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:
Rent and Rates                       3400

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.

 

www.learninghubtz.co.tz

Download Learning
Hub App

For Call,Sms&WhatsApp: 255769929722 / 255754805256

GO TO NECTA EXAMS