Financial Accounting Lesson Note SS1 Third Term
Financial Accounting Topics – Edudelight Enotes
SS1 THIRD TERM SCHEME OF WORK
1. Revision of last term’s work
2. Preparation of bank reconciliation with credit balances
3. Preparation of bank reconciliation when there is bank overdraft i.e debit balance
4. End of year adjustments in profit and loss account –Accruals and Prepayment
5. Provision for bad debts .Provision for discount allowed and received
6. Bad debt recovered, work exercise
7. Depreciation of fixed assets –meaning, reasons, methods of provision for depreciation, elements, terminologies. Amortization and depletion
8. Straight line and reducing balance methods. Depreciation schedule, advantages and disadvantages
Of each method-ledger
9. Treatment of Depreciation in profit and loss and balance sheet.
10. Preparation of final Accounts with end of year adjustment.
11&12 revision and exam.
WEEK 2
PREPARATION OF BANK RECONCILIATION WITH CREDIT BALANCES
Elementary treatment of bank reconciliation statement
Three basic methods can be used for the preparation reconciliation statement
These are:
1. Preparation of Bank Reconciliation statement: starting with the balance as per Cash Book.
2. Preparation of bank Reconciliation statement: Starting with the balance as per Bank statement.
3. Adjustment of cash book and preparation of bank Reconciliation Statement.
Method one: Starting With Cash Book Balance
When the cash book balance is used is used ,unpresented cheques, credit transfers, dividends are added while uncredited cheques , standing order, bank charges, dishonored cheques are deducted giving us the balance as per bank statement. Layout of bank Reconciliation statement when starting with with balance as per cash book
# #
Balance as per cash book xx
Add unpresented cheques x
Dividend x
Credit transfers x
—- Xx
——-
Xx
Less: uncredited cheques x
Bank charges x
Dishonored cheques x
Standing order x
—— x
——–
Balance as per bank statement xx
———-
ILLUSTRATION 1: On 31st July 1993, Ologolo’s cash book showed a debit balance of #4000. His bank statement showed a balance of #4270 .On comparison, the following the following were found:
a. Cheque issued amounting to #2500 had not been presented for payment
b. The bank rejected cheques amounting to #140
c. Standing order of #700 to a club was not taken into consideration.
d. A customer, Segun paid #170 directly into the bank without any notice to the firm
e. Bank charges of #160 were #160 were entered in the bank statement only
f. A dividend of #250 was paid directly in the bank and not recorded in the cash book
g. Cheques for #1650 were entered into the cash book and paid to the bank but had not been cleared thus not credited.
You are required to prepare the bank reconciliation Statement for the month of July 1993
Bank Reconciliation statement as at 31st July 1993 # #
Balance as per cash book 4000
Add; presented cheques 2500
Credit transfer 170
Dividend 250
—— 2920
——–
6920
———
Less dishonored cheques 140
Standing order 700
Bank charges 160
Uncredited cheques 1650
—— 2650
——–
Balance as per bank statement 4270
———
Method Two: Starting with Bank Statement balance
It is also possible to start with the balance as per bank statement. Item like uncredited cheques, standing order, bank charges, etc. will be added while presented cheques, dividend and credit transfer will be deducted. At the end, the balance as per Cash book will be arrived at.
Layout of bank reconciliation when starting with balance as per bank statement
# #
Balance as per bank statement x
Add: uncredited cheques x
Standing order x
Bank charges
Dishonored cheques x
Less: presented cheques x
Dividend x
Credit transfer x
—– Xx
——
Balance as per cash book xxx
—–
TREATMENT OF OVERDRAFT
Overdraft occurs when the customer has withdrawn more than what he has in his account. The cash book will show a credit balance. The procedures needed to reconcile will be a complete opposite of that needed when the account is not overdrawn. Bank
Layout of bank reconciliation statement when starting with overdraft as per cash book
# #
Overdraft as per cash book x(OD)
ADD: Uncredited cheques x
Standing order x
Dishonored cheques x
Bank commission x
—- X
—–
Xx
Less presented cheques x
Dividend x
Credit transfer x
—— Xx
—-
Balance as per bank statement xx
—–
Illustration: On 31st December 1999, the cash book of a trader showed a balance of #478 (OD) while his bank statement showed a balance of #402 (OD).It was discovered that the following transactions were responsible for the discrepancy between the two balances
a. Cheques issued amounting to #77 had not been presented for payment
b. uncredited cheques #119
c. A standing order with the bank for a subscription for insurance premium #57 was not considered.
d. bank charges amounted to #30
e. dividends of #205 collected and credited by the bank did not appear in the cash book.
You are required to prepare the bank reconciliation statement.
SOLUTION:
Bank reconciliation statement # #
Overdraft as per cash book 478(OD)
ADD: uncredited cheques 119
Standing order 57
Bank charges 30
—– 206
—–
684
Less: presented cheques 77
Dividend 205
—– 282
—-
Overdraft as per bank statement 402(OD)
—-
NOTE: When overdraft as per bank statement is used then the reverse is the case .All items that were added will now be deducted ,while all items deducted will now be added.
