Book-keeping · Lesson 9

Accruals, prepayments, bad debts and the provision for doubtful debts

WAECNECO

What the syllabus asks

WAEC: (1) adjustment for prepayments and accruals; (2) making adjustments in the appropriate books. Topic 12, Bad and Doubtful Debts: (1) meaning, differences and provision; (2) posting to the appropriate books. Extends fa6.4–6.5.

NECO: (1) adjustment for prepayments and accruals; (2) making adjustments in the appropriate books. Topic 12, Bad and Doubtful Debts: (1) meaning, differences and provision; (2) posting to the appropriate books. Extends fa6.4–6.5.

What you will learn

Explain why year-end adjustments are needed.
Treat accrued and prepaid expenses in the accounts.
Treat accrued income and income received in advance.
Prepare expense and income accounts with opening and closing balances.
Record adjustments by journal and in the final accounts.
Write off bad debts and record recoveries.
Create and adjust a provision for doubtful debts.
Show the effects of adjustments on profit and the balance sheet.

Key points

Adjustments make profit match the period.
Accrued expense: add; liability.
Prepaid expense: deduct; asset.
Accrued income: add; asset.
Income in advance: deduct; liability.
Opening balances reverse automatically next year.
Bad debts are written off: Dr Bad debts, Cr Debtor.
Provide for doubtful debts after writing off bad debts.
Only the change in provision goes to P&L.
Show debtors less provision in the balance sheet.

Start here: Why year-end adjustments are needed

The ledger records cash paid and received, and invoices sent and received. But the profit for a year must include every income earned and every expense incurred in that year, whether or not money has changed hands. This is the accruals (matching) concept. At the year end, therefore, the book-keeper adjusts the trial balance figures before preparing the final accounts.

Think of Halima, who runs a restaurant in Wuse, Abuja, with a 31 December year end. On 31 December she has not yet received the December electricity bill (but she used the power). In October she paid a whole year’s insurance in advance. She lets a room upstairs to a tailor who paid rent for January in December. A customer who owes her for a wedding party has disappeared. Each of these needs an adjustment if her 2025 profit is to be true.

The two kinds of timing difference

Accrual: the expense has been incurred (or income earned) but not yet paid (or received). It is added to the trial balance figure.
Prepayment (or income in advance): money has been paid (or received) but relates to the next period. It is deducted from the trial balance figure.

Every adjustment has two effects

As in bk7, each adjustment appears once in the profit and loss account (changing an expense or income) and once in the balance sheet (as a current asset or current liability). In the ledger, the adjustment appears as a balance carried down on the expense or income account, which becomes the opening balance of the next year.

Cash basis versus accruals basis

A very small trader who simply compares cash received with cash paid is using the cash basis. It is easy, but it can give a badly wrong picture. Suppose Halima pays two years’ shop rent of ₦1,200,000 in December 2025. On the cash basis, 2025 bears the whole ₦1,200,000 and 2026 bears nothing, so 2025 looks poor and 2026 looks excellent, although the business did equally well in both years. On the accruals basis, each year bears ₦600,000 and the comparison is fair. All businesses that prepare proper final accounts, and every WAEC question on final accounts, use the accruals basis.

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Practice questions

1. An accrued expense is

an expense incurred but not yet paid
an expense paid in advance
income received in advance
a bad debt

Show answer

A: an expense incurred but not yet paid
Owing.

2. Electricity paid 72,000; owing at start 12,000; owing at end 18,000. Expense is

₦66,000
₦102,000
₦72,000
₦78,000

Show answer

D: ₦78,000
72 − 12 + 18.

3. Insurance ₦360,000 for 12 months paid 1 October; year ends 31 December. Prepaid is

₦360,000
₦30,000
₦270,000
₦90,000

Show answer

C: ₦270,000
9 months.

4. A prepaid expense appears in the balance sheet as a

capital item
current asset
current liability
fixed asset

Show answer

B: current asset
Paid ahead.

5. Rent received 1,100,000 including 100,000 for last year and 150,000 for next year. Income for the year is

₦850,000
₦1,150,000
₦950,000
₦1,000,000

Show answer

A: ₦850,000
1,100 − 100 − 150.

Key words

Accrual: Expense incurred or income earned but not yet paid or received.
Prepayment: Expense paid in advance for a later period.
Accrued income: Income earned but not yet received.
Income in advance: Income received for a later period.
Adjustment: Change to a trial balance figure at year end.
Bad debt: Debt certain not to be recovered.
Doubtful debt: Debt that may not be recovered.
Provision for doubtful debts: Estimate of debts likely to be lost.
General provision: Percentage of total debtors.
Specific provision: Provision against named debtors.
Bad debts recovered: Debt written off but later paid.
Net debtors: Debtors less provision.

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