Adjustments, Accruals, Prepayments and Bad Debts
Adjustments, Accruals, Prepayments and Bad Debts
This domain tests year-end adjustments needed to apply accrual accounting and to report receivables at a prudent amount. SPM questions often combine an accrued expense, a prepayment, a bad debt write-off and an allowance for doubtful debts.
Core rules
- An accrued expense is an expense incurred but unpaid: debit expense, credit accrued expense liability.
- A prepaid expense is paid in advance: debit prepaid expense asset, credit expense.
- Accrued income is income earned but not received: debit accrued income asset, credit income.
- Income received in advance is a liability.
- Writing off a bad debt: debit bad debts expense, credit trade receivables.
- An allowance for doubtful debts is a provision against remaining receivables; only the movement is an expense or income.
Worked example
Trade receivables are RM20,000. Write off RM800 as bad. Remaining receivables = RM19,200. A 5% allowance is required: RM960. If the existing allowance was RM700, increase it by RM260. Entries: Dr Bad debts RM800; Cr Trade receivables RM800. Then Dr Doubtful debts expense RM260; Cr Allowance for doubtful debts RM260. Receivables are reported at RM19,200 - RM960 = RM18,240.
Traps
- Debiting the allowance account when writing off a bad debt.
- Calculating the allowance before deducting the write-off.
- Treating a prepayment as an expense in the current year.
- Recording accrued wages as a liability without the matching expense.
Key points
- Accrual means expense before payment
- Prepayment is an asset
- Write-off reduces receivables directly
- Allowance is calculated after write-offs
- Only allowance movement hits profit