Layout of bank reconciliation statement when starting with overdraft as per bank
Statement
Bank reconciliation statement as at 31st June 1999
# #
Overdraft as per bank statement x (OD)
ADD: unpresented cheques x
Dividend x
Credit transfer x
—- X
Less: uncredited cheques x
Standing order x
Dishonored cheques x
— X
——-
Balance as per cash book xx
—-
Using the question in illustration 3:
# #
Overdraft as per bank statement 402(OD)
Add: Unpresented cheques 77
Dividend 205
——- 282
——-
684
Less: uncredited cheque 119
Bank charges 30
Standing order 57
—- 206
—–
Overdraft as per cash book 478
—–
EVALUATION: Briefly describe the following terms
1. Un Presented cheques
2. Uncredited cheques
3. Standing order
4. Credit transfer
5. Bank reconciliation statement
6. Direct debit
ASSIGNMENT: Take assignment from book –keeping and accounting textbook revision question 8 & 10 page 114 &115.
Financial Accounting Topics – Edudelight Enotes
BANK RECONCILIATION STATEMENT 2
Comprehensive summary of format of bank reconciliation statement
# #
Balance as per cash book xx
Add: unpresented cheques x
Dividend x
Interest received x
Credit transfers x
Receipt under cast x
Payment overcast x
— Xx
—
Xx
Less: Uncredited cheques x
Bank charges x
Interest payment x
Standing order x
Dishonored cheques x
Payment under cast x
Receipts overcast x
Direct debits x
—– Xx
—-
Balance as per bank statement xx
——
METHOD THREE: Preparation of Adjusted cash book
The cash book will be adjusted before the bank reconciliation statement is prepared. The balance of the adjusted cash book will be used in preparing the reconciliation statement. This ensures that the items in the bank reconciliation are reduced
DR Adjusted cash book CR
BAL b/f xx bank charges xx
Payment overcast xx interest payment xx
Credit transfer xx standing order xx
Dividends xx dishonoured cheques xx
Receipts under cast xx receipts overcast xx
Interest received xx payment under cast xx
Direct debits xx
Bal C/D xx
—— —–
Xx xx
—– —–
BAL b/d xx
NOTE: After the preparation of adjusted cash book, the bank reconciliation statement will then be prepared using the balance as per adjusted cash book.
Bank reconciliation statement #
Balance as per adjusted cash book x
Add: unpresented cheques x
—-
Xx
Less: uncredited cheques xx
—-
Balance as per bank statement xx
———
Overdraft as per bank statement
It is pertinent to state that the cash book and bank statement can be given in the examination. When this occurs, students are advised to compare the two accounts in order to ascertain the causes of discrepancy. This will be illustrated below:
Cash book
# #
May 1 bal b/f 4950 May9 Oguns 470
“ 8 Olu 760 “ 26 Adeoba(b) 1060
“ 15 Abbey 540 “ 28 Gbemi (c) 420
“ 26 cash 880 “ 30 balance c/d 6340
“ 30 charles(a) 1160
——- ——–
8290 8290
——– ———-
Bank statement
DR# CR# BALANCE
May1 BAL b/f 4950
“ 8 Cheque: Olu 760 5710
“ 9 Oguns 470
“ 15 cheque: Abbey 540 5780
“ 26 cash 880 6660
“ 29 credit transfer(d) 520 7180
“ 30 bank charges (e) 200 6980
“ 31 standing order(f) 200 6780
In order to prepare the bank reconciliation statement, the following steps must be followed
Step1: compare CR side of cash book with DR side of bank statement. Any item on the CR of cash book not on the DR side of bank statement is an unpresented cheque.item b and c (Adeola #1160 and Gbemi #420) are unpresented cheques.
Step 2: compare DR side of cash book with CR side of bank statement.Any item on the DR side of cash book not on the CR side of bank statement is an uncredited cheque. Item a (Charles #1160) is uncredited cheque
Step3 : Compare CR side of bank statement with DR side of cash book .Any item on the CR side of the bank statement not on the DR side of the cash book can be dividend, credit transfer, ;item d is a credit transfer
Step4: Compare the DR of bank statement statement with CR of cash book
Any item on the DR of bank statement not in the CR side of cash book can be bank charges, dishonored cheques, standing order, items e and f are bank charges, and standing orders respectively
Step 5: Prepare the bank reconciliation statement
# #
Balance as per cash book 6340
Add: credit transfer 520
Unpresented cheques: (b) 1060
(c) 420
——- 2000
——
8340
Less uncredited cheque (a) 1160
Bank charges (e) 200
Standing order (f) 200
——— 1560
——–
Balance as per bank statement 6780
——–
EVALUATION: Momoh Enterprise cash book showed a debit balance of Le4500 on December 31, 2014 .Further examination revealed the following:
1. A direct debit of Le 350 for subscription had been paid by the bank
2. Bank charges of Le 500 had not been reflected in the cash book
3. Payment settled by standing orders were omitted from the cash book; electricity, bill, Le70 insurance Le100 and medical bill Le120.
