Question Tag: Bad Debt

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  • 20 Marks

PT – March 2023 – L2 – Q4 – Income Tax Liabilities

Compute the chargeable income and capital allowance for Adwoa Mansa based on her accounts.

Adwoa Mansa is self-employed and has not filed her tax returns to the Ghana Revenue Authority. She applied for a tax clearance certificate in February 2023, and the head of her Tax Office insisted that she submit her accounts for the 2022 year of assessment. Below are the details from her auditors for the year ended 31 December 2022.

Details Amount (GH¢)
Gross Profit 5,200,000
Expenses:
Utilities 70,000
Travelling expenses 43,000
Depreciation 30,500
Rent 21,200
Maintenance 25,260
Donations 60,250
Bad debts 52,000
Sanitation 20,000
Business promotion 25,620
Salaries 86,000
Net profit 4,766,170

Additional Information from Adwoa Mansa in response to queries raised by the tax official:

  1. Utilities and Rent:
    Adwoa Mansa and her husband occupy the apartment next to the shop. 25% of the expenditure on utilities and rent relates to her home.
  2. Travelling Expenses:
    28% of the travelling expenses were for private journeys.
  3. Maintenance:
    The maintenance figure includes GH¢11,500 for furniture and fittings bought for the shop and GH¢10,000 for painting her apartment.
  4. Donations:
    • Donation to Covid-19 fund: GH¢32,250
    • Donation to Mallam Atta Women’s Association: GH¢19,500
    • Donation to Farmers Day celebration: GH¢8,500
  5. Bad Debts:
    • General provision: GH¢26,000
    • Specific provision: GH¢10,000
    • Loan to husband written off: GH¢16,000
  6. Sanitation:
    GH¢1,000 was spent on acquiring equipment for cleaning the office premises.
  7. Business Promotion:
    • Permanent billboard: GH¢8,000
    • Television advertisement: GH¢6,620
    • Entertainment of customers: GH¢11,000
  8. Dividend and Interest:
    Adwoa Mansa received a dividend of GH¢18,800 (net) from her investment with Tarzan Ltd and interest of GH¢15,600 from Government Treasury bills. These amounts were included in her gross profit.
  9. Assets Purchased in 2022:
    • Computers: GH¢300,000
    • Warehouse: GH¢330,000
    • Air conditioners: GH¢100,700
      All assets are depreciable for capital allowance purposes.

Required:

a) State the circumstances under which bad debt will be allowable.
(4 marks)

b) Calculate the chargeable income of Adwoa Mansa for the 2022 year of assessment.
(16 marks)

a) Circumstances under which bad debt will be allowable:

  1. The bad debt must be specific, not general.
  2. The bad debt must have arisen in the ordinary course of business.
  3. The amount of the bad debt should have been included in income for previous years.
  4. Necessary steps should have been taken to recover the debt before it is classified as bad.

(4 marks)

b) Computation of Chargeable Income for Adwoa Mansa for the 2022 Assessment Year

Details GH¢ Explanation
Net Profit per accounts 4,766,170
Less:
Dividend (Tarzan Ltd) (18,800) Non-taxable
Interest (Government Treasury bills) (15,600) Non-taxable
Adjusted Net Profit 4,731,770
Addbacks:
Utilities (25% personal use) 17,500 25% relates to personal use
Depreciation 30,500 Non-deductible
Travelling expenses (28% personal use) 12,040 28% relates to personal use
Rent (25% personal use) 5,300 25% relates to personal use
Maintenance: Furniture & fittings (capital) 11,500 Capital expenditure
Maintenance: Painting (personal use) 10,000 Relates to personal use
Donations: Mallam Atta Women’s Association 19,500 Non-allowable donation
Bad debts: General provision 26,000 Non-allowable
Bad debts: Loan to husband 16,000 Non-allowable
Sanitation (equipment) 1,000 Non-allowable (capital expenditure)
Business Promotion: Permanent billboard 8,000 Non-allowable (capital expenditure)
Business Promotion: Entertainment of customers 11,000 Non-allowable
Total Addbacks 168,340
Adjusted Net Profit 4,900,110
Less: Capital Allowance (176,440) See working below
Chargeable Income 4,723,670

Capital Allowance Calculation:

Class Cost (GH¢) Capital Allowance Rate Allowance (GH¢)
Class 1 300,000 40% 120,000
Class 3 113,200 20% 22,640
Class 4 338,000 10% 33,800
Total 176,440

Total Capital Allowance: GH¢176,440

(16 marks)

  • 20 Marks

AAA – May 2017 – L3 – Q1 – Planning | Audit evidence | Evaluation and review

Assess the audit implications of subsequent events involving bad debt and legal actions, describe subsequent events review, and recommend audit procedures for identifying material subsequent events.

