Share this:


RESERVES AND PROVISIONS
INTRODUCTION:
  • Any business firm must have an asset in conducting its activities.
  • Assets are the possessions of the business.
  • They are things of value that the firm utilizes in conducting business
  • They are the actual resources that are in the business.
  • Assets include land, building, machinery , stock of goods, debtors cash.
  • Assets are financed by capital and liabilities or in technical terms are financed by equities.
DEFINITION OF RESERVE:
It is an amount set aside out of profits (i.e. from the profit and loss account or any surpluses for unidentified or Unspecified purposes.
KIND OF RESERVES:
Reserved can be classified into the following major categories.
1. Revenue reserve
2. Capital reserve
1.REVENUE RESERVE
Is a fund / amount created by voluntary transferring part of the profit kind normally becomes part of the name of that reserve.
TYPES OF REVENUE RESERVE
1. Specific reserves: These reserves created out of revenues profit for a specific purpose.
2. General reserve: These are reserves created out of revenue profit for
general purposes.
2. CAPITAL RESERVES.
These are reserves which are created out of the capital profits. These reserves are not available for distribution among shareholders as dividend in the case of companies.
Examples or sources of capital reserve:
1. Profit on sale of fixed assets: it should be noted that capital profit is only excess of sale price over the cost of fixed asset.
2. Profit prior to incorporation.
3. Premium on issue of shares of debentures.
4. Profits on redemption of debentures
5. Profit on for feature of shares.
6. Surplus on revaluation of fixed assets
7. Amount transferred out of profits to capital.

PROVISION
Provision usually means any amount written off or retained by way of providing
depreciation, renewals or diminution in the value of asset or retained by way of
providing for any known liability of which the amount cannot be determined with substantial accuracy.
Difference between reserve and provision
  1. A reserve is an appropriation of profit while a provision is a charge against profits .in other words true profits cannot be determined without making adjustment for the provisions required.
  2. Creation of reserves increases proprietor’s funds while creation of provisions decreases his funds in the business.
  3. Provisions are created to meet some known contingency, the amount of which cannot be precisely determined .Reserves are created to meet some financial position of the business, while creation of previsions help in maintaining the exiting financial position.
PROVISION FOR BAD AND DOUBTFUL DEBTS.
Bad debts:
1. Accounting entries on bad debts.
Dr; bad debts a/c
Cr; debtors a/c
Then at the end of accounting period.
Dr: P&L
Cr: bad debts

2. Discount allowed
Dr: P&L
CR: Provis
ion for discount allowed.
3.Treatment on provision for B.D D
i.In the first year:
Dr: P&L
Cr: provision for B. D.D
ii. Decrease in provision for B.D.D
Dr .Provision for B.D.D
Cr: P&L
iii. Increase in provision
Dr: P&L
CR: Provision for B.D.D
EXAMPLE
List of debtors.
YEAR
DEBTORS
2008
2009
2010
2012
100,000
150,000
145,000
140,000
Rate of provision for B.D.D is 10% P.A
Draw Up:
1. provision for B.D.D A/C
2. balance sheet as at 31. 12. 2000 – 2011
2008: 100,000 x 10/100 = 10,000
2009: 150,000 x 10/100 = 15,000
2010: 145,000 x 10/100 = 14,500
2011: 140,000 x 10/100 = 14,000
DR PROVISION FOR BAD AND DOUBTFUL DEBTS A/C CR
31.12.2008
Balance c/d
10,000
31.12.2008
P & L
10,000
31.12.2009
Balance c/d
15,000
1.1.200
9
Balance b/d
10,000
31.12.2009
P & L
5,000
15,000
15,000
31.12.2010
P & L
500
1.1.2010
Balance b/d
15,000
31.12.2010
Balance c/d
14,500
15,000
15,000
31.12.2011
P & L
500
1.1.2011
Balance b/d

14,500
31.12.2011
Balance c/d
14,000
14,500
14,500
1.1.2012
Balance b/d
14,000
BALANCE SHEET AS AT 31.12.2008
2008
Debtors
100,000
less: Provision for B.B.D
10,000
90,000
2009
Debtors
150,000
less: Provision for B.B.D

