Balance day adjustments

Topic 5

Learning outcomes

After studying this topic, you should be in a position to:

Describe various types of non cash adjustments Compute depreciation charge for the period Compute amortization charge Compute gain or loss on disposal of equipments Recognize allowance for doubtful debts Differentiate between allowance for doubtful debts and

write-off Prepare adjusted trial balance Prepare financial statements from the adjusted trial

balance

Recap of topic 4In topic 4 we learnt that;

Accrual basis of accounting requires period end adjustments to be posted

Adjustments necessary to ensure financial reports comply with accounting concepts and conventions

Major classes of period end adjustments include; prepayments and accruals, and non cash charges

Topic 4 dealt with prepayments and accrualsIn Topic 5 we learn more about non cash

charges

Non cash charges

They include

Depreciation chargeAmortization chargeGain or loss on disposalAllowance for bad debtsBad debts expense

Depreciation chargeA charge to recognize cost of wear and tear of

property and equipment due to use in generating revenues

Depreciation charge should be made to the period in which it was incurred

Computation requires an estimationThree main methods of estimation

i. Straight line basisii. Reducing balance basisiii. Sum of years digits method

Posting depreciation expense;Dr Expense

Cr Accumulated depreciation

Depreciation chargeIllustrationRakesh & Sons Limited is a rice distributor

covering a number of regions in the country. The business owns a fleet of trailers and prime movers that are used in transporting rice to retailers. It is the policy of the company to charge depreciation on the year of purchase.

Cost: $100,000Year of purchase: 2011Expected useful life: 10 yearsScrap value at the end of useful life:

$10,000

IllustrationRequired:-

1. Determined what will be the depreciation charge and accumulated depreciation for years 2011, 2012, 2013 and 2014 using;

(a)straight line depreciation basis, (b)Reducing balance basis, (c)Sum of years digits basis.

Illustration: suggested solution

(a) Straight line basisWorkingsCost 1 100,000 Expected useful life 2 10 Scrap value 3 10,000 Depreciable value D=1-3 90,000 Depreciation charge

A = D/2 9,000

Solution

Year Depreciation charge

Accumulated depreciation

2011 9,000 9,000 2012 9,000 18,000 2013 9,000 27,000 2014 9,000 36,000

Illustration: suggested solution

(b) Reducing Balance methodWorkingsCost 1 100,000 Expected useful life 2 10 Scrap value 3 10,000 Depreciation base

D=1-3 90,000

SolutionDepreciable value = (D - Accumulated depreciation for the preceding period)

Depreciation charge

Accumulated depreciation

Year 2011 90,000 9,000 9,000 2012 81,000 8,100 17,100 2013 72,900 7,290 24,390 2014 65,610 6,561 30,951

Illustration: suggested solution

(c) Sum of years digits depreciation basis

YearSum of years Rate (r)

Depreciable base

(D)Depreciation (D*r)

Accumulated

depreciation

2011 1 (10/55) 90,000

16,364 16,364

2012 2(9/55)

90,000 14,727 31,091

2013 3(8/55)

90,000 13,091 44,182

2014 4(7/55)

90,000 11,455 55,636

2015 5(6/55)

90,000 9,818 65,455

2016 6(5/55)

90,000 8,182 73,636

2017 7(4/55)

90,000 6,545 80,182

2018 8(3/55)

90,000 4,909 85,091

2019 9(2/55)

90,000 3,273 88,364

2020 10(1/55)

90,000 1,636 90,000 55

Gains or losses on disposalWhen an item of property and equipment is sold, a

gain or loss resultsA gain results where the proceeds are higher than

the net book value of the asset soldA loss is where net book value of the asset

disposed is higher than the sales proceeds

To record a disposal where a gain is madeDr Accumulated depreciation XXDr Bank (with the amount of sales proceeds) XX

Cr Gain on disposal XXCr Disposal Account (with the cost of asset

sold) XX

Gains or losses on disposalTo record a disposal where a loss is made

Dr Accumulated depreciationDr Bank (with the amount of sales proceeds)Dr Loss on disposal

Cr Disposal Account (with the cost of asset sold)

See next slide for an illustration

Illustration: gains/losses on disposal In our earlier example, suppose that come

year 2012, Rakesh sells the trailer and prime mover for

(i)$60,000(ii)$ 90,000

Required:--

Determine the entries that should be made to recognize the sale under the three depreciation basis.

