TOPIC 1
ADJUSTMENTS
DEPRECIATION OF FIXED ASSETS
Depreciation is the part of the cost of the fixed asset consumed during its period of rise by the firm.
OR
Depreciation is the loss of value of assets.
Depreciation therefore, is the expenses and therefore debited in trading profit and loss account as expenses.
Depreciation causes the decrease in value of assets.
In Balance sheet is deducted from a respective asset.
Methods of calculating depreciation.
(i) Straight line method
(ii) Reducing balance method
(iii) Sum of year digit method
(iv) Revaluation method
(v) Machine hour method
(vi) Unit of output.
CAUSES OF DEPRECIATION
(i) Wear and Tear
(ii) Physical factor such as erosion, evaporation corrosion.
(iii) Fall in market price
(iv) New inventions
(v) Passage of Time
STRAIGHT LINE METHODS
This method the depreciation is charged every year throughout the life of the asset, keeping in view the estimated economic life of the asset and scrap value which is expected to be realized at the time of disposal.
Depreciation = 
Example:
IDM bought a vehicle for shs. 400,000/= on 1st Jan 2013 for cash. The economic life of the motor vehicle is considered to be 6 years leaning a scrap value at the end of 6 years shs. 100,000/=
Depreciation = 
= Shs. 50,000/=
This means that each year the asset will decrease by 50,000/=
Therefore;
31 Dec 2013 the value will be 400,000 – 50,000 = 350,000/=
31 Dec 2014 the value will be 350,000 – 50,000 = 300,000/=
31 Dec 2015 the value will be 300,000 – 50,000 = 250,000/=
DR Motor vehicle a/c CR
| Jan. 2013 Bal. b/d 400,000
400,000
Jan. 2014 Bal. b/d 350,000
350,000
Jan. 2015 Bal. c/d 300,000
300,000 | Depreciation 50,000 31 Dec. Bal. c/d 350,000 400,000
31 Dec. Depreciation 50,000 Balance c/d 300,000 350,000
Depreciation 50,000 Balance c/d 250,000 300,000 |
DR Motor vehicle a/c CR
| Jan. 2013 Depreciation 50,000
50,000
Jan. 2014 Depreciation 50,000
50,000
Jan. 2015 Depreciation 50,000
50,000 | Profit & Loss s/c 50,000
50,000
Profit & Loss a/c 50,000
50,000
Profit & Loss a/c 50,000
50,000 |
TREATMENT OF DEPRECIATION
There are two ways of treating depreciation; namely:-
- Directly charged the amount of depreciation to the asset account.
- Making the provision of or the depreciation.
DIRECTLY CHARGING DEPRECIATION FROM ASSETS A/C
a) DR. Depreciation a/c, CR Fixed asset a/c ) To charge depreciation fixed assets.
b) DR. Profit and Loss a/c, CR. Depreciation a/c ) To close depreciation a/c
Reducing Balance Method.
(Diminishing balance Method)
A fixed per percentage for depreciation is deducted from cost in the first year. In the second or later years the same percentage in taken of the reduced balance i.e. cost less depreciation already charged.
Example:
A machine is bought for Tshs. 100,000/= and depreciation is to be charged at 20% on reducing balance method.
Calculate the depreciation charges for the first three years.
Solution:
1st year 100,000 
= 20,000
2nd year 80,000 
= 16,000
3rd year 64,000 = 12,800
After three year the assets will be 51,200
DR Machine a/c CR
| 1st Cash 100,000
100,000
2nd Balance b/d 80,000
80,000
3rd Balance b/d 64,000
64,000 | Depreciation 20,000 Dec 1st 80,000 100,000
Dec 2nd 16,000 Balance c/d 64,000 80,000
Dec 3rd 12,800 Balance c/d 51,200 64,000 |
DR Depreciation a/c CR
| 1st Balance c/d 20,000
2nd Balance c/d 16,000
3rd Balance c/d 12,800
| Profit % Loss 20,000
Profit % Loss 16,000
Profit % Loss 12,800
|
DR Profit and Loss Extract CR
| 1st Depreciation 20,000
2nd Depreciation 16,000
3rd Depreciation 12,800
|
|
Revaluation Method
Is the method used when there are few expensive items or fixed assets.