15,000
135,000
2010
Debtors
145,000
less: Provision for B.B.D
14,500
130,500
2011
Debtors
140,000

less: Provision for B.B.D
14,000
126,000
BAD DEBTS RECOVERED.
  • when bad debts recorded
Dr: cash / bank
Cr: bad debt recoverable a/c
Then at the end of accounting period:
Dr: bad debts recoverable a/c
Cr: P & L
QUESTIONS:
1. A business makes a provision for bad debts and discount allowed at a r
ate of 6% and 3% of debtors respectively
The debtors balance as at 31st December were;
1995 85,000
1996 75,000
1997 90,000
You are required to show the necessary entries in the provision accounts, profit and loss account and balance sheets for those years.
1. A trader makes a provision for discounts received at the rate of 4% of creditors at the end of the year. The creditors balance as at 31st December were.
19 -2 12,000
19-3 15,000
19-4 10,000
19-5 13,000
You are required to show the necessary entries in the provision for discount received account, profit and loss account and balance sheet as at for these gears.
3. The following items appear in A white trial balance dated 31st December 19-7
DR

CR
Tsh
Tsh
Bad debts
3,000
Discount allowed
1,420
Discount received
3,000
Trade debtors

70,000
Trade creditors
110,000

It is white’s policy to keep the provision for bad debts. Discount allowed and discount received at the rate of 5%, 2.5% and 6% on debtors.
You are required to show the entries in:-
1.The P & L account (extract) for the year ended 31 .12. 19-9
2. Balance sheet (extract) as at 31. 12. 19-9
CALCULATION (1)
Provision for bad debts at a rate of 6%
1995: 85,000 x 6/100 = 5,100
1996: 75,000 x 6/100 = 4500
1997: 90,000 x 6/100 = 5400
DR PROVISION FOR BAD AND DOUBTFUL DEBTS A/C CR
31.12.1995
Balanc
e c/d
5100
31.12.195
p&L
5100
31.12.1996
p&l
600
1.1.1996
balance b/d
5100
31.12.1996
Balance c/d
4500
5100
5100
1.1.1997
balance b/d
4500
31.12.1997
Balance c/d
5400
p&l
900
5400
5400
1.1.1998
balance b/d
5400
DR PROFIT AND LOSS A/C CR
31.12.1995
provision for B.D.Debts
5100
31.12.1996
provision for B.D.Debts
600
31.12.1997

provision for B.D.Debts
900
4. E.C Commenced business on 1st January 1997 and his account end to 31 December, every year. For the ended 31. 12. 1997, bad debts written off amounted to 1200/=, if was also found necessary to create the provision for doubt of 2,000/= in 1998, debts, amounting to 1600, proved bad and were w/o. Mrs Lema, whose debts of 350 was w/o as bad in 1997 settled her account in full on 30.11.1998. As at 31.12.1998 total debts outstanding were 56,000 it was decided to bring provision up to 5% on this figure of that date.In 1999, 2,350 debts were w/o during the year, and another recovery of 150 was made in respect of debts w/o in 1997. As 31st .12.1999, total debts outstanding were 42,000; the provision for doubtful debt is to be maintained at 5% of this figure.
You are required to prepare:-
1. Bad debts a/c.
2. Provision for bad debts a/c.
3. Bad debts recovery a/c.
CALCULATION (4)
DR BAD DEBTS A/C CR
31.12.1997
Debtors
1200
31.12.1997
p&l
1200
31.12.1998
Debtors
1600
31.12.1998
p&l
1600
31.12.1999
Debtors
2350
31.12.1999
p&l
2350
DR PROVISION FOR BAD AND DOUBTFUL DEBTS A/C CR
31.12.1997
Balance c/d
2,000
31.12.1997
p&l
2,000

31.12.1998
Balance c/d
2,800
1.1.1998
balance b/d
2,000
31.12.1998
p&l
800
2,800
2,800
31.12.1999
p&l
700
1.1.1999
balance b/d
2,800
31.12.2000
Balance c/d
2,100
2,800
2,800

1.1.2000
balance b/d
2,100
Workings:
31.12.1998: 56000 X 5/100 = 2800
31.12.1999: 42000 X 5/100 = 2100
DR BAD BEBTS RECOVERY A/C CR
31.12.1998
p&l
350
31.12.1998
cash/bank
350
31.12.1999
p&l
150
31.12.1999
cash/bank
150

PROVISIONS FOR DEPRECIATION

Depreciation
Is that part of the original cost of a non – current asset that is consumed during its period of use by the business, OR Is the fall in value of an asset.
  • Causes of Depreciation:
1. Physical deterioration:-
1. Wear and tear.
2. Erosion , rust and decay.
2. Economic factors:-
1. Obsolescence.
2. Inadequacy.
3. Time.
4. Depletion.


