Lesson Notes By Weeks and Term v3 - Senior Secondary 1
Adjustments in Profit and Loss Account
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Adjustments in Profit and Loss Account
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Subject: Financial Accounting
Class: Senior Secondary 1
Term: 3rd Term
Week: 4
Theme: Classes Of Accounts And Final Account Of A Sole Trader (Proprietor)
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Distinguish between bad debts and provisions for bad debts. Make the entries of bad debts and bad debts provisions in to Ledger and Final Account. Distinguish between prepayments (payments in advance) and accruals (payments in arrears). Make entries of payment (payment in advance) and Accounts (payments in arrears) to the final account. Identify provisions for discount allowable. make entries in to the ledger and final accounts of provisions for discounts allowable. Identify provisions for depreciation. Make entries in to ledger and final accounts of provisions for depreciation.
figure for Provision for Discount Allowable (Cr) N3,000)
1. To adjust Provision for Discount Allowable (increase): Dr. Profit and Loss Account N610 Cr. Provision for Discount Allowable Account N610 Extracts from Final Accounts (as at 31st December 2023): Profit and Loss Account (Extract) | Expenses: | N | | :---------------------------------------- | :-------- | | Increase in Provision for Discount Allowable | 610 | Balance Sheet (Extract) | Current Assets: | N | | :----------------------------------------------- | :---------- | | Debtors (after Bad Debts and Provision for Bad Debts) | 180,500 | | Less: Provision for Discount Allowable | (3,610) | | Net Realisable Value of Debtors | 176,890 | 2.
5. Provision for Depreciation 2.5.
1. Definition and Identification Definition: Depreciation is the systematic allocation of the cost of a tangible non-current (fixed) asset over its estimated useful life. It represents the portion of the asset's value consumed or used up during an accounting period. It is not a cash outflow but an expense.
Identification: Applies to most non-current assets (e.g., machinery, vehicles, furniture, buildings) except land. It is calculated using methods like Straight-Line Method or Reducing Balance Method.
Treatment: Depreciation is an expense that reduces the asset's book value over time and is charged against profits. The "Provision for Depreciation" account (also known as "Accumulated Depreciation") accumulates the total depreciation charged on an asset over its life.
Common Methods for SS1: Straight-Line Method: (Cost - Salvage Value) / Useful Life (in years). This method charges an equal amount of depreciation each year.
Reducing Balance Method: A fixed percentage is applied to the net book value (Cost - Accumulated Depreciation) of the asset each year. This results in higher depreciation in earlier years and lower in later years.
Ledger Entries:
1. To record depreciation for the period: Debit: Depreciation Account (an expense account)
Credit: Provision for Depreciation Account (a contra-asset account that accumulates depreciation)
2. To transfer depreciation to P&L: Debit: Profit and Loss Account Credit: Depreciation Account (This closes the Depreciation A/c at year-end, charging it as an expense.)
Final Accounts Treatment: Profit and Loss Account: The depreciation for the current period is shown as an expense under "Operating Expenses." Balance Sheet: The original cost of the asset is shown. The total "Provision for Depreciation" (accumulated depreciation) for that asset to date is deducted from its cost. The resulting figure is the "Net Book Value" (or Written Down Value) of the asset. Example 2.5.1: Provision for Depreciation (Straight-Line Method) "Mama Nkechi Logistics" purchased a delivery van for N2,500,000 on 1st January
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3. It is estimated to have a useful life of 5 years and a salvage (residual) value of N500,
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0. The business uses the straight-line method for depreciation. Accounting year ends 31st December.
Calculations:
1. Depreciable Amount: Cost - Salvage Value = N2,500,000 - N500,000 = N2,000,000
2. Annual Depreciation (Straight-Line): Depreciable Amount / Useful Life = N2,000,000 / 5 years = N400,000 Ledger Entries:
1. To record depreciation for 2023: Dr. Depreciation Account (Delivery Van) N400,000 Cr. Provision for Depreciation A/c (Delivery Van) N400,000
2. To transfer Depreciation to P&L: Dr. Profit and Loss Account N400,000 * Cr. Depreciation Account (Delivery Van) N400,000 Extracts from Final Accounts (as at 31st December 2023): Profit and Loss Account (Extract) | Expenses: | N | | :------------------------------------ | :-------- | | Depreciation on Delivery Van | 400,000 | Balance Sheet (Extract) | Non-Current Assets: | N | | :------------------------------------ | :---------- | | Delivery Van (at cost) | 2,500,000 | | Less: Provision for Depreciation | (400,000) | | Net Book Value | 2,100,000 | 2.
