My name is Steve Chen, a fellow member of ACCA and course director at APC (www.globalapc.com), teaching ACCA online courses to students from all around the world.

In ACCA Financial Accounting papers syllabus, only direct write off method for recognising irrecoverable debt expenses is required. However, there are clear limitations of this method, ie not meeting with ‘matching’ principle. Lots of businesses in the real world would use the second method to recognise irrecoverable debt expenses.

Therefore, this article is supplement to your ACCA FA/FR and SBR studies regarding the recognition of bad debt expenses.

Method one: Direct write off Method:

  1. Customer A Will Not Pay the Invoice

Before the Financial Statements year end, customer A sends an email that it has financial difficulties and has declared its bankruptcy. This means customer A is not going to pay us the invoice of $1,600 and certainly, the cash discount was not taken. The following journal entries should be recorded:

When customer A announces its bankruptcy:

Dr Irrecoverable debt expense (statement of profit or loss) $1,600

Cr Accounts receivable $1,600

The irrecoverable debt expense has increased by $1,600 whereas the accounts receivable asset has decreased by $1,600.

  1. Customer A Settles the Invoice

After customer A (based in the USA) files its bankruptcy petition according to Chapter 11 of the USA Bankruptcy Code, customer A (business) is protected by the code and allowed to reorganise or improve its business operations. Eventually, customer A becomes profitable again and is able to settle the invoice. Hence when customer A pays, the following journal entry should be made:

Dr Bank $1,600

Cr Irrecoverable debt expense (statement of profit or loss) $1,600

This means that we had recognised the previous $1,600 irrecoverable debt expense because we knew the bad debt may potentially occur. Now, the bad debt will not occur and therefore, the business increased the cash received by debiting $1,600 bank. An increase in asset will also result in an increase in equity, in this case, because we have charged the previous irrecoverable debt expense. Now, we need to reduce this expense by crediting it, and in reducing the expense, the equity will increase. This is how the direct write-off method works.

Please note, when the customer pays us the previously recognised bad debt amount, it has nothing to do with accounts receivable because the accounts receivable has been previously derecognised when the business recognised the irrecoverable debt expense. Therefore, there will be no changes to the accounts receivable.

From the above journal entry, we credited the irrecoverable debt expense. Now, suppose the customer settled the invoice in the second year and we had recognised the irrecoverable debt expense in the first year. Would we credit the irrecoverable debt expense in the second year’s Financial Statements or back in the first year’s Financial Statements?

The answer is to credit the irrecoverable debt expense at the time when we receive the money from the credit customer, i.e., in the second year, not the first. The reason for this is that the Financial Statements are prepared based on the management’s best estimate. In the first year, the management estimated that customer A would not pay due to customer A’s announcement of its bankruptcy, and therefore an expense had been recorded.

In the second year, because the money is paid back by customer A, the expense needs to reduce at this juncture. You can also argue that this approach has a flaw, i.e., the decrease in bad debt expense did not match with its original sales revenue, particularly if the sales revenue and bad debt expense took place in different accounting periods.

Method 2: Allowance (allowance for doubtful debts) Method:

From the above example, if the business has not previously recognised an ‘allowance’ for the accounts receivable, the accounting treatment for the bad debt is exactly the same as before:

Dr Irrecoverable debt expense (statement of profit or loss) $1,600

Cr Accounts receivable $1,600

The subsequent treatment will be the same as before if there is no allowance.

let us look at another case:

The company has three credit transactions: credit sales of $1,000 to customer A, credit sales of $5,000 to customer B, and $7,000 to customer C. No cash discounts are offered to these customers. For ‘prudence’ reasons—the company is very careful not to overstate these receivable balances—the business has prepared the following receivable age analysis for the credit transactions at the Financial Statements year end:

In technical terms, according to IFRS 9 Financial Instruments, the above table is called the ‘provision matrix’.

  1. The business needs to first set up the allowance for doubtful debt according to its best estimate regarding the future likely bad debt expense. However, please note, the above $146 allowance for doubtful debts is not a real bad debt, i.e., the business assumes that perhaps only $12,854 may be received. ($13,000 total receivable, subtracting $146 allowance). The following entry is made:

Dr Irrecoverable debt expense (statement of profit or loss) $146

Cr Allowance for doubtful debt (statement of financial position) $146

  1. The customer C has announced its bankruptcy and could only settle $6,900 of the invoice (it originally owed us $7,000). Hence, $100 bad debt expense incurred. The following entry is made:

Dr Allowance for doubtful debt (statement of financial position) $100

Cr Accounts receivable (statement of financial position) $100

  1. A few days later, the customer C has settled the previously-recognised $100 bad debt. The following journal entry is made:

Step 1: Reverse the above allowance journal:

Dr Accounts receivable (statement of financial position) $100

Cr Allowance for doubtful debt (statement of financial position) $100

Step 2: Record the cash transaction:

Dr Bank (statement of financial position) $100

Cr Accounts receivable (statement of financial position) $100

Let’s recalculate the allowance for doubtful debt, as customer C has now settled the full invoice. Let’s assume that customer A and customer B have not settled their invoices yet:

The allowance for doubtful debt was $146 at the start, and now it has gone down to $55. The following journal entry is made:

Dr Allowance for doubtful debt (statement of financial position) $91

Cr Irrecoverable debt expense (statement of profit or loss) $91

Now, customer D has a $9,000 credit transaction with the business.

