Balance day adjustments

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Topic 5

• Balance day adjustments

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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

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Recap of topic 4

• In 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 accruals
• In Topic 5 we learn more about non cash charges

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Non cash charges

• They include
• Depreciation charge
• Amortization charge
• Gain or loss on disposal
• Allowance for bad debts
• Bad debts expense

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Depreciation charge

• A 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 estimation
• Three main methods of estimation
• Straight line basis
• Reducing balance basis
• Sum of years digits method
• Posting depreciation expense
• Dr Expense
• Cr Accumulated depreciation

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Depreciation charge

• Illustration
• Rakesh 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 100,000
• Year of purchase 2011
• Expected useful life 10 years
• Scrap value at the end of useful life 10,000

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Illustration

• Required-
• 1. Determined what will be the depreciation
  charge and accumulated depreciation for years
  2011, 2012, 2013 and 2014 using
• straight line depreciation basis,
• Reducing balance basis,
• Sum of years digits basis.

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Illustration suggested solution
(a) Straight line basis (a) Straight line basis
Workings
Cost 1 100,000
Expected useful life 2 10
Scrap value 3 10,000
Depreciable value D1-3 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
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Illustration suggested solution
(b) Reducing Balance method (b) Reducing Balance method (b) Reducing Balance method
Workings
Cost 1 100,000
Expected useful life 2 10
Scrap value 3 10,000
Depreciation base D1-3 90,000
Solution
Depreciable 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
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Illustration suggested solution
(c) Sum of years digits depreciation basis (c) Sum of years digits depreciation basis (c) Sum of years digits depreciation basis (c) Sum of years digits depreciation basis (c) Sum of years digits depreciation basis (c) Sum of years digits depreciation basis
Year Sum of years Rate (r) Depreciable base (D) Depreciation (Dr) 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
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Gains or losses on disposal

• When an item of property and equipment is sold, a
  gain or loss results
• A gain results where the proceeds are higher than
  the net book value of the asset sold
• A loss is where net book value of the asset
  disposed is higher than the sales proceeds
• To record a disposal where a gain is made
• Dr Accumulated depreciation XX
• Dr Bank (with the amount of sales proceeds) XX
• Cr Gain on disposal XX
• Cr Disposal Account (with the cost of asset
  sold) XX

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Gains or losses on disposal

• To record a disposal where a loss is made
• Dr Accumulated depreciation
• Dr 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

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Illustration gains/losses on disposal

• In our earlier example, suppose that come year
  2012, Rakesh sells the trailer and prime mover
  for
• 60,000
• 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

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Illustration gains/losses on disposal
Straight line Reducing balance Sum of years digits
Sale at 60,000
Cost (a) 100,000 100,000 100,000
Accumulated depreciation Accumulated depreciation 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 (ln-c) 22,000 22,900 8,909

Adjustment
Dr 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) (100,000) (100,000) (100,000)
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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 Accumulated depreciation 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 (gc-n) 8,000 7,100 21,091
Adjustment
Dr 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) (100,000) (100,000) (100,000)
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Amortization charge

• Similar concept with depreciation
• Charge 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 XX
• Cr Accumulated amortization charge XX

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Allowance for doubtful debts

• Some credit sales might turnout to be
  uncollectible
• The loss should be charged in the period in which
  it occurs
• Estimation of the charge depends on managements
  experience
• Illustration
• 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

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Allowance for doubtful debts

• Suggested 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 transaction
• Dr Bad and doubtful debts 10,000
• Cr Allowance for bad and doubtful debts 10,000

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Difference between bad debts and provision for
doubtful debts

• Illustration
• Suppose 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 XX
• Cr Accounts receivables XX

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Preparing an adjusted trial balance

• Period 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

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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

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Conclusion/summary

• In 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.

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Questions