Example:
On 1st Jan. 2013 the firm had a steel containers valued at 3,500,000, during the year container valued 1,300,000/= were purchased. On 31Dec 2013 all the containers were valued at 3,500,000/=
Required:-
Calculate the depreciation for the year.
Solution:
Opening stock container 3,500,000
Purchases of new container 1,300,000
Value of containers 4,800,000
Less: Value of container 31 Dec. 3,500,000
Sum of Year digits.
- This method provides for higher depreciation to be charged early in the life of an asset with lower depreciation in later years.
Example:
Given an asset costing Tshs. 3,000,000 which will be in use for five years. Calculate depreciation in later years:-
1st year will last for 5 years 3,000,000 
2nd year will last for 4 years 3,000,000 
3rd year will last for 3 years 3,000,000 
4th year will last for 2 years 3,000,000 
UNIT OF OUTPUT METHOD
This method established the total expected units of output expected from the asset. Depreciation based cost less sewage value is then calculated for the period by including that period’s units of output as a proportion of the total expected output of the life of the asset.
Example:
A machine is expected to produce 10,000 units of widgets over its useful life. Initial cost of Tshs. 6,000,000/= and an expected sewage value of 1,000,000/=. In year 1 a total of 1,500 widgets are produces. In the year 2 the production is 250,000 widgets.
Calculate depreciation charges for year 1 and 2.
Depreciation = (cost – sewage value) 
1st year = 6,000,000 – 1,000,000) 
5,000,000 
Tshs. 750,000
2nd year (6,000,000 – 1,000,000) 
5,000,000 
Tshs. 1,250,000
PROVISION FOR DEPRECIATION
Is the estimate made to bring the value of depreciation near to the value.
Treatment:-
a) DR – Provision for depreciation a/c
CR – Fixed asset a/c
b) DR – Profit and loss a/c
CR – Provision for depreciation a/c
BAD DEBITS AND PROVISION FOR BAD DEBTS.
Bad debt is uncollectable debts of the business firm.
This occurs when the debtors coved not pay the debts.
Example:
Firm sold goods for Tshs. 900 to C. Migwi on J. Jan 1995 but he had become bankrupt. On 16th Feb. 1995 sold goods for 2,400 to R. Tsuma. He managed to pay shs. 2,000 on 17th May 1995 hut it become obviously that he would never be able to pay 400 on 31 Dec. 1995.
Account would be:-
C. Migwi a/c
| Jan. Sales 900 900 | 31 Dec. Bad debt 900 900 |
R. Tsuma a/c
| Jan. Sales 2,400
2,400 | Cash 2,000 31 Dec. Bad debt 400 2,400 |
Bad debts a/c
| 31 Dec. C. Migwi 900 R. Tsuma 400
1,300
| 31 Dec. Profit & Loss a/c 1,300
1,300
|
Example:
The policy of the company is that if a debtors will not pay his or her debts even after the end of the financial year such a debt will be counted as bad debts. The transactions for the year ended 2013 were as follows. 08.1 Goods sold on credit to Jackson 50,000/= 16.1 Goods sold on credit to lightness 240,000/=
17.8 Lightness paid to us Tsh. 200,000/= in respect of goods sold to her.
Required to prepare:-
a) Jackson a/c
b) Lightness a/c
c) Bad debt a/c
Jackson a/c
| 8 Jan. Sales 50,000 | Bad debt 50,000
|
Lightness a/c
| 16 Jan. Sales 240,000
240,000 | 17 Jan. Cash 200,000 Bad debt 40,000 240,000
|
Bad debt a/c
| 8 Jackson 50,000 Lightness 40,000
90,000 | Trading, P & L a/c 90,000
90,000
|
PROVISION FOR BAD DEBTS.
Is the estimate made to bring the value of bad debts near to time value.
This estimated amount is debited to profit and loss account of an expenses and credited to a provision for bad debt account.
Such estimate for a provision could be made.
By looking at each debt and estimating which ones will be bad debts.
By estimating on the basis of experience what percentage of the debts will prove to be bad debts.