4. A dividend of Le 320 paid directly into the bank had not been entered in the cash book .
5 It was discovered that the cash book balance brought down was undercast by Le180
6. Cheques amounting to Le4800 issued had not been presented for payment.
7. Cheers amounting to Le 1990 paid into the bank had not yet been credited
You are required to prepare
a. the revised cash
b. Bank reconciliation statement as at December 31 2014
SOLUTION momoh enterprise
DR Le Adjusted cash book CR Le
Bal b/f 4500 direct debit 350
Dividend 320 bank charges 500
Receipt undercast 180 standing order 290
Bal c/d 3860
——— ———
5000 5000
———– ———
Bal b/d 3860
Bank reconciliation statement as at December 31st 2014
Le
Balance as per adjusted cash book 3860
Add unpresented cheque 4800
———-
8660
Less :uncredited cheque 1990
——-
Balance as per bank statement 6670
——–
ASSIGNMENT: Take assignment from simplified and amplified book-keeping &accounting for senior sec. schools revision questions 3 &4 page 122 & 123
Financial Accounting Topics – Edudelight Enotes
WEEK 4
END OF YEAR ADJUSTMENT IN PROFIT AND LOSS ACCOUNT— ACCRUALS AND PREPAYMENTS
1. ACCRUALS: This concept states that revenue and expenditure are recognized as they are earned or incurred and dealt with in the profit and loss account for the period to which they relate and not the period they are paid and received .It can be divided into: accrued income and accrued expenses
a.Accrued income : These are income which are due in respect of the current trading period but such income have not been received at the close of final accounts preparation.It is also referred to as outstanding income
Treatment in final accounts
Credited to profit and loss account
Current assets in the balance sheet
Income account
# #
Last yr. accrual x cash x
Profit&loss account x current yr. accrual x
——— ——-
Xx xx
———- ——-
BAL b/d xx
Illustration: Write up the ledger account of Mr Monday as at 31st December 1996 showing the transfer to the final accounts. He earned commission from sales for the year 31st December 1995 #800 owing at 31st December 1996 #1450.
DR commission receivable account CR
# #
Bal b/f 800 cash 8500
P &l 9150 bal b/d 1450
—— ——–
9950 9950
——– ———-
Bal b/f 1450
NOTE: The balance of #1450 should be treated as current asset in the balance sheet.
b. Accrued Expenses: These are expenses, which accrue but have not been discharged
These could be called expenses owing or creditor for expenses e.g telephone, rates.
Treatment in final accounts
Debited to profit and loss account
Current liability in the balance sheet
Expenses account
# #
Cash paid x amount owing from last yr x
Owing during the trading yr x profit and loss x
—– ——
X x
—— ———-
Illustration 3: Write up the ledger account of Oando ltd as at 31st December 1998
Motor expenses paid for the year #15000
Motor expenses owing at31st December 1997 #3000
Motor expenses owing at 31st December 1998 # 2700
DR motor expenses account CR
# #
Cash 15000 BAL b/f 3000
BAL C/D 2700 p & l 14700
——- ——–
17700 17700
——- ———-
BAL b/d 2700
The balance of #2700 should be treated as current liability in the balance sheet
2. PREPAYMENTS: Prepayments represent amount paid in the current period for a subsequent period .Expenses can be paid in advance and income can also be received in advance. It can be referred to as Prepaid or paid in advance.
a. Expenses in advance: These are expenses like rent ,insurance ,etc which are paid in advance for subsequent period .Only the expenses for the period must be charged to the profit and loss account
Treatment in final accounts
Reduction of expenses debited to profit and loss account
Current assets in the balance sheet
DR Expenses account CR
# #
Prepaid last year x prepaid for next year x
Cash x p&l x
—– —–
Xx xx
—— ——-
Bal b/d x
Illustration: Write up the ledger account of Mr Okonkwo as at 31st December 1998.He paid insurance of #5000 for the year ended 31st December 1997 #740 .prepaid as at 31st December 1998 #1000
DR Insurance account CR
# #
Prepaid last year 740 prepaid for next year 1000
Cash 5000 p&l 4740
——– ——-
5740 5740
—— —–
Bal b/d 1000
The balance brought down of #1000 will be treated as current asset in the balance sheet
b. Income in advance: These are income received by the organization during the current period which relates to the next trading period e.g rent received in advance.
