AOS 5 start of Unit 4 Flashcards
Why would management may decide to create an allowance for doubtful debts?
Management should create an allowance for doubtful debts if there is a reasonable expectation that some accounts receivable may not settle their accounts. This expectation may be based on past experience where a certain number of credit customers have not paid.
Explain why an allowance of doubtful debts is reported in a balance sheet?
The allowance for doubtful debts is shown as a negative asset and is deducted from the amount shown for accounts receivable. This then shows the amount which is likely to be collected from accounts receivable.
Difference between bad and doubtful debts
Doubtful debts is the allowance created in anticipation of some accounts receivable not meeting their financial obligations in the future.
Bad debts are recorded when it has been established that either an accounts receivable is not going to pay, or is unable to pay – possibly due to bankruptcy.
What is depreciation
Depreciation is the allocation of the cost of a non-current asset over its effective working life.
What does the term scrap value or residual value mean?
Scrap value is another name for residual value, which is the estimated value of an asset at the end of its useful life. This estimate is made when the asset is purchased and it is how much management predicts it will receive for the asset when it is sold in the future.
Explain what it is meant by straight-line depreciation
The straight-line method of depreciation is a method of allocating the cost of an asset at a constant rate throughout the asset’s life. That is, the same amount of depreciation is allocated each period, regardless of how old the asset is.
Explain what the carrying value of an asset is?
The carrying value of an asset is shown in the balance sheet and is determined by deducting the accumulated depreciation from the original cost of the asset. The carrying value is made up of two components: it includes the amount of the asset yet to be depreciated, plus the original estimate of the residual value of the asset.
Explain the workings of the reducing balance method
The reducing balance method of depreciation allocates a fixed percentage of the carrying value of the non-current asset. As the assets gets older, its carrying value decreases and therefore so does the amount of depreciation being allocated.
Outline the difference in cost allocation between straight line and reducing balance methods of depreciation.
In the earlier years of an asset’s life, reducing balance will allocate a greater amount of depreciation. In the last few years of an asset’s life, the straight line method will allocate a greater amount of depreciation. Over the whole life of an asset, the two methods will allocate the same amount of depreciation.
On what basis should depreciation method should be selected
The method of depreciation chosen should reflect the revenue earning pattern of the asset under consideration.
• If the asset is expected to earn more revenue in its early years and less in its latter years, the reducing balance method should be selected. This is because this method allocates more depreciation in the early years and less in the latter years.
• If the asset is expected to have a consistent revenue earning pattern over its life the straight line method should be selected. This is because the straight line method allocates a consistent amount of depreciation over the years, in line with the revenue earning pattern of the asset.