The management has revised the accounts receivable aged analysis as follows: (suppose the previous customers A and B have settled their invoices in part of $300 and $2,000 and therefore, they still owe us $700 and $3,000):

The allowance for doubtful debt has now gone up by $153 from $55 to $208. The following journal entry is made for the increase in the allowance for doubtful debt:

Dr Irrecoverable debt expense (statement of profit or loss) $153

Cr Allowance for doubtful debt (statement of financial position) $153

Can you see the differences between the direct write-off and the allowance method? In the second method, (allowance method), the bad debt will be adjusted from the allowance for doubtful debt account but not directly write off the accounts receivable, i.e., the bad debt is written off from the accumulated allowance account. It, therefore, solves the ‘unmatching’ problem as we have seen in the direct write-off method. Under IFRS, both methods are allowed.

In addition to providing ACCA lectures online, I also wrote articles in ACCA AB magazine. Besides, I am the author of four accounting books. If you are interested in studying ACCA courses with me, please visit my website http://www.globalapc.com for further information, where you can find many of my ACCA demo video lectures.

My name is Steve Chen, a fellow member of ACCA and course director at APC (www.globalapc.com), teaching ACCA online courses to students from all around the world. This article will explain the concept of PAYE system in your ACCA Financial Accounting and Tax Papers.

Pay As You Earn (PAYE) System

This system means the employer withholds income tax and national insurance contributions from employees and pays them directly to the HMRC.

This system was originally developed by Sir Paul Chambers in the UK in 1944 and is now widely used in other countries such as New Zealand, South Africa, USA, Australia and other countries.

PAYE system is also called Pay As You Go (PAYG) withholding system in some countries. However, in Hong Kong (SAR), there is no PAYE system.

This means the employer does not need to withhold income tax from the employee on behalf of the government. The taxpayer needs to complete the tax return and submit it to the Hong Kong (SAR) tax authority (Inland Revenue Department) each year.

In addition to providing ACCA lectures online, I also wrote articles in ACCA AB magazine. Besides, I am the author of four accounting books. If you are interested in studying ACCA courses with me, please visit my website http://www.globalapc.com for further information, where you can find many of my ACCA demo video lectures.

My name is Steve Chen, a fellow member of ACCA and course director at APC (www.globalapc.com), teaching ACCA online courses to students from all around the world. This article will explain the concept of tax return in your ACCA Financial Accounting Papers.

Tax return

Each year, a business needs to complete a tax return indicating the amount paid to the tax authority. The tax return can be completed either in paper format or via an online form. The company may pay its tax bill in one instalment or in several, according to the tax rules in different countries. For example, in the UK, if the taxable profits are up to £1.5 million in the year, a single tax payment to the HMRC will need to be made. This payment is due nine months and one day after the end of the accounting period.

Taxable profits

If the taxable profits are more than £1.5 million, depending on their accounting periods, the tax payments may be settled in three or four instalments. For example, a company with a standard accounting period of twelve months will pay in four instalments. A company with an accounting period of nine months (less than twelve months) will normally pay tax in three instalments.

However, if the business has just commenced trading (that is, producing Financial Statements for the first time) or in administration (business to be liquidated soon), the accounting period can be extended to a maximum of eighteen months. The calculation of the tax due by instalments now becomes quite complicated. The business will first need to estimate the total tax liability payable in the first and remaining instalments. As the accounting period extends, the business will need to revise the estimated payable tax liability.

In this case, the company may have underpaid or overpaid its tax liability in previous instalments.

In this case, the company needs to top up the amount which is underpaid or to claim the refund from the tax authority for the amount overpaid. This is called under- or overpayment of tax.

Under or over pay taxes

Other examples where the business under or overpays tax may include errors made, or it could be the case that the transfer price set for the sale of goods among group entities is not at fair value, and hence the tax authority requires additional adjustments to be made regarding the taxable profit.

The business will also need to consider interest charged by the tax authority for the amount underpaid, or to claim the interest income back from the tax authority for the amount overpaid, and this really depends on the tax rules in different countries.

In addition to providing ACCA lectures online, I also wrote articles in ACCA AB magazine. Besides, I am the author of four accounting books. If you are interested in studying ACCA courses with me, please visit my website http://www.globalapc.com for further information, where you can find many of my ACCA demo video lectures.

My name is Steve Chen, a fellow member of ACCA and course director at APC (www.globalapc.com), teaching ACCA online courses to students from all around the world. This article will explain the concept of accruals in your ACCA Financial Accounting Papers.

