Chapter 6:

Accounting adjustments 2
(Leiwy and Persk: parts of Chapter 9 and 10)

Maja Ribić
Snežana Miletić
Learning outcomes

 calculate the values of non-current assets and the depreciation

expense in the income statement

 calculate the profit or loss on disposal of a non-current asset and

demonstrate the effects of the disposal on the statement of financial
position and income statement

 calculate and account for a revaluation of land and buildings

 account for taxation on the company’s profits in the two financial

statements and any under or overprovision in taxation
 Non-current assets – the essential
characteristics
 Used for more than one year (long-term assets whose benefits will be realized
over more than one year, cannot be transformed into cash easily, low
liquidity)

Non-current assets

Tangible assets Intangible assets

Land Patent
Property Goodwill
Building Reputation
Machinery Branding
Equipment Copyright
Plants Trademark
Non-current assets

 price paid for non-current asset appears in S of FP (capital

expenditure – not an expense in IS)
 UEL (useful economic life) – number of years that assets is expected
to be used by business
 Residual value (RV) at the end of UEL
 Depreciation: the value of tangible non-current assets in the S of FP is
gradually reduced (until it is =RV)
 The reduction of intangible assets - amortisation
Non-current assets

What causes depreciation?

 Time and physical deterioration
✓ destruction,
✓ damage,
✓ wear and tear
 Economic factors
✓ Obsolescence (out of date, inefficiency)
✓ Inadequacy
Non-current assets

Depreciation application of the matchin concept

Revenue (or
Costs of buying other benefits)
asset generated by
use of asset

UEL
Non-current assets
How to calculate depreciation?
 2 main methods:
1. straight-line depreciation
2. reducing balance depreciation
 Chose the method that most closely matches the cost to the pattern of
benefits obtained!
 Are all non-current assets depreciated?
 Land is never depreciated (unless it is mined or quarried) because has no
definitive useful life!
Non-current assets
 For each category of non-current assets there are two accounts:

1. Non-current assets at cost (or valuation) – debit balance, shows original cost
price (or revalued amount)
2. Provision for depreciation – credit balance, shows cumulative depreciation
built up over a number of years
Net book value (NBV=1-2) = cost (revalued amount) – cumulative depreciation

A jouranl entry:
Dr: Depreciation expense (IS)
Cr: Provision for depreciation (S of FP)
Straight-line depreciation

 Pattern of benefits is stady and unchanging over time

 Cost of using asset is spread evenly over UEL
 What asset is appropriate for?

Acquisition cost – Estimated residual value

Annual depreciation charge =
Expected UEL in years

 OR:
Annual Depreciation Expense 100%
Straight Line Depreciation Rate = OR
Acquisition cost – Estimated residual value UEL

Annual depreciation charge = (Acquisition cost – Estimated residual value) x SLDR(%)

Example 6.1

A piece of machinery is purchased at a cost of £56,000 on 1 January 20X0, the

first day of a company’s accounting year. Its estimated useful life is 10 years,
after which time it is expected it will have a scrap value of £6,000.

The annual straight-line depreciation charge for the machinery is:

56,000– 6,000
=5,000
10

OR

100%
SLDR= =10%
10
(56,000– 6,000)x10%=5,000
„T“ accounts

Provision for
Non-Current Asset depreciation (S of FP)

56,000 5,000

Depreciation expense (IS)

5,000
Reducing balance depreciation

 Asset is expected to produce more benefits in early years of UEL than in later
years
 Depreciation charge is greater in first year and gets smaller each year
(declining depreciation expenses)
 What asset is appropriate for?
 A new machine will have higher functionality when it is new and more likely
to generate additional revenue and requires less maintenance.
 Always expressed as a percentage rate

Annual depreciation charge in year n = NBV of asset at start of year n x RBDR (%).
Example 6.2
 Given the information in Example 6.1, the annual depreciation charges for
depreciation using the reducing balance method at a rate of 20 per cent
would be:

Residual
value
 What would be the figures appearing in the financial
statements of the company at 31 December 20X0 and 20X1,
using the information in Examples 6.1 and 6.2?

S of FP IS
SLD RBD SLD RBD
Machinery Deprec Deprec
Machinery 20X0 5,000 20X0 11,200
56,000 at cost 56,000 iation iation
at cost
31.12.20X0
31.12.20X0

Deprec Deprec
20X1 5,000 20X1 8,960
iation iation
Provision Provision
(5,000) (11,200)
for deprec. for deprec.

NBV Using a different method of

NBV 51,000 44,800
calculating depreciation
Machinery changes the figures which
Machinery appear in the financial
56,000 at cost 56,000
at cost
31.12.20X1
31.12.20X1

statements

Provision Provision
(10,000) (20,160)
for deprec. for deprec.

NBV 46,000 NBV 35,840

Sale of non-current assets
 Busenesses will usually make either a profit or a loss on the disposal of non-
current asset:

Profit Loss

Profit (Loss) on disposal =

Sales Proceeds - NBV

NBV<Sale Proceeds NBV>Sale Proceeds

Sale of non-current assets
 Cost and accumulated depreciation of sold asset must be removed and transfered
to disposal of non-current asset account (because it no longer belongs to the
business)
 Disposal of non-current asset account is used to calculate the profit or loss

Dr: Disposal of non-current asset

Cr: Non-current asset account

Dr: Provision for depreciation IS – other

then
Cr: Disposal of non-current asset
operating
profits
Dr: Cash
Cr: Disposal of non-current asset

 If an Asset disposal account shows debit balance losshas

loss hasbeen
been incurred
incurred
 If an Asset disposal account shows credit balance profithas
profit hasbeen
beenearned
earned
Sale of non-current assets

 Depreciation – start
❖ IAS 16: Depreciation of an asset starts when the asset is available for use, that
is when it is in the location and condition necessary for it to be capable of
operating in the manner intended by management.
• It is customary to depreciate a non-current asset in the year of acquisition as if it
was purchased at the beginning of the year.