1. The Need for Adjustments Financial statements are prepared for a specific accounting period (e.g., one year).
However, some transactions might not be fully completed within that period.
Matching Concept: This accounting principle dictates that expenses incurred to generate revenue must be matched against that revenue in the same accounting period.
Accrual Concept: This principle states that revenues and expenses are recognised when they are earned or incurred, regardless of when cash is exchanged. Adjustments ensure that the Profit and Loss Account accurately reflects the profitability for the period, and the Balance Sheet presents a true and fair view of assets and liabilities at the period end. 2.
2. Bad Debts and Provision for Bad Debts 2.2.
1. Bad Debts Definition: Bad debts (or irrecoverable debts) are amounts owed to the business by its debtors (customers who bought goods/services on credit) that are considered uncollectible and will never be paid. This is a realised loss for the business.
Identification: Occurs when a debtor goes bankrupt, disappears, or explicitly refuses to pay, and all reasonable efforts to recover the debt have failed.
Treatment: Bad debts are an expense to the business, reducing profit.
Ledger Entries:
1. To write off the bad debt: Debit: Bad Debts Account (an expense account)
Credit: Debtor's Account (e.g., Emeka A/c, Ifeanyi A/c) (This removes the specific debtor's balance from the ledger.)
2. To transfer bad debts to Profit and Loss Account: Debit: Profit and Loss Account Credit: Bad Debts Account (This closes the Bad Debts A/c at year-end, charging it as an expense.)
Final Accounts Treatment: Profit and Loss Account: Appears as an expense under "Operating Expenses." Balance Sheet: Does not directly appear as the specific debtor's balance has been written off and removed from "Debtors" (Accounts Receivable). 2.2.
2. Provision for Bad Debts (or Provision for Doubtful Debts)
Definition: This is an estimated amount set aside by a business at the end of an accounting period to anticipate potential future bad debts from its existing debtors whose balances are still outstanding. It is an application of the prudence concept.
Identification: Calculated as a percentage of the total remaining debtors at the end of the period, based on past experience or industry trends. It is an estimate, not a definite loss.
Treatment: A provision creates a reserve against future losses, reducing current profit to reflect potential uncollectible amounts.
Ledger Entries:
1. To create/increase provision for bad debts: Debit: Profit and Loss Account (expense to charge the estimated loss)
Credit: Provision for Bad Debts Account (a liability/contra-asset account) (The Provision for Bad Debts A/c is a permanent account that carries its balance forward.)
2. To decrease provision for bad debts (if new provision old provision (increase): The increase is shown as an expense.
If new provision old provision (increase): The increase is shown as an expense. If new provision < old provision (decrease): The decrease is shown as an income.
Balance Sheet: Shown as a deduction from "Debtors" (after deducting provision for bad debts) in the Current Assets section. Example 2.4.1: Provision for Discount Allowable Continuing from Oga Emeka Provisions (Example 2.2.1), after providing for bad debts, net debtors are N180,
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0. The old provision for discount allowable was N3,
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0. Oga Emeka wants to maintain a provision for discount allowable of 2% of net debtors.
Calculations:
1. Net Debtors: N180,500 (from previous calculation)
2. New Provision for Discount Allowable: 2% of N180,500 = N3,610
3. Increase in Provision: New Provision (N3,610) - Old Provision (N3,000) = N610 Ledger Entries: (Assuming Trial Balance figure for Provision for Discount Allowable (Cr) N3,000)
1. To adjust Provision for Discount Allowable (increase): Dr. Profit and Loss Account N610 * Cr. Provision for Discount Allowable Account N610 Extracts from Final Accounts (as at 31st December 2023): Profit and Loss Account (Extract) | Expenses: | N | | :---------------------------------------- | :-------- | | Increase in Provision for Discount Allowable | 610 | Balance Sheet (Extract) | Current Assets: | N | | :----------------------------------------------- | :---------- | | Debtors (after Bad Debts and Provision for Bad Debts) | 180,500 | Teacher Activities: Introduction (10 mins): Begin by reviewing the basic components of the Profit and Loss Account and Balance Sheet.