Example:
At the 31 Dec. 1993, debtors amounted to shs. 100,000/= It is estimated that 2% of debts (i.e. shs. 2,000/=) will prove to be bad debts and it is decided to make provision for these. The accounts would appear as follows.
Profit and Loss a/c for the year ended 31 Dec. 1993
| Provision for bad debts 2,000 |
|
Provision for bad debts a/c
|
| Profit and Loss a/c 2,000
|
In balance sheet the balance on provision for bad debts will be deducted from the total of debtors.
Balance sheet extracts as on 31 Dec. 1993
Current assets.
Debtors 100,000
Less: provision for bad debt = 2,000
98,000
INCREASING PROVISION
As from example above at the end of the following year 31 Dec. 1994 t he bad debts provision needed to be increased. This was because the provision was kept at 2% but the debtors had risen to shs. 120,000/= A provision of shs. 2,000/= had been brought forward from the previous year but we now want a total provision of shs. 2,400 i.e. 2% of shs. 120,000)./= All that in a provision for an extra shs. 400/=.
The double entry will be:-
- DR. Profit and loss account
- CR. Provision for Bad debts Account.
P % L a/c
| Provision for bad debt 400 |
|
Provision for bad debt a/c
| 31 Dec. Balance c/c 2,400
2,400 | 1 Jan. Balance b/d 2,000 31 Dec P % L a/c 400
2,400 |
Balance sheet extract.
Debtors 120,000
Less provision for bad debt 2,400
117,600
REDUCING THE PROVISION:
The provision is shown as a credit balance. Therefore to reduce it we would need a debit entry in the provision account. The credit would be in the profit and loss account.
Assume the debts had felled from 120,000/= to 105,000/= but the provision remained at 2% i.e. 2,100. Thus the provision needs a reduction of 300/= the double entry is.
- DR. Provision for bad debt account
- Cr. Profit and loss account
i.e.
Profit and Loss account
|
| Provision for bad debt reduction 300 |
Provision for bad debt account
| Dec. 31P & L a/c 300
Balance c/d 2,100 2,400
| 1 Jan. 1995 balance b/d 2,400
2,400 |
Balance sheet extract.
Current Assets:-
Debtors 105,000
Less provision for bad debts 2,100
102,900
DISPOSAL OF FIXED ASSET.
When the asset is sold we need to eliminate it from the accounts. The cost of the sold asset should be taken out of the asset account.
Also asset could have been depreciated for the period existed in the business. The depreciation of the asset which has been sold will have to be taken out of the depreciation provision.
The profit or loss on disposal will be determined by company cash received on disposal plus provision for depreciation against cost of the asset.
Accounting treatment for Disposal
DR – Asset disposal a/c
CR – Asset account (at cost price)
1) Cost of asset was transferred from asset a/c to asset disposal a/c
2) DR – provision for depreciation a/c
CR – disposal a/c
3) When cash is received a disposal
DR – Cash a/c
CR – Disposal of Asset a/c
4) Any difference in disposal a/c should be transferred to profit and loss a/c
DR – Profit and Loss (when disposal a/c show debt balance
CR – Disposal a/c
OR
DR – Disposal a/c (when it shows credit balance)
CR – Profit and Loss a/c to indicate profit on disposal.
CAPITAL EXPENDITURE AND REVENUE EXPENDITURE.
Capital expenditure: Is made when a firms spends money either to buy fixed assets or add value to existing assets.
- Capital expenditure include:-
- Acquiring fixed asset
- Bringing them into the firm.
- Legal cost of buying fixed assets
- Carriage inward of assets
- Installation cost
- Any other cost needed to get the fixed asset ready to work.
Revenue expenditure: Is an expenditure which is not for increasing the value of fixed asset but for running business on day to day basis.
E.g.
(i) Repairing,
(ii) Maintainance,
(iii) Paying interest,
(iv) Paying bill,
(v) Refueling car,
(vi) Tyre refilling,
(vii) Painting old building,
(viii) Vanishing used furniture etc.,
(ix) Paying property tax etc.
Mixed revenue and Capital expenditure.
It happen that are transaction involve both capital and revenue expenditure.
E.g. taking heavy bank loan and purchase fixed assets. There must be interest on loan which will be paid regularly.
There purchasing fixed expenditure and paying loan interest is revenue expenditure.