You are the audit manager in charge of the audit of Serwah Ghanaba Ltd for the year ended 31 December 2014. The partner in charge of the audit instructs you to carry out a review of the company’s activities during the financial year end. The following issues came up during the review.

i) On 28 February 2015, Jessica Mensah, who owed the company GH¢500,000.00, was killed by some robbers on her way to Accra after a visit to her hometown. The amount was part of the GH¢800,000.00 debtors appearing on the statement of financial position for the year end 31 December 2014. It was realized that it will not be possible to recover the amount from the family of Jessica Mensah.

ii) In another development, the marketing director of the Company, Stephen Odoi, who was due to retire on 31 March 2015, embarked on a 6-month leave prior to retirement with effect from 1 October 2014. Investigation instituted in May 2015 revealed that Mr. Stephen Odoi took a contract appointment with another company from 1 November 2014. As a result of the investigation, the company decided to bring an action against Mr. Stephen Odoi to recover the salary paid to him from 1 November 2014 to 31 March 2015.

Required:

a) Assess the audit implications of issues (i) and (ii) above. (10 marks)

b) Describe the nature and purpose of subsequent events review. (5 marks)

c) Recommend the audit procedures which would be carried out in order to identify any material subsequent events. (5 marks)

a)

i) Subsequent Events – Bad Debt

  • The issue under consideration is an adjusting event – that is, the event provides further evidence of conditions that existed at the end of the reporting period. The GH¢500,000.00 appeared on the statement of financial position for the year ended 31 December 2014. In addition, the amount is material. There is a need for the debt to be written off in the December 2014 financial statement since there is no hope for the amount to be recovered.
  • If the client refuses to make the write-off, the auditor should consider the type of modified opinion to issue—Qualified opinion or adverse opinion depending on the pervasiveness of the auditor.

ii) Legal Action Against Marketing Director

  • The auditors should first ascertain from the board minutes that the board intends to proceed with the lawsuit and should then attempt to assess the outcome by consulting the directors and the company’s legal advisors. Only if it seems probable that the salary paid to Stephen Odei will be recovered should a contingent gain be disclosed in the notes to the accounts along with a summary of the facts of the case. A prudent estimate of legal cost should be deducted.
  • It could be argued that the breach of contract by Mr. Stephen Odei existed at the year-end, and therefore the salary for November and December 2014 should be treated as contingent assets, and that for January – 31st March 2015 should be disclosed in notes to the accounts.

(10 marks)

b) Subsequent Events Review:

  • The auditor’s active responsibility extends to the date on which they sign their audit report. As this date is inevitably after the year-end, it follows that in order to discharge their responsibilities, the auditor must extend the audit work to cover the period after the year-end.
  • The objective of this review is to ascertain whether management has dealt correctly with any events, both favorable and unfavorable, which occurred after the end of the reporting period and which need to be reflected in the financial statements if those statements are to show a true and fair view.
  • The general rule is that, in the preparation of year-end financial statements, no account should be taken of subsequent events unless to do so is required by statute or to give effect to retrospective legislation, or to take into account an event that provides information about a condition existing at the end of the reporting period, for example, realizable values of inventory, or indicates that the going concern concept is no longer applicable. Additionally, certain events may have such a material effect on the company’s financial condition, for example, a merger, that disclosure is essential to give a true and fair view.

(5 marks)

c) Audit Procedures to Identify Material Subsequent Events:

  • Ask management if there have been any material subsequent events.
  • Identify and evaluate procedures implemented by management to ensure that all events after the end of the reporting period have been identified, considered, and properly evaluated as to their effect on the financial statements.
  • Review relevant accounting records to identify subsequent cash received in relation to accounts receivable, to check items uncleared at the year-end on the bank reconciliation, and to check NRV of inventories from sales invoices.
  • Review budgets, profit forecasts, cash flow projections, and management accounts for the new period to assess the company’s trading position.
  • Consider known ‘risk’ areas and contingencies, whether inherent in the nature of the business or revealed by previous audit experience or by lawyers’ letters.
  • Read minutes of shareholders and management meetings, and correspondence and memoranda relating to items included in the minutes to identify any matters arising.
  • Consider relevant information which has come to the auditors’ attention from sources outside the entity, including public knowledge of competitors, suppliers, and customers.
  • Obtain written representations concerning subsequent events from management.

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