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Topic 5

Topic 5. Balance day adjustments. 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

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Topic 5

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  1. Topic 5 Balance day adjustments

  2. 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

  3. 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

  4. Non cash charges • They include • Depreciation charge • Amortization charge • Gain or loss on disposal • Allowance for bad debts • Bad debts expense

  5. 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

  6. 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

  7. 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.

  8. Illustration: suggested solution

  9. Illustration: suggested solution

  10. Illustration: suggested solution

  11. 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

  12. 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

  13. 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

  14. Illustration: gains/losses on disposal

  15. Illustration: gains/losses on disposal

  16. 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

  17. 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 management’s 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

  18. 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

  19. 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

  20. 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

  21. 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

  22. 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.

  23. Questions

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