ADJUSTMENTS IN FINAL ACCOUNT.
The following Trial balance was extracted from the books of K. Obane at the close of Business on 28 Feb, 1997.
|
| DR | CR |
| Purchases and sales Cash at Bank Cash in Hand Capital on 1st March 1996 Drawings Office Furniture Rent and Rates Wages and salaries Discounts Debtors and creditors Stock 1 march 1996 Provision for Bad debt Delivery van Van running costs Bad debt written off | 37,600 3800 700
9500 4800 3400 8600 2300 16400 9900
8000 1500 2700
109,200 | 65,800
33,000
1200 8300
900
108,200 |
Additional information:-
Stock 28 Feb. 1997 11,700
Wages and salaries accrued at 28 Feb. 1997 shs. 300
Increase the provision for bad and doubtful debts by 200
Depreciation office furniture 600
Delivery van 1,600
Required to: - Draw up Trading, profit and loss account for the year ending 28 Feb, 1997 and B/sheet.
DR Trading Profit and Loss a/c CR
| Opening stock 9,900 Purchases 37,600 Cogas 47,500 Less: Closing stock 11,700 Cogs 35,800 Gross profit c/d 30,000 65,800
Expenses: Wages and salaries 8600 Discount allowed 2300 Provision for bad debt 900 Depreciation 600 Provision for bad 200 Net provision cost 1500
Bad debt 2700 Net profit 31,200 | Sales 65,800
65,800 Gross profit b/d 30,000 Discount received 1,200
31,200
|
Balance sheet.
| Office furniture 4800 Less Depreciation 600 Delivery van 8000
Cash at Bank 3800 Cash in Hand 700 Debtors 16400 Less: provision 900 Bad debt 2700 200 | Capital 33,000 Net profit Less drawing 9500
Liabilities Creditors 8300 Wages and salaries 300 |
Required to prepare Trading Account of T – Borongo from the given information as on 31 Dec. 1997.
|
| DR | CR |
| Sales Purchases Sales return Purchases Return Opening stock Provision for bad debt Wages and salaries Rates Telephone Fittings Van Debtors and creditors Bad debts Capital Bank balance Drawings |
350,000 5000
100,000
30,000 6000 1000 40,000 30,000 9,800 200
3,000 18,000 595,000 | 400,000
6200
800
700
179,000
593,000 |
Adjustments:
(i) Closing stock at 31 Dec 1997 Shs. 120,000
(ii) Accrued wages 5000
(iii) Rate prepaid 500
(iv) Provision for bad debts to be increased to 10% of debtors
(v) Telephone account outstanding sh. 220
(vi) Depreciation fittings 10% per annum
(vii) Depreciation van 20% per annum
Financial Analysis of the Business Firm.
The financial analysis of Business strength and weakness can be done through financial statements. This is done through ratio analysis.
E.g. Working capital = Current asset – current liabilities.
This is used to measure firms current financial position.
i.e. If the working figure is not enough, firm may take loan.
Current ration – It measure firms ability to meet its current liability.
Current ratio = 
Gross profit margin = 
Net profit margin = 
Debt to asset ratio – known as describe how much company assets are financed by borrowed money.
= 
Gross profit margin = 
It measure profit made before deducting operating cost such as selling administrative and general expenses. It used for comparison between one period and another to see if the profit is improving or declining
Net profit margin =
It measure profit after deducting cost incurred (expenses)
Also need for comparison between periods.
Stock turnover ratio / inventory turn.
Stock turn over = 
But average stock = 
It measure number of times the inventory has been replaced during the accounting period.
Business want goods turnover the higher the turnover more sales and therefore more profit.
Account receivable turnover Ratio. It measure how quickly account receivable are being collected
If it is small it indicate that people are paying their bills very slowly.
Account receivable turnover = 
Return on Assets ratio – Is the ratio between profit and assets.
Return on Asset = 
It measure how well the firm has performed with its assets.
E.g. If A = 10m A = 100m assets
B = 10m Profit B = 1000m assets
A has made much better than B.
Return on owners investment (capital)
Net Income:
Total owners equity/capital
It measure amount of money earned for each shillings invested by the owners.
It just measure how well the firm is performing with the money invested.
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