Treatment in final accounts
Decrease income credited to the profit and loss
Current liability in the balance sheet
DR income account CR
# #
P&l X last year advance x
Advance for next year x cash x
—– —-
Xx xx
——– —-
Bal b/d x
Illustration: Write up the ledger account of Mr. Jones as at 31st December 1999.He earned commission of #30000 for the year 31st December 1999. Prepaid as at31st December 1998 #7700; paid in advance at 31st Dec. 1999 was #6830
DR Commission receivable account CR
# #
P&L 30870 last year advace 7700
Advance for next year 6830 cash 30000
———- ———
37700 37700
——– ———
BAL b/d 6830
The balance brought down of #6830 will be treated as a current liability in the balance sheet
CAPITAL AND EXPENDITURE ITEMS
Capital Expenditure:These are expenditure incurred in purchase of fixed assets or which add to the value of an existing fixed asset. The benefits will not be fully consumed in period but spread over several periods .It includes expenditure on:
a. Acquisition or purchase of fixed assets
b. Improvement of assets in order to add value
c. Increase of the earning capacity of a business.
E.g Cost of acquiring fixed assets , installation cost , legal cost of buying buildings, .Capital expenditure will never appear in the profit and loss account but only in the balance sheet,
REVENUE EXPENDITURE: These are expenditure incurred in the day –today-day running of the business of the in a period of accounts ,the benefit of which is consumed in that period .It includes:
a.Maintenance of assets
b. Expenditure on day –today administration.
FEATURES OF REVENUE EXPENDITURE:
a. It relates to one accounting period
b. It is posted to the the income statement
c.Accrued expenses are added in the income statement
e.g. repairs ,depreciation ,rates and wages . It will be charged to the profit and loss account.
DEFERRED REVENUE EXPENDITURE : These are expenditure which are incurred in one accounting period but which provides benefits in future period and are not written off in one period e.g advertising expenditure
.
CAPITAL EXPENDITURE REVENUE EXPENDITURE
a. Includes expenditure on acquisition includes expenditure on repairs and
Of assets maintenance of assets
b. Charged to the appropriate real or charged to appropriate nominal account
Asset account
CAPITAL RECEIPTS: These include money injected into the business permanently or for a long period e.g. proceeds of an issue of shares, sales of assets, additional capital paid in.
REVENUE RECEIPTS: These are revenue arising from the daily activities of the business such as cash from sales, discounts received, commission received and interest on investment.
Capital receipt revenue receipts
Includes all money received as additional include all income earned by the
As additional capital or proceeds from sales the business
Of assets.
They are credited to capital or asset they are credited to income account
Account
EVALUATION: 1write up the ledger accounts of Okete for year ended 30th June 1999.Insurance paid for the year to 30th June 1999 #10000; owing at 30 June 1998 #1500; owing at 30th June 1999 #2300
expenditure: I Interest on loan to purchase micro computer
2. Cost of software for use with the micro computer
3. Cost of customizing the software for a company’s use
4. Cost of paper used by the computer printers
5. Wages of computer operators
6. Cost of ribbon used by the computer printers
7. Cost of adding extra memory to the micro computer
8. Cost of adding a manufacture’s upgrade to the micro computer equipment
9. Cost of floppy discs used during the year
10. Cost of adding air conditioning system to the computer room.
WEEK 5 & 6
PROVISION FOR BAD DEBTS ,PROVISION FOR DISCOUNTS ALLOWED AND RECEIVED.
RESERVES: These are amount set aside out of profit and other surpluses, which are not designed to meet any liability or losses but are retained in the business in order to strengthen the financial position of a business
Examples
a.share premium
b. capital redemption reserve fund
c. revaluation surplus
Reserve can be divided into two:
1. Capital reserves: These are reserves which are not available for distribution as dividends.
e.g
1. Share premium
2. Pre- incorporation profit
3. Profit on forfeiture of shares
4. Capital redemption reserve fund
5. Surplus on revaluation of assets
Revenue reserves: These are normally regarded as available for distribution through the profit and loss. It can be divided into general reserve and specific reserves
a. General reserves: This is created by setting aside profits in order to strengthen the general financial position of a business
b. Specific reserve: These are set aside out of profits for a specific purpose
PROVISIONS: They are set aside out of profit to provide for depreciation, renewals, diminution in the value of asset of which the amount cannot be determined with substantial accuracy.
Examples:
a. Provision for depreciation
b. provision for doubtful debts
c. provision for discounts allowances
BAD DEBTS: These are debts, which have become irrecoverable .It is charged against profit on the debit side of profit and loss account.Bad debt occurs as a result of the inability of the customer to pay his debt. It will reduce the account of debtors in the balance sheet.
Reasons for bad debt
Death or insolvency of the debtor
PROVISION FOR DOUBTFUL DEBTS:This is an estimated expense for bad debts
Which cannot be calculated with substantial accuracy .This is charged to the profit and loss as an expense
ACCOUNTING ENTRIES FOR PROVISION FOR DOUBTFUL DEBTS
Accounting entries for provision
Year1 :year in which provision is first made
Dr:profit and loss
Cr: provision for doubtful debts
Year2: To increase the provision
DR Profit and loss account
CR:Provision for doubtful debts account
To reduce the provision
Dr provision for doubtful debts account
Cr profit and loss account.