See next slide for suggested solutions

Illustration: gains/losses on disposal

Straight line

Reducing balance

Sum of years digits

(i)Sale at $60,000Cost (a) $100,000 $100,000 $100,000 Accumulated depreciation Year 2012 (b) $18,000 $17,100 $31,091

Net book value (n= a-b) $82,000 $82,900 $68,909

Sales proceeds (c) $60,000 $60,000 $60,000 Loss (l=n-c) $22,000 $22,900 $8,909

AdjustmentDr Accumulated depreciation (b) $18,000 $17,100 $31,091 Dr Bank (c) $60,000 $60,000 $60,000 Dr Loss on disposal (l) $22,000 $22,900 $8,909

Cr Motor vehicles (k)($100,00

0) ($100,000) ($100,000)

Illustration: gains/losses on disposal

(ii) Sale at $90,000 Straight line

Reducing balance

Sum of years digits

Cost (a) $100,000 $100,000 $100,000 Accumulated depreciation Year 2012 (b) $18,000 $17,100 $31,091

Net book value (n= a-b) $82,000 $82,900 $68,909

Sales proceeds (c) $90,000 $90,000 $90,000 Gain on disposal (g=c-n) $8,000 $7,100 $21,091 AdjustmentDr Accumulated depreciation (b) $18,000 $17,100 $31,091 Dr Bank (c) $90,000 $90,000 $90,000 Cr Gain on disposal (g) $8,000 $7,100 $21,091

Cr Motor vehicles (a)($100,00

0) ($100,000) ($100,000)

Amortization chargeSimilar concept with depreciationCharge for decrease in value over time of

intangible assets such as good will and computer software

Computations for amortization charge similar to those of depreciation

Entries passed

Dr Amortization charge XXCr Accumulated amortization

charge XX

Allowance for doubtful debtsSome credit sales might turnout to be uncollectibleThe loss should be charged in the period in which it

occursEstimation of the charge depends on management’s

experienceIllustration

At year end Rakesh had an accounts receivable balance of $200,000. Out of experience, 5 percent of all credit sales turnout to be bad and are not collected. Required: Compute the general provision for doubtful debts and journalise the entry to be made, if any

Allowance for doubtful debtsSuggested solution

In this case out of the $200,000, 5 percent of it $10,000 are expected to be unpaid. This should be adjusted as follows;

Doubtful debts = $200,000 * 5% = $10,000 

Posting the transactionDr Bad and doubtful debts 10,000

Cr Allowance for bad and doubtful debts10,000

Difference between bad debts and provision for doubtful debts

IllustrationSuppose that in the above example, Rakesh learns

that one of the long outstanding credit customers has since been declared bankrupt and efforts to collect the debt are futile. Such a debtor has ceased to be doubtful and should be written off.

To adjust for write offs; we pass the following entry;

Dr Allowance for bad and doubtful debts XXCr Accounts receivablesXX

Preparing an adjusted trial balancePeriod end adjustments should be analysed

and posted in the unadjusted trial balance to produce the adjusted trial balance

We shall revisit the illustration in Topic 3 and post the adjustments in the course notes.

Please find the adjusted trial balance in the course notes

Prepare financial statements

After passing all the adjustments as provided in the suggested solution in your lecture notes, you should be in a position to derive;

An profit and loss account (income statement)

A balance sheet

Conclusion/summaryIn this topic we have learnt; How to compute depreciation and amortization charge How to record period end adjustments for depreciation

and amortisation Differentiating between bad and doubtful debts Period end adjustments for doubtful debts Period end adjustments for bad debts Preparing period end adjustments Adjusting the unadjusted trial balance with period end

adjustments to prepare an adjusted trial balance Preparation of financial statements from the adjusted

trial balance

In our next topic, we shall appreciate some of the most common types of errors that are made in preparing financial statements and how to correct them.

Questions