  • METHODS OF CALCULATING DEPRECIATION CHARGES:-
(i) Straight line method:
In this method, the number of years of use is estimated. The cost is then divided by the number of years.
Example
If a van was bought for 22,000 and we thought we could keep it for four years and then sell it for 2,000. What depreciation to be charged each year would be?.

(disposal value)/(Estimated number of year).

Depreciation = (22,000-2,000)/4 = 20,000/4 = 5,000/=
Therefore, Depreciation to be per year is 5,000/=
(ii) Reducing balance method:-
In this method, a fixed percentage for depreciation is deducted from the cost in the first year. In the second and the third years the same percentage is taken of the reduced balance. This method is also known as “Diminishing balance method” A machine is bought for 10,000/= and depreciation is to be charged at 20%. The calculations of the first three years would be as follows:-
cost
10,000
1st year
Depreciation (20%)
-2,000
Remaining value 1st year
8,000
2nd year
Depreciation (20%) of 8,000
-1,600
Remaining value 2nd year
6,400
3rd year
Depreciation (20%) of 6,400
-1,280
Remaining value 3rd year
5,120
(iii) Units of output method:-
This method establishes the total expected units of output expected from the assets. Depreciation, based on cost less salvage value, is then calculated for the period by taking that period units of output as a proportion of the total expected output over the life of the asset. A machine which is expected to be able to produce 10,000 widgets over its useful life. It has cost 6,000/= and has an expected salvage valu
e of 1,000/=. In year 1 a total of 1500/= widgets are produced and in year 2 the production is 2500 widgets.

(Cost – salvage value) x { Period’s production Total expected production}
Year 1: (6000 – 1000 ) x (31500)
10,000
= 5000 x 3/20 = 1500 = 750
2
Year 2: 5000 x 2,500
= 10000
= 1,250
= Year 1: = 750/= Depreciation
= Year 2: = 1,250/= Depreciation
(iv) Sum of years digit method:-
Given an asset costing 3,000/= which will be in use for five years, the calculation will be:-
Sum of years digit = n/2 (n + 1)
= 5/2 (5 +1)
= 5/2 x 6 = 15
1st year : 5/15 x 3000 = 1,000
2nd year: 4/15 x 3,000 = 800
3nd year: 3/15 x 3,000 = 600
4th year: 2/15 x 3,000 = 400
5th year: 1/15 x 3,000 = 200
3,000
(v) Depletion unit method:-
A quarry was bought for 5000/= and it was expected to contain 1,000 tonnes of salable materials, then for each tonne taken out we would depreciate it by 5/=,(Since 5000 ÷ 1,000) = 5. This can be shown as;
(cost of asset)/(Expected total contents in units) x Number of units taken
(vi) Machine hour method:-
With a machine the depreciation provision may be based on the number of hours that the machine was operated during the period compared with the total expected running hours during the machines life with the business.
ASSIGNMENT:
A Company, which makes up its financial statements annually to 31st DEC, provides for depreciation of its machinery at the rate of 15% per annum using the reducing balance method.
On 31/12/2008, the machinery consisted of three items purchased as shown:-
On 1st January 2006 (Machine A)
2,000
On 1st September 2001 (Machine B)
4,000
On 1st May 2008 (Machine C)
3,000


Required:
Your calculations showing the depreciation provision for the year 2008.
Calculations:
Machine A
Machine B
Machine C
Bought on 1.1.2006
2,000
15% × 2,000
-300
1,700
Bought on 1.9.2006
4,000
15% × 1,700
-255
15% × 4,000 × 4/12
-200
1,445
3,800
Bought on 1.5.2007
3,000
15% × 1,445

-217
15% × 3,800

ecolebooks.com
-570
15% × 3,000 × 8/12
-300
1,228
3,230
2,700
ASSIGNMENT:-
A machine which cost Tshs. 200,000 is to be depreciating at the rate of 20% p.a. On the straight line method. Assuming this machine was purchased on 1st January 19-7. Show the entries to record this as at 31st Dec 19-7, 19-8 and 19 – 9, by applying two alternative methods.
Workings:-
Straight line method:-
19 – 7: 200,000 x 20,000 = 40,000
19 – 8: 200,000 x 20/100 = 40,000
19 – 9: 200,000 x 20/100 = 40’000
METHOD 1:
ENTRIES IN THE ASSET A/C
DR. MACHINERY A/C CR
1.1.1997
cash