BAD DEBTS RECOVERED:
It is possible to recover debts written off earlier .When this occurs ,the book-keeping procedures are as follows:
DR:Debtors accounts
CR;Bad debts recovered account
WHEN CASH IS RECEIVED FROM DEBTORS
DR cash book
CR debtors account
Transfer of debts recovered to profit and loss account
DR Bad debts recovered account
CR Profit and loss account
PROVISION FOR DISCOUNTS:
Provision for discount on debtors: This is a charge made against profit in order to provide for an expected loss in the form of discounts that will have to be allowed to the firm’s debtors on payment of their accounts .It should be calculated on the net amount of debtors after deducting any provision for doubtful debts.
Provision for discount on creditors: This is an addition to the profits to provide for those discounts expected to be received on payment of the firm’s creditors
Illustration : The debtors balance as at 31st December are #20000. A bad debt provision of 10% is made and also a discount provision of 10%. The discounts allowed during the year amounted to #700 .The discounts provision on 1st January was #800.
Show the Journal, ledger ,profit and loss and balance sheet.
SOLUTION
journal
DR CR
# #
Profit and loss account 700
Discounts allowed 700
Transfer of discounts to profit and loss
Profit and loss account 1000
Provision for discount on debtors 1000
Increase in provision for discount
Workings:
Provision for bad debts :10% x20000=#2000
Provision for discounts on debtors;debtor 20000-2000=18000 x10%
=#1800 new provision
=800 old provision
——-
1000 increase in provision
——
Notes:provision for bad debts must be deducted first before calculating the provision for discount.
Ledger Entries
DR Discount allowed accounts CR
# #
Debtors 700 p&l 700
DR Provision for discount on debtors account CR
Dec 31 bal c/d 1800 Jan. 1 bal b/d 800
p& l 1000
——— ——–
1800 1800
———- ——–
DR P&l account CR
Discount allowed 700
Prov. For discount on debtor 1000
DR Balance sheet extract CR
# #
Debtors 20000
Less:prov for doubtful debt 2000
———
18000
Less prov.for discount 1800
———- 16200
Illustration:2 On 1st January , the provision for discounts on creditors was #2000. The discounts received during the year amounted to #2100.The creditors at 31st December was #12000 and a new provision of 20% is required. Show the journal , ledger ,profit and loss account and balance sheet.
SOLUTION:
JOURNAL
DR CR
Discount received account 2100
p&L account 2100
Transfer of discount to profit and loss account
Provision for discount on creditors 400
P & l account 400
Increase in provision for discount on creditors
Workings:provision for discount on creditors: 12000×20%=2400
New provision 2400
Old provision 2000
——— #400
Ledgers Entries
DR Discount received CR
# #
P &L 2100 Creditor 2100
DR Profit and loss account CR
# #
Discount received 2100
Prov. For discount on creditor 400
Provision for discounts on creditor account
DR CR
Bal b/b 2000 bal c/d 2400
Profit & loss 400
——- ——–
2400 2400
—— ——-
BALANCE SHEET
# #
Creditors 12000
Less provision 2400
——–
9600
———
EVALUATION:Explain the following terms :
a. bad debts b. provision for doubtful debts c reserves d provision for discount on creditors
ASSIGNMENT:Take assignment from simplified and amplified book-keeping & accounting for senior sec school revision question 4 page 161
Financial Accounting Topics – Edudelight Enotes
WEEK 7-9
DEPRECIATION OF FIXED ASSETS
Definition:1. Depreciation can be defined as the fall or decrease in the economic service potential of an asset as a result of wear , tear ,usage, obsolescence and inadequacy.
2. Depreciation can also be defined as the fundamental process of recognizing the loss in the value of fixed assets as a result of usage.
3. The statement of accounting standard defines depreciation as an estimate of the portion of the historical cost or revalued amount of a fixed asset chargeable to operations during an accounting period.
REASONS FOR DEPRECIATION
1. Since it reduces net profit , tax will be reduced
2. The value of the assets will not be overstated in the balance sheet.
3. The firm may have fund to replace the assets
4. It ensures that the cost of an asset is spread in an equitable fashion over its estimated life
5. It helps to ascertain the true profit because it is deducted from the gross profit
FACTORS TO BE CONSIDERED IN THE COMPUTATION OF DEPRECIATION
1. Method of depreciation
2. The historical cost
3. Estimated useful life
4. Estimated scrap value.
5. Internal causes of depreciation
6. External causes of depreciation
ELEMENTS OF DEPRECIATION
a. Original cost of asset: This refers to the cost incurred in purchasing an asset. This include the actual cost, cost of carriage, cost of installation and other capitalized expenditure on the assets.
b. salvage value: This is the estimated value recovered when the asset is disposed of at the end of its useful life.
c. Estimated useful life: This is the number of years of expected use.