Pose a scenario: "Imagine a local tailor, Madam Bisi, makes clothes for customers on credit. What happens if some customers never pay? Or if she pays her shop rent for a whole year in advance? How do these affect her yearly profit?" Explain that these situations require "adjustments" to ensure her financial statements are accurate and reflect the true situation. Concept Explanation and Demonstration (30 mins per concept, 120 mins total): For each adjustment type (Bad Debts & Provision, Prepayments & Accruals, Provision for Discount, Depreciation): Clearly define the concept using simple, relatable Nigerian examples. Explain the "why" – linking back to matching and prudence concepts. Demonstrate the ledger entries (T-accounts) on the board, explaining debit and credit rules for each step. Show how each adjustment impacts the Profit and Loss Account and the Balance Sheet (using extract formats). Use prepared charts or projected slides for visual reinforcement of journal entries and final account presentation. Engage students with questions after each concept. E.g., "If Bad Debts is an expense, what effect does it have on profit?" Worked Examples (30 mins): Work through 1-2 comprehensive examples that combine several adjustments, emphasizing the sequential order of adjustments (e.g., bad debts first, then provision for bad debts on remaining debtors). Show detailed calculations on the board.
Recap and Q&A (10 mins): Summarise the key types of adjustments discussed. Address any lingering questions or misconceptions from students.
Student Activities: Active Listening and Note-Taking: Students listen attentively, copy definitions, ledger entries, and final account formats from the board or provided handouts.
Participation: Answer questions posed by the teacher, contribute to discussions, and ask clarifying questions.
Scenario Analysis: Engage in mini-discussions about the presented Nigerian scenarios and how they relate to the concepts.
Practice: Work through the guided practice questions individually or in pairs, applying the principles learned.
Preparation: Students should come prepared with their notebooks, pens, and potentially a calculator for calculations.
Materials: Whiteboard/Blackboard, markers/chalk, projector (optional), charts/slides of ledger entries and final account extracts, calculators. (after Bad Debts and Provision for Bad Debts) | 137,750 | | Less: Provision for Discount Allowable | (2,755) | | Net Realisable Value of Debtors | 134,995 | | | | | Non-Current Assets: | | | Motor Vehicle (at cost) | 800,000 | | Less: Provision for Depreciation | (160,000) | | Net Book Value | 640,000 |
Commentary: The provision for discount allowable is based on the net debtors after bad debts and provision for bad debts have been accounted for. Depreciation is an expense that reduces the asset's value on the Balance Sheet and is charged to the P&L.
Small Business Management in Nigeria (Provision Stores, Tailoring, Mechanics): Bad Debts: A provision store owner in a Nigerian market, like "Mama Joy's Shop," who sells goods on credit (locally known as "on tab") needs to understand bad debts. If a customer moves away without paying, that's a bad debt. Making a "Provision for Bad Debts" helps Mama Joy estimate how much of her outstanding credit sales she might not collect, allowing her to set more realistic profit expectations and manage her cash flow better.
Prepayments/Accruals: A mechanic, "Dele Auto," pays a year's rent for his workshop in Ojodu-Berger upfront. The portion of rent relating to the next year is a prepayment – an asset. Conversely, his electricity bill for December might arrive in January; this is an accrued expense, a liability, ensuring his December profit reflects all costs of operations.
Asset Management and Replacement: Depreciation: A transport company like "God is Good Motors" that owns a fleet of buses needs to account for the depreciation of these vehicles. Their buses lose value over time due to wear and tear from long journeys across Nigeria's roads. Recognizing depreciation annually as an expense helps the company understand the true cost of using its assets and allows it to gradually set aside funds (conceptually, not literally cash in a separate account) for eventual replacement of the aging fleet, ensuring business continuity. Financial Reporting and Investment Decisions: For larger Nigerian companies listed on the Nigerian Exchange Group (NGX), accurate financial statements with proper adjustments are crucial. Investors and banks in Lagos, Abuja, or Port Harcourt rely on these adjusted statements to make informed decisions about lending to or investing in these companies. If a company fails to account for potential bad debts or future depreciation, its reported profit would be overstated, misleading stakeholders and potentially leading to poor economic decisions within the Nigerian economy.