200,000
31.12.1997
P&L
40,000
31.12.1997
Balance c/d
160,000
200,000
200,000
1.1.1998
Balance b/d
160,000
31.12.1998
P&L
40,000
31.12.1998
Balance c/d

120,000
160,000
160,000
1.1.1999
Balance b/d
120,000
31.12.1999
P&L
40,000
31.12.1999
Balance c/d
80,000
120,000
120,000
1.1.2000
Balance b/d
80,000
DR PROFIT AND LOSS A/C (EXTRACT) CR
31.12.1997
Depreciation
40,000
31.12.1998
Depreciation
40,000
31.12.1999
Depreciation
40,000
BALANCE SHEET
31.12.1997 Machinery 160,000
31.12.1998 Machinery 120,000
31. 12. 1999 Machinery 80,000
METHOD 2:
DR MACHINERY A/C CR
1.1.1997 Cash
200,000
31.12.1997 Balance c/d
200,000
1.1.1998 Balance b/d
200,000
31.12.1998 Balance c/d
200,000
1.1.1999 Balance b/d
200,000
31.12.1999 Balance c/d
200,000
DR PROVISION FOR DEPRECIATION A/C CR
31.12.1997 Balance c/d
40,000
31.12.1997 P&L
40,000
1.1.1998 Balance b/d
40,000
31.12.1998 Balance c/d
80,000
31.12.1998 P&L
40,000
80,000
80,000
31.12.1999 Balance c/d
120,000
1.1.1999 Balance b/d
80,000
31.12.1999 P&L
40,000
120,000
120,000
PROFIT AND LOSS A/C (EXTRACT)
31.12. 1997 Provision for depreciation
40,000
31.12.1998 Prov. for depreciation
40,000
31.12.1999 Provision for depreciation
40,000
BALANCE SHEET (EXTRACT)
ASSETS
NON-CURRENT ASSETS
31.12.1997
Machinery
200,000
Less: Provision for depreciation
40,000
160,000
31.12.1998
Machinery
200,000
Less: Provision for depreciation
80,000
120,000
31.12. 1999
Machinery
200,000
Less: Provision for depreciation
120,000
80,000
DISPOSAL OF A NON-CURRENT ASSET:-
  • Accounting treatment:-
1. When we buy assets:-
DR: Asset a/c.
CR: Cash / Bank / Creditor.
2. Annual provision for depreciation:-
DR: P &L
CR: Provision for depreciation
3. When asset sold / disposal :-
1st step: DR: Disposal a/c at cost.
CR: Asset a/c
2nd step: Dr. Cash / Bank} Selling price of the asset
Cr. Disposal
3rd step: Dr. Provision for depreciation} with the amount of Prov.
Cr. Disposal for depreciation Of the asset sold.
4th step: Dr. P & L } In case of loss on disposal.
Cr. Disposal.
Or
Dr. Disposal } In case of gain on disposal.
Cr. P & L
A machine bought on 1.1.2008 for 1,000,000 and sold on 1.1.2010 for 500,000. Depreciation per annum is 10% on straight line method.
Draw up: – Disposal a/c
-Provision for depreciation a/c
-P & L a/c
DR MACHINERY A/C CR
1.1.1998 Cash
1,000,000
31.12.2008 Balance c/d
1,000,000
1.1. 2009 Balance b/d
1,000,000
31.12.2009 Balance c/d
1,000,000
1.1.2010 Balance b/d
1,000,000
1.1.2010 Disposal
1,000,000


DR. PROVISION FOR DEPRECIATION A/C CR
31.12.2008 Balance c/d
100,000
31.12.2008 P & L
100,000
31.12. 2009 Balance c/d
200,000
1.1 .2009 Balance b/d
100,000
31.12.2009 P & L

100,000
200,000
200,000
1.1.2010 Disposal
2,000,000
1.1.2010 Balance b/d
200,000

DR DISPOSAL A/C CR
1.1.2010
Machine
1,000,000
1.1.2010
Cash/Bank
500,000
Provision for depreciation
200,000
P&L
300,000
1,000,000
1,000,000