USEFUL TERMINOLOGIES
1. Depletion:This is the process of allocating the cost of the natural resources to the units removed .Examples of assets are timber , mining etc.
2. Appreciation: This is a permanent increase in the value of an asset. Accounting procedure usually ignores bringing appreciation into account as this will go against the cost and prudent concepts.
3. Amortization: Assets with fixed period of legal life such as lease, patent, copyright, also depreciates. Depreciation for such assets is regarded as amortization. Amortization can be defined as the provision made for the consumption of intangible assets
METHODS FOR CALCULATING DEPRECIATION
The method which is chosen for calculating depreciation on any depreciable asset may be based on the usage or contribution of the asset to operations or on the passage of time. Importantly, the nature of an asset determines the appropriate method to be used.
Method based on the level of usage
The depreciation method based on the level of usage or output are as follows;
a. Service hour
Under the service hour method, the life span of a depreciable asset is determined by the total number of hour it can be used in producing the goods and services. The depreciable amount of the asset is divided by the estimated total service hours to obtain the depreciation rate per hour which is then used to multiply the total hours of use of the assets during the period
b. Productive output:
Under the productive output method, the life span of the depreciable asset is determined in terms of the total number of units it could produce .The depreciable amount of the asset is divided by the estimated total number of units to obtain a unit depreciation rate, which is then used to multiply the total output for the period to derive the depreciation expense for the period
METHOD BASED ON THE PASSAGE OF TIME
The method based on the passage of time are as follows
1. Straight line method
2. Reducing balance method
3. Sum- of –years ‘digits method
4.Annuity and sinking fund method
Straight line method
This method is at times called fixed deposit method because it allocates a fixed percentage of the original cost of the asset equally to business operations at each year of the estimated useful economic life of the asset, and thus reduces the asset to nil or break-up value at end of its life.
The depreciation amount is computed by dividing the original cost of the fixed asset minus the estimated residual value by the useful life of the asset.
A mathematical formula can be deduced as follows
Annual depreciation = original cost of asset – residual value/Estimated useful life
Illustration: A motor vehicle was purchased for #300000 on January 1, 2006.The motor vehicle is estimated to have useful life of 5 years and a residual value of #20000
You are required to calculate:
a. The depreciation charge for each year
b. The accumulated depreciation charge
c. The net book value as at the end of 2010 using the straight line method
Solution:
Original cost =#300000
Estimated useful life=5 years
Residual value =#20000
Applying the formula given above
Annual depreciation=300000-20000/5=280000/5=#56000
MOTOR VEHICLE ACCOUNT
CASH 300000
DOUBLE ENTRY RECORDS FOR DEPRECIATION
The calculation and determination of depreciation charge for an accounting year necessitates correct recording in the books of account. The process of providing for depreciation entails the recording of the use of fixed assets during an accounting period.
DR Accumulated provision for depreciation account CR
31/12/2006 bal c/d 56000 31/12/2006 depr exp. 56000
31/12/2007 bal c/d 112000 1/1/2007 balb/d 56000
31/12/2007 bal b/d depr exp 56000
——— ———
112000 112000
——– ———-
31/12/2008 bal. c/d 168000 1/1/2008 bal b/d 112000
31/12/2008 depre exp. 56000
———— ______
168000 168000
———— ______
31/12/2009 bal c/d 224000 1/1/2009 bal b/d 168000
31/ 12 2009 depr exp 56000
_______ ______
224000 224000
_______ ______
31/12/2010 bal c/d 280000 1/1/2010 bal b/d 224000
31/12/2010 Depr exp 56000
_______ ______
280000 280000
________ _______
DR Depre exp. account CR
# #
31/12/2006 accum provision 56000 31/12/2006 p&l a/c 56000
31/12/2007 accum provision 56000 31/12/2007 p& l a/c 56000
31/12/2008 accum provision 56000 31/12/2008 p & l a/c 56000
31/12/2009 accum provision 56000 31/12/2009 p&l a/c 56000
31/12/2010 accum provision 56000 31/12/2010 p&l a/c 56000
DR Profit & loss Account (extract) for the relevant year end CR
2006 Depre. Expense. 56000
2007 “ “ 56000
2008 “ “ 56000
2009 “ “ 56000
2010 “ “ 56000
DR Balance sheet (extract) as at December for the respective years
2006: # #
Motor vehicle at cost 300000
Less: Accum depr (56000) 244000
2007
Motor veh at cost 300000
Less Accum depr (112000) 188000
2008
Motor veh.at cost 300000
Less accum depr (168000) 132000
2009:
Motor veh at cost 300000
Less accum depre (224000) 76000
Motor veh at cost 300000
Less Accum depre (280000) 20000
Reducing balance method or diminishing balance method
Under this method of charging depreciation, the book value of a fixed asset at the beginning of the year is multiplied by a fixed percentage in order to determine the depreciation for the accounting year. This procedure is repeated in the subsequent years of usage of the asset so as to reduce the depreciable value of the fixed asset to zero (i.e to reduce the cost to its residual value).
