ADJUSTMENT TO FINAL ACCOUNTS: DEPRECIATION

DEPRECIATION:
Depreciation is the part of the fixed asset that is consumed or used up during the
period. Depreciation is regarded as an expense just like items such as rent, wages
etc. Because depreciation is an expense it is charged to the profit and loss therefore
reduces net profit.
CAUSES OF DEPRECIATION
1. Physical Deterioration
a) Wear and Tear: Because of consistent use of a fixed asset, it will eventually
wear out and lose value.
b) Erosion, Rust, Rot and Decay: Land may be eroded or wasted away by actions
of wind, rain, sun or other elements of nature. Similarly metals in a motor
vehicle or machinery will rust or corrode. Wood will eventually rot and decay.
2. Economic Factor
a) Obsolescence: This is the process where fixed assets may become outdated
because to technological development which leads to the manufacture of
more sophisticated and new machinery.
b) Inadequacy: This is the process whereby assets are no longer used becausr
the growth and changes in the size of the firm has led to their replacement
with much larger ones.
3. Time Factor
This refers to assets that have legal life fixed in terms of years. For instance if
a building is rented for ten years (leased), when the years are finished, the
lease is worth nothing. Whatever is paid for the lease is not of no value.
A smaller asset is patent right where a person is given complete right so that
he alone can produce something. When the patent time has finished, it no
longer has any value.
4. Depletion
Some assets have a wasting character perhaps as a result of the extraction of
raw material e.g. Bauxite
Methods of Calculating Depreciation
I.
Straight Line Method
This method is also called the fixed installment method. The same
amount is changed to the profit and loss account each year.
Depreciation
= Cost Price- Scrap value
# of years
Or
Depreciation
= Cost x Percentage
II.
Reducing Balance Method

This is where a reduced sum is changed to the profit and loss each
year. A fixed percentage is changed in the first year. In the second and
last years the same percentage is changed but is taken from a reduced
balance. i.e (cost depreciation already charged).
Depreciation
= Cost Total Previous Depreciation x
Percentage

ADJUSTMENTS TO FINAL ACCOUNTS: BAD DEBTS

Provision for bad debt:
Provision for bad debt is made for amounts owed to the business, which may
eventually turn out to be bad. It is an amount set aside out of the profits, to write of
bad debts when they occur. Generally, provision for bad debts is based on a
percentage of total debts outstanding and not a specific debt as it is with bad debts.
The percentage is normally based on past trends.
If provision is not made, then the financial statement would not be giving a true
and fair view of the financial position of the business.
To create a provision
DR
Profit and Loss a/c
CR
Provision for Bad Debts a/c
The balance on the Provision for Bad Debt a/c will be carried forward in the books of
accounts and also be shown as a deduction for the total debtors figure on the
balance sheet, hence reducing the debtors figure.
E.g.
Debtors
$40 000
Bad Debts
4 000
Provision
2% of debtors
Note here that provision cannot be made for debts that are already bad. This means
that bad debts must be deducted before provision is calculated.
Hence, provision = 2% ($40 000- $4 000) = $720
Profit and Loss Extract
$
Bad Debts
4 000
Provision for Bad debts
720

Adjusting the Provision

Balance Sheet Extract

Current Asset
$
Stock
XXXXXX
Debtors
36 000
Less Prov. For bad
720 35
280
debts

In future periods, we may consider our provision to be too small or too large, hence
we will need to either increase or decrease the provision.
Increasing the provision
Let us assume that in the following year, the debtors figure is not $50 000, there are
no bad debts and provision is still 2% of the debtors
New provision = 25 ($50 000)
= 1 000
Since the provision account is already showing a balance of $720 only an additional
amount of the $280 is needed i.e.
DR
Profit and Loss a/c $280
CR
Provision for Bad Debts a/c $280
Profit and Loss Extract
$
Increase in Provision

280

Balance Sheet Extract

Current Asset
$
Debtors
50 000
Less Prov. For Bad
Debt
-1 000
49 000

Decreasing the Provision

If in year 3 the debtors figure is $45 000, bad debts are $5 000 and provision is still
2% of debtors.
New Provision = 2% ($45 000- $5 000)
= $800
Note here that the provision account is carrying a balance of $1 000, hence we will
now need to reduce this amount to $800
i.e.
DR
Provision for Bad Debts a/c $200
CR
Profit and Loss a/c $200
Profit and Loss Extract
$
Bad Debts
5 000
Decrease in Provision 200

Balance Sheet Extract

$
Stock
XXXXXX
Debtors
40 000
Less Provision
800
200

39

1. Grouped with expenses

2. Added to Gross Profit

Provision for Bad Debt

A business starts on 1 January 20x2 and its financial year end is 31 December
annually. A table of the debtors, the bad debts written of and the estimated bad
debts at the rate of 2 percent of debtors at the end of each year is now giving. The
double entry accounts and the extracts from the final accounts follow.

Year to 31
December

20X2
20X3
20X4
20X5

Debtors at the end

of the year (after
bad debts written
of)
6
7
7
6

$
000
000
750
500

Bad debts written

of during year
$
423
510
604
610

Debts throughout
at the end of year
to impossible to
collect: 2% of
debtors
$
120 (2% of $6000)
140 (2% of $7000)
155 (2% of $7750)
130 (2% of $6500)

BAD DEBTS
20X2
$
Dec 31
423
20X3
Dec 31
510
20X4
Dec 31
604
20X5
Dec 31
610

Various Debts

Various Debts

Various Debts

Various Debts

20X2
$
Dec 31
423
20X3
Dec 31
510
20X4
Dec 31
604
20X5
Dec 31
610

Profit and Loss

Profit and Loss

Profit and Loss

Profit and Loss