ASSIGNMENT
1. A motor vehicle was purchased for Tshs. 400,000 on 1st January 1996. Depreciation was to be provided at the rate of 25% per annum on diminishing balance method. Show the entries as 31.12.1996, 1997, and 1998 in the following a/c.
(a) Motor vehicle a/c.
(b) Provision for depreciation on motor vehicle a/c.
(c) P & L a/c (Extract).
(d) Balance sheet (Extract).
2. Best view hotel had crockery valued at sh. 65,000 on 1.1.1987. During 1987, they purchased some more crockery for sh. 50,000 and on 31.12.1987; it was valued at Sh. 100,000. Calculate the depreciation charge of crockery for the year ending 31.12.1987 and show the entries in the relevant a/c’ s.
3. Kilimanjaro Company Limited acquired the following fixed assets during 1986.
(a) Furniture and fitting for Tshs. 10,000. These are expected to be depreciation at 20% per annum. Date of purchase 1.1.1986.
(b) Premises on a 99 years lease for Tshs. 198,000. Date of acquisition 17:1986.
(c) Motor van for Tshs. 45,000. It is expected to have a useful life of 7 years and leave a scrap value of shs. 3,000. Date of purchase 1.09.1986.
The company has no other fixed assets. It maintains a provision for depreciation a/c for each fixed asset.
you are required to calculate the following:-
1. The balance on motor van a/c on 31.12.1987.
2. The balance of provisions for depreciation on furniture and fittings a/c on 31.12.1987.
3. The book value of premises on 31.12.1987.
4. The amount of depreciation charged to profit and loss a/c on all fixed assets at the end of 1987.
5. On 1st January 1986 Kahawa Transporters LTD, purchased three motor vehicle costing shs. 108,000 each. The useful life of these vehicles was estimated to be five years with a disposal value of shs. 8,000 for each vehicle.
The company’s normal practice is to use straight line method for depreciation.
One of the vehicles was damaged in an accident and was sold on 1.1.1986 for Tshs. 45,000.
Required:
Prepare the following a/c for the three years ended 31.12.1986, 1987, and 1988:-
1. Motor vehicle a/c.
2. Motor vehicle disposal a/c.
3. Provision for depreciation on Motor vehicle a/c.
The following transactions relate to AJS limited in respect of plant and machinery:-
1. On 1st March 1986 machine M. 5 purchased for Tshs. 120,000. The estimated useful life being 5 years and having a residual value of sh.20, 000.
2. On 1.1. 1987 machine M.6 purchased for Tshs. 180,000. The estimated useful life being 7 years and having a residual value of Tshs. 40,000.
3. On 1.9.1988 machine M.5 was given a part exchange for machine M.7, the allowance being sh. 40,000, machine M.7 costs Tshs 200,000 will an estimated useful life of 10 years and having a residual value of sh. 60,000.
Assume full depreciation expenses in the year of purchase, and ignore depreciation in the year of sale.
Required:-
Plant and machinery a/c and the related depreciation and disposal a/c in respect of the three years ending 31.12.1989.
WORKINGS/SOLUTIONS
FOR ASSIGNMENT. 1


DR MOTOR VEHICLE A/C CR
1.1.1996 Cash
400,000
31.12.1996 Balance c/d
400,000
1.1.1997 Balance b/d
400,000
31.12.1997 Balance c/d
400,000
1.1.1998 Balance b/d
400,000
31.12.1998 Balance c/d
400,000
1.1.1999 Balance b/d
400,000
DR PROVISION FOR DEPRECIATION A/C CR
31.12.1996 Balance c/d

100,000
31.12.1996 P&L
100,000
1.1.1997 Balance b/d
100,000
31.12.1997 Balance c/d
175,000
31.12.1997 P&L
75,000
175,000
175,000
31.12.1998 Balance c/d
231,250

1.1.1998 Balance b/d
175,000
31.12.1998 P&L
56,250
231,250
231,250
1.1.1999 Balance b/d
231,250
DR. PROFIT AND LOSS A/C (EXTRACT) CR
31.12.1996 Prov. for depreciation
100,000

31.12.1997 Prov. for depreciation
75,000
31.12.1998 Prov. for depreciation
56,250

BALANCE SHEET (EXTRACT)
31.12.1996
Motor vehicle
400,000
Less: Depreciation
100,000

300,000
31.12.1997
Motor vehicle
400,000
Less : Depreciation
175,000
225,000
31.12.1998
Motor vehicle
400,000
Less :Depreciation
231,250
168,750
Other method:-
SINKING FUND:-

    • According to this method, the amount charged by way of depreciation is invested in a certain securities carrying a particular rate of interest.
    • The amount received from an account of interest from this security is also invested from time to time together with annual amount charged by way of depreciation.
    • At the end of useful life of the asset, when replacement is required, the securities are sold away and money realized on account of the sale of securities is used for the purchase of a new asset.




Share this:


subscriber

Leave a Reply

Your email address will not be published. Required fields are marked *

Accept Our Privacy Terms.*