Balance day adjustments Topic 5. Learning outcomes After studying this topic, you should be in a...
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Transcript of Balance day adjustments Topic 5. Learning outcomes After studying this topic, you should be in a...
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