2. Using reducing balance method
Illustration 2 ; on 1. January, Megida limited purchased equipment for #350000.It is the policy of the business to depreciate plant at 25%. You are required to show the equipment account.
SOLUTION
Calculation of annual depreciation
Year 2001: Depreciation calculation
=25%x350000=#87500
Year 2002: Depre calculation
=25% (350000-87500)
=#65625
Year 2003:depre calculation
25%x(350000-(87500+65625)=#49218
Year 2004 depreciation calculation
25%x(350000-(87500+65625+49218)
#36914
Ledger accounts
DR Equipment account CR
#
1/12003 350000
DR Accumulated provision for depreciation a/c CR
# #
31/12 2003 bal b/d87500 31/12/2003 depre exp. 87500
31/12/04 bal b/d 153125 1/1/2004 bal b/d 87500
31/12/2004 dep exp. 65625
________ ______
153125 153125
_______ _______
31/12/05bal c/d 202343 1/1/2005 bal b/d 153125
31/12/05 depre exp. 49218
______ _______
202343 202343
_______ _______
31/12/06 bal c/d 239257 1/1/2006 bal b/d 202343
31/12/2006 depr exp. 36916
______ _______
239257 239257
______ _______
DR Depreciation expense account CR
# #
31/12/2003 prov. For dep. 87500 31/12/2003 p&l 87500
31/12 2004 “ “ “ 65625 31/12/2004 P&l 65625
31/12/2005 “ “ “ 49218 31/12/2005 p&l 49218
31/12/2005 “ “ “ 36914 31/12/2006 p&l 36914
profit and loss account(extract) for the relevant year end
2003 #
2003 depreciation exp. 87500
2004 “ “ “ 65625
2005 “ “ “ 49218
2006 “ “ “ 36914
Balance sheet (extract) as at 31 Dec. for the respective year
# #
Equipment at cost 350000
Less depre. 87500
______ 262500
2004
Equipment at cost 350000
Less depreciation 153125
Net book value 196875
2005
Equipment at cost 350000
Less depreciation 202343
_____ 147657
2006
Equipment 350000
Less depreciation 239257
______ 110743
Depletion Method:The method is used for wasting assets such as quarry , mine timber etc.they are depreciated by charging depreciation by the unit extracted
Illustration: The right to work a mine cost #90000 and the estimated quantity is 900000 tons output for three years are as follows.
1st year 1500 tons
2nd year 4800 tons
3rd year 7000 tons
SOLUTION:
DR MINE ACCOUNT CR
# #
Year 1 cash 90000 year 1 p & l 150
Bal c/d 89850
______ ______
90000 90000
______ _____
Year2 :bal b/d 89850 year2 p&l 480
Bal c/d 89370
______ _____
89850 89850
______ ______
Year 3:bal b/d 89370 year3 p&l 700
Bal c/d 88670
_____ ______
89370 89370
_____ ______
Bal b/d 88670
Workings:year1 1500/900000×90000=#150
Year2 =4800/900000×90000= #480
Year3 =7000/900000×90000=# 700
DR Profit and loss account CR
# #
Year 1 : Depreciation 150
“ 2 “ 480
“ 3 “ 700
4. Revaluation Method: Under this method, the asset is revalued each year, any difference will be charged to the profit and loss account . Assets like loose tools , livestock, cattle ,cannot be easily depreciated because of their nature ,hence they are revalued on yearly basis.
The calculation is as follows: #
Opening stock x
Add purchases during the year x
_____
Xx
Less closing stock x
___
Consumption in a year x
___
Illustration: 1st January 1999 ,stock of loose tools #15000. Purchases during the #4500.On 31st December 1999, stock of tools #15600.
Show the necessary accounts
Calculation of depreciation #
Loose tools: opening stock 15000
Purchases 4500
____
19500
Less closing stock 15600
_____
Depreciation 3900
______
DR Loose tools account CR
# #
1999 1999
Jan. bal b/d 15000 Dec.31 depreciation 3900
Dec.31 cash 4500 Dec,31 bal c/d 15600
_____ ____
19500 19500
____ _____
DR depreciation account CR
# #
1999
Jan. loose tools 3900 Dec.31 p&l 3900
DR Profit and loss CR
# #
1999 Dec. depreciation 3900
balance sheet
# 1999 #
Loose tools 19500
Less depreciation 3900
____ 15600
5. Machine Hour Rate Method: This is an estimate of the total effective working hours of the machine during its expected useful life .
The cost of the machine less its scrap value (if any )divided by the estimated working hours will give us the machine hourly rate .The charge for depreciation is therefore the actual number of hours the machine was operated during the period.
Illustration: A company purchased plant and machinery at a cost of #105000 with an estimated total effective hour of 125000 and scrap value of #5000. The number of hours the plant and machinery was put into use for the first 3years are stated below:
Year1 10000 hrs.
Year2 12000 hrs.
