Year-End Adjustments in a Fabric Retailer
Ngozi Eze runs a fabric retail business; her year end is 31 December 2024. The draft statement of profit or loss prepared by her nephew shows a net profit of ₦4,280,000, and the following have not been adjusted: (i) rent of ₦1,200,000 was paid on 1 November 2024 covering the twelve months to 31 October 2025 and was charged in full; (ii) insurance of ₦240,000 was paid in March 2024 for the twelve months to 28 February 2025 and charged in full; (iii) wages paid during the year were ₦3,600,000; wages accrued at 31 December 2023 were ₦240,000 and at 31 December 2024 ₦275,000; (iv) trade receivables of ₦2,450,000 are stated before any adjustment; a customer owing ₦130,000 has been declared bankrupt and a further customer owing ₦70,000 is in liquidation with no assets expected; (v) the allowance for doubtful debts brought forward was ₦96,000 and is to be set at 5% of the remaining receivables.
1. Prepare a schedule adjusting the draft net profit and state the corrected figure.
Read the worked answer
| ₦ | |
|---|---|
| Draft net profit | 4,280,000 |
| (i) Rent: charged 1,200,000, expense for 2024 is 2 months (Nov–Dec) | 1,200,000 × 10/12 = +1,000,000 |
| (ii) Insurance: charged 240,000, expense for 2024 is 10 months (Mar–Dec) | 240,000 × 2/12 = +40,000 |
| (iii) Wages: 3,600,000 + 275,000 − 240,000 = 3,635,000 charged, draft had 3,600,000 | (35,000) |
| (iv) Bad debts written off (130,000 + 70,000) | (200,000) |
| (v) Increase in allowance (see below) | (16,500) |
| Corrected net profit | 5,068,500 |
Working for (v): receivables 2,450,000 − 130,000 − 70,000 = 2,250,000; 5% = 112,500; less opening allowance 96,000 = increase of 16,500.
The prepayments of ₦1,000,000 and ₦40,000 are added back because the draft has charged the whole invoice to 2024, while only the portion relating to 2024 is an expense. They become current assets. Wages move the other way: the closing accrual is an expense not yet paid (+275,000), while the opening accrual was paid this year and must be removed (−240,000).
2. Show the journal entries for the bad debts and the allowance for doubtful debts, and explain why the allowance is not deducted from receivables directly.
Read the worked answer
| Dr | Cr | ₦ |
|---|---|---|
| Bad debts expense | Trade receivables | 200,000 |
| Bad debts expense | Allowance for doubtful debts | 16,500 |
Receivables then appear in the statement of financial position as 2,250,000 less allowance 112,500 = 2,137,500.
Why the allowance is separate: the ₦130,000 and ₦70,000 are specific debts known to be irrecoverable, so they are removed from the ledger against the individual customer accounts. The 5% allowance is a general estimate covering debts not yet individually identified as bad. Keeping it as a credit balance against the receivables total preserves the original ledger balance (which is still legally owed and may yet be collected or sold), shows the gross debt and the estimated irrecoverable portion, and avoids re-opening customer accounts each year. It also makes the charge to profit automatic each year through the movement in the allowance.
3. Advise whether the ₦70,000 debt owed by the customer in liquidation should be written off or merely provided for, and explain the effect of each choice on profit and net assets.
Read the worked answer
Write it off. The customer is in liquidation and no assets are expected, so there is no longer an asset - an allowance would be a provision against something that is in substance already gone. The ₦130,000 bankrupt customer is in the same position.
Effect of writing off: profit falls by ₦70,000 in the year, receivables fall by ₦70,000, and net assets fall by ₦70,000. Because the debt is removed before the 5% allowance is calculated, the allowance also falls slightly, which slightly cushions the profit hit.
If instead it were merely included inside the general 5% allowance, the profit charge would be spread and understated in the year the loss became known, and receivables would be overstated by roughly ₦70,000 × 95%. That would mislead a bank reading the accounts.
Judgement points that earn credit: the decision rests on evidence of recoverability, not on the size of the debt or on the customer's assurances; if the liquidator later pays a dividend, the recovery is credited to profit in the year received, not back-dated; and the write-off must be authorised and documented, with the debt still pursued.