Accruals Concept

Suppose the business has used electricity in the recent three months but has not received the invoice from the electricity company as at the Financial Statements year end. Should the business recognise electricity expenses or not?

The answer is yes because the business needs to match the income earned with expenses, to calculate profits or losses. Without electricity, the business may not have produced and sold those high-quality products.

Hence, even if the business has not paid for electricity expenses, the business still needs to account for those expenses to reflect that the electricity has been used. This is known as ‘accruals’ or ‘matching’ concept.

Other examples of accruals include:

Example one: invoice is due:

The business has not paid the invoice from the supplier for the use of electricity as at the year end, although the invoice is due. If we have received the invoice from the electricity supplier but we have not paid it yet, we do need to provide for an electricity expense and liability to reflect the fact we owe money to the supplier.

Example two: depreciation

Depreciation expense for the non-current assets which must be provided for. This is because when the non-current asset is used in the daily business operations—such as machinery—these machineries are likely to become less and less efficient as time passes.

From the accounting’s point of view, we do need to write down the machinery’s value, but the value written down will be very subjective, i.e., according to our judgement. The depreciation expense will never be settled in cash, and this is just an accounting adjustment, i.e., to artificially match the income the business generates from using the machinery to the expense we think it may have incurred.

Example three: unsold inventories

Unsold inventories need to reduce the costs of sales. Costs of unsold inventories should not be recognised as the cost of sales because we only match the costs of those sold inventories with their associated income.

Example four: income tax estimate

The estimate of income tax expense for the current period should be provided for. This is to match the income the business generates in the current period, with the estimated tax expense to calculate the net profit.

In addition to providing ACCA lectures online, I also wrote articles in ACCA AB magazine. Besides, I am the author of four accounting books. If you are interested in studying ACCA courses with me, please visit my website http://www.globalapc.com for further information, where you can find many of my ACCA demo video lectures.

My name is Steve Chen, a fellow member of ACCA and course director at APC (www.globalapc.com), teaching ACCA online courses to students from all around the world. This article will explain different types of shares in your ACCA FA/FR studies.

Ordinary Shares:

When a company issues shares, there might be different classes of shares, including ordinary and preference shares. The ordinary shares are the basic shares usually carrying voting rights to vote on company resolutions at the general meeting. General meetings are meetings held by the company and attended by shareholders, in which they will discuss the company's past performance and future outlook. Some family companies such as Daily Mail and General Trust may prefer non-voting ordinary shares because the family members can still control the company even though more shareholders are introduced.

Preference Shares:

These shares usually do not carry voting rights. They usually have a cumulative dividend feature, i.e., if preference shares dividends are not paid to the preference shareholders in any given years, those dividends must be paid first when the company decides to pay ordinary share dividends to ordinary shareholders in the following year, i.e., cumulating the unpaid dividends plus the preference share dividends due in the next year. This means that the preference shares dividends are preferred or ahead of the ordinary share dividends paid to ordinary shareholders.

If the business is wound up and the business has enough assets, the preference shareholders must be repaid before the ordinary shareholders. Either preference or ordinary share is quite risky from the investors’ perspective because they may not get the money back from the company if the company winds up. The shares issue is quite safe from the company’s perspective because the company does not need to pay dividends to those shareholders if the company does not plan to do so.

Other Types of Shares:

The company may issue other classes of shares including management shares, i.e., giving the directors additional votes on the resolution, for example, three votes per share instead of the normal one vote per share in the normal ordinary shares. Non-voting shares are normally issued to the employees enabling them to share the company’s profits rather than allowing them to vote at the general meeting. Different types of deferred shares could be issued, for example, dividends in these shares may be paid after all other classes of shares are paid, or paid at a certain date, or the shares cannot be traded until a certain date. Different classes of shares are allocated, termed Class A, Class B, or Class C shares.

Preference shares can be further divided into redeemable and irredeemable preference shares. Redeemable preference shares mean the money can be repaid to the investor in the future, for instance, in five years. Irredeemable preference shares do not need to be redeemed during the company’s lifetime unless the company winds up. To simplify the idea in respect of preference shares, we only look at these from the perspective of either redeemable or irredeemable. In the real scenario, many other features exist in preference shares. These include cumulative or non-cumulative dividends—a convertible feature in the preference shares, allowing for their conversion into ordinary shares at a future point—and the participating feature, allowing preference shareholders to share any additional profits apart from fixed preference share dividends after paying out the ordinary shareholders.

I hope this article helps clarify different types of shares that a company may issue. This topic is relevant to your ACCA Financial Reporting (F7 or FR) exam and ACCA Financial Accounting (F3 or FA) exam.

In addition to providing ACCA lectures online, I also wrote articles in ACCA AB magazine. Besides, I am the author of four accounting books. If you are interested in studying ACCA courses with me, please visit my website http://www.globalapc.com for further information, where you can find many of my ACCA demo video lectures.