“ 3 13000 hrs
Required; calculate the yearly depreciation
Rate per hour= cost –scrap value/estimated effective hour
=105000-5000/125000=#0.80
Yearly depreciation charge
Year1 = 10000x#0.8 =#8000
“ 2= 12000x#0.8=#9600
“ 3= 13000x #0.8=10400
6.Sum Of The Years Digit Method :Under this method , the years in the life of the assets are represented with digits and are added .The fraction of the assets cost are charged to the years in reverse order.It means , on five year life,that the first year will attract 5/15 and the second year 4/15 etc
Illustration:A machine cost #9000 and has a life of3 years after which it can sold for #1800
SOLUTION
YEAR DIGIT
1 3
2 2
3 1
Sum of the digits 6
Depreciation charged for each year will be
Year
1 3/6x(9000-1800)= #3600
2 2/6 x(9000-1800)=#2400
3 1/6 x(9000-1800)= #1200 total =#7200
EVALUATION:
1. List 6 methods of depreciation and explain any three
2. Briefly explain the following terms with examples
a. Amortization
b. depletion
c.depreciation
d. appreciation
ASSIGNMENT:
A machine XYZ bought by a business firm has the following data
Cost of purchase = #200000
Installation cost =#25000
Annual maintenance cost=#15000
Estimated useful life =5years
Estimated residual value #10000
Determine the following:
a.What is the historical cost of the machine to be recorded?
b. Determine the annual depreciation charged using straight line method of depreciation
c. Prepare the following ledger accounts;
1. asset
2. Provision for depreciation account
3 Depreciation expense account
4. Profit and loss extract
5 balance sheet extract.
WEEK 10
PREPARATION OF FINAL ACCOUNTS WITH END OF YEAR ADJUSTMENTS
Illustration: below is the trial balance of olonto as at 31st Dec.2011
Dr # cr #
Capital 32000
Purchases 15610
Drawings 4000
Rates and taxes 388
Interest receivable 48
Salaries 1612
Lighting and heating 164
Electric power 384
Travellers’commision 414
Insurance 206
Advertising 214
Sales 34080
Bad debts 62
Income receivable 48
General expenses 604
Postage 222
Carriage inwards 754
Stock 6160
Stationery 7962
Land and building 15840
Plant and machinery 4034
Furniture and fittings 378
Debtors 6080
Creditors 4182
Cash in bank 5270
_________ ______
70358 70358
_____ ______
Additional information:
a. provide 20% for discount on debtors and create a bad debt provision of 10%
b. Depreciation of 5% is to be written off on plant and machinery and furniture 10%
c. Stock at close #8760
d. Stationery owing #300
e. insurance paid in advance amounted to #40
f. Write off bad debt of #1000
g. The owner withdrew goods worth #1500
h. Income receivable in advance #20
I. interest receivable in arrears #10
You are required to prepare:
The Trading profit and loss account and balance sheet as at 31st Dec.2011
SOLUTION: Olonto
dr Trading profit and loss account for the year ended 31st DEC 2011
# # # #
Opening stock 6160 sales 34080
Add purchases 15610
Carriage inward 754
____
16364
Less goods withdrawn 1500
____ 14864
______
21024
Less closing stock 8760
______
12264
Gross profit 21816
_____ ______
34080 34080
_____ ______
Expenses: gross profit 21816
Rates 388 income receivable(48-20) 28
Salary 1612 interest receivable (48+10) 58
Light 164
Travellers’ commission 414
Electricity 384
Insurance (206-40) 166
Advertising 214
Bad debts(62+1000) 1062
General expenses 604
Postage 222
Stationery (7962 +300) 8262
Provision for bad debts 508
Provision for discount allowance 914
Depreciation:
Furniture 38
Plant 202
Net profit 6748
____ _____
21902 21902
____ ____
Olonto
Balance sheet as at 31st Dec. 2011
# #
Capital 32000 Fixed assets:
Add net profit 6748 land and building 15840
_____ plant & machinery 4034
38748 less :depreciation 202
Less drawings (4000 +1500) 5500 _____ 3832
____
33248 furniture 378
Less depreciation 38
___ 340
____
20012
Current liabilities:
Creditors 4182 current assets:
Stationery owing 300 cash at bank 5270
Income 20 stock of goods 8760
Insurance prepaid 40
Debtors 6080
Less bad debt 1000
____
5080
Less prov.for debt 508
___
4572
Less prov. For discount 914
3658
Accrued interest 10
______ ____
37750 37750
____ _____
WORKINGS:
DEPRECIATION:
1. Plant and machinery: 4038×5%=202
2. furniture: 378×10%=38
3. debtors 6080
Less bad debt 1000
____
5080
Less prov.for bad debt(10%x5080 508
___
4572
Less: prov. For discount(20%x4572)914
____
3658
ASSIGNMENT:
Take assignment from simplified and amplified book-keeping& accounting
For senior sec school revision question 4x page 211 and revision question 5 page212
