calculate the trade receivables after writing off irrecoverable debts. [2]
(b) Calculate the new allowance for irrecoverable debts at 31 December 2024. [2]
(c) Calculate the change in the allowance for irrecoverable debts. State whether this is an increase or decrease. [2]
(d) Show the entries in the income statement relating to irrecoverable debts for the year ended 31 December 2024. [4]
(e) Show how trade receivables will appear in the statement of financial position at 31 December 2024. [4]
(f) Explain the purpose of maintaining an allowance for irrecoverable debts. [4]
(g) State the accounting concept that supports the creation of an allowance for irrecoverable debts. [2]
Answer Details
(a) Trade receivables after writing off irrecoverable debts
Trade receivables after write-off = $48 000 - $3 000 = $45 000 [1][1]
The irrecoverable debts are removed from the receivables balance because these amounts will not be collected.
(b) New allowance for irrecoverable debts
New allowance = 5% x $45 000 = $2 250 [1][1]
The allowance is calculated on the trade receivables balance after the irrecoverable debts have been written off.
(c) Change in the allowance
Change = Old allowance - New allowance = $2 400 - $2 250 = $150 decrease [1][1]
The allowance has decreased because trade receivables (after write-off) are lower than the previous year, and 5% of a lower figure produces a smaller allowance.
(d) Income statement entries
| Income statement extract (expenses section) | |
|---|---|
| Irrecoverable debts written off | $3 000 [1] |
| Less: Decrease in allowance for irrecoverable debts | ($150) [1] |
| Net charge for irrecoverable debts | $2 850 [1] |
The irrecoverable debts written off are an expense. The decrease in the allowance partially offsets this because it releases some of the previous year's provision back as income. Correct presentation. [1]
(e) Trade receivables in the statement of financial position
| Statement of Financial Position (current assets extract) | |
|---|---|
| Trade receivables | $45 000 [1] |
| Less: Allowance for irrecoverable debts | ($2 250) [1] |
| Net trade receivables | $42 750 [1] |
Shown under current assets. [1] The net figure represents the amount the business realistically expects to collect.
(f) Purpose of maintaining an allowance
The allowance recognises that not all trade receivables may ultimately be collected - some customers may default on payment. [1]
It provides for estimated future irrecoverable debts based on past experience and current conditions. [1]
This gives a more realistic and prudent valuation of trade receivables on the statement of financial position. [1]
It ensures the financial statements present a true and fair view of the business's financial position. [1]
(g) Accounting concept
The prudence (conservatism) concept. [1] This concept requires that losses should be anticipated and provided for as soon as they are foreseen, while profits should not be recognised until they are realised. Creating an allowance for potential future losses on receivables applies this principle. [1]
Download The App On Google Playstore
Everything you need to excel in your exams
