Drafting Adjustments and Improving Credit Control

Adjustments at the Balance Date and Preparation of Sole Proprietorship Financial Statements

Skill: Create

Stimulus

Question

(a) Draft the required adjustments: show the calculation of the bad debt, the new provision for doubtful debts and its change, and the vehicle's depreciation for the year.

(b) Puan Halimah is worried the bad debt will recur. Propose TWO improvements to her business's credit control and, for each, explain how it links to healthier financial statements.

Thinking steps

1. Separate the three types of adjustment (bad debt, provision for doubtful debts and depreciation). Each affects profit and the statement of financial position differently.
2. Write off Encik Rosli's bad debt of RM2,000 first; accounts receivable falls from RM40,000 to RM38,000.
3. Compute the new provision: 3% × RM38,000 = RM1,140. Compare with the old provision RM1,500 → a decrease of RM360, so the reduction is credited to profit or loss (increasing profit).
4. Compute the vehicle depreciation: 20% × RM60,000 (cost) = RM12,000. Accumulated depreciation becomes RM24,000 + RM12,000 = RM36,000; net book value = RM24,000.
5. Link the effects: the bad debt and depreciation are expenses (reduce profit); the reduced provision is income/less expense (raises profit); the receivables balance and asset carrying value fall in the statement of financial position.
6. For (b), choose credit-control improvements that tackle the cause of bad debts (customer screening, collection speed) and explain the cause-and-effect chain through to the financial statements.

Model answer

(a) Drafted adjustments:

• Bad debt: write off Encik Rosli RM2,000 as an expense. Accounts receivable: RM40,000 − RM2,000 = RM38,000.

• New provision for doubtful debts: 3% × RM38,000 = RM1,140. Old provision RM1,500, so it decreases by RM360. The RM360 reduction is credited to the Income Statement (raising profit), and the RM1,140 provision balance is deducted from receivables in the statement of financial position (net receivables = RM38,000 − RM1,140 = RM36,860).

• Vehicle depreciation: 20% × RM60,000 = RM12,000 (expense). Accumulated depreciation = RM24,000 + RM12,000 = RM36,000; net book value of the vehicle = RM60,000 − RM36,000 = RM24,000.

Net effect: the bad debt expense RM2,000 and depreciation RM12,000 reduce profit, while the RM360 reduction in provision raises profit.

(b) Two improvements (examples):

1) Set credit limits and run credit background checks before approving credit sales. This screens out high-risk customers, so the chance of non-payment falls → fewer bad debts and a smaller provision for doubtful debts in future → lower expenses and steadier net profit.

2) Issue monthly statements and carry out firm collection follow-ups, or offer a cash discount for early payment. This speeds up cash collection and reduces overdue debtors → a higher-quality receivables balance, a smaller provision for doubtful debts and improved cash flow in the financial statements.