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 1^st 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:

1^st year 100,000 = 20,000

2^nd year 80,000 = 16,000

3^rd 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 1^st 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:-

1^st year will last for 5 years 3,000,000

2^nd year will last for 4 years 3,000,000

3^rd year will last for 3 years 3,000,000

4^th 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)

1^st year = 6,000,000 – 1,000,000)

5,000,000

Tshs. 750,000

2^nd 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 16^th Feb. 1995 sold goods for 2,400 to R. Tsuma. He managed to pay shs. 2,000 on 17^th 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.