 Depreciation – end
❖ IAS 16: Depreciation does not cease when the asset becomes idle, or is retired
from active use, and held for disposal, unless the asset is fully-depreciated.
• It is customary not to calculate or charge any depreciation for the asset being
disposed of in the year of disposal
Example 6.4
 Suppose that the machinery in Example 6.3 was sold on 1 January 20X2 for
one of the following amounts:
1. £48,000
S of FP at 31.12.20X1
Profit
2,000 Machinery at cost 56,000
Provision for depreciation 10,000
NBV 46,000
2. £46,000

Nil

3. £43,000

Loss
3,000
„T“ accounts

Provision for
Non-Current Asset depreciation (S of FP)

bal 56,000 56,000 bal 10,000

10,000

Cash Disposal account

56,000 10,000
Cr balance:
48,000 48,000 2,000
(Profit)
„T“ accounts

Provision for
Non-Current Asset depreciation (S of FP)

bal 56,000 56,000 bal 10,000

10,000

Cash Disposal account

56,000 10,000
in balance
46,000 46,000
(Nil)
„T“ accounts

Provision for
Non-Current Asset depreciation (S of FP)

bal 56,000 56,000 bal 10,000

10,000

Cash Disposal account

56,000 10,000
Dr balance:
43,000 43,000 3,000
(Loss)
Revaluation of land and buildings

IAS 16 permits the choice of two possible treatments in respect of PPE:

• The cost model (carry an asset at cost less accumulated depreciation and any
accumulated impairment losses).
• The revaluation model (carry an asset at its fair value at the revaluation date
less subsequent accumulated depreciation and subsequent impairment
losses).
✓ Revaluation must be done by independent and expert valuer.
✓ RM provides more revelant information to users of accounts.
✓ The principal reason for companies to adopt this approach is to ensure that
noncurrent assets are shown at their market value in financial statements, thus
this provides a more accurate picture than the cost model.
✓ There are a series of accounting adjustments that must be undertaken when
revaluing a non-current asset.
Revaluation of land and buildings
Business has a property with a cost of £100,000 and an accumulated depreciation
of £40,000 and the valuer places a market value of £150,000.
Dr Property 50,000
Dr Provision for depreciation 40,000
Cr Revaluation reserve 90,000

 Appears on the S of FP in the owners’ equity section

 Non-distributable reserve - is not a realised profit so no dividend can be
distributed or paid out to shareholders from this reserve
 Appears in the Statement of movements in equity
„T“ accounts

Provision for
Non-Current Asset depreciation (S of FP)

Bal 100,000 40,000 bal 40,000

50,000

Revaluation reserve

90,000
Taxation

 which form of business organization pays taxation? (limited liability company)

 sole trader and a partnership - the tax liability falls upon the owners

Dr: taxation expense (IS)

Cr: taxation liability (S of FP)

 underprovision and overprovision for tax – when provision for taxation for one
year is found to be wrong (uderestimated or overestimated by the company)
 underprovision and overprovision for tax appears in TB
Example 6.5

 Company X estimates its 20X1 tax liability to be £200,000.

Dr: Taxation expense 200,000
Cr: Taxation liability 200,000

That provision is agreed by the tax authority in 20X2.

Dr: Taxation liability 200,000
Cr: Cash 200,000
 Underprovision for tax for the previous
year
20X1: Company X estimates its 20X1 tax liability 20X2:
to be £200,000.
The taxation for 20X1 is subsequently agreed to
Tax be 210,000.
Tax
liability
Estimated taxation expense for 20X2 is 260,000.
200,000 200,000 Tax
Tax
liability
1) 10,000 2)210,000 bal 200,000
3) 260,000 1) 10,000
3) 260,000

Cash

Bal 600,000 2)210,000

 Overprovision for tax for the previous
year
20X1: Company X estimates its 20X1 tax liability 20X2:
to be £200,000.
The taxation for 20X1 is subsequently agreed to
Tax be 190,000.
Tax
liability
Estimated taxation expense for 20X2 is 260,000.
200,000 200,000 Tax
Tax
liability
3)260,000 1)10,000 1)10,000 bal 200,000

2)190,000 3) 260,000

Cash

Bal 600,000 2)190,000

Ko-Furn Limited is an office furniture manufacturer. The following is a list of balances extracted from its
accounting records at 31 December 2009:

Dr Cr
£000 £000
Land, at valuation 240
Buildings: cost 500
Buildings: accumulated depreciation at 1.1.09 180
Equipment: cost 392
Equipment: accumulated depreciation at 1.1.09 152
Vehicles: cost 568
Vehicles: accumulated depreciation at 1.1.09 264
Inventory at 1.1.09 214
Trade receivables 366
Provision for doubtful debts at 1.1.09 16
Prepayment at 1.1.09 12
Accrual at 1.1.09 18
Cash 408
Trade payables 248
Share capital: ordinary 50c shares 50
Share premium 350
Retained earnings 606
Sales 2,924
Purchases 976
Wages and salaries 540
Distribution costs 200
Other administrative expenses 360
Corporation tax 12
Disposal account 20
Dividend paid 40
4,828 4,828
Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

i. Ko-furn prices its furniture using a normal 30% mark-up policy. An inventory count
carried out at 31 December 2009 valued inventory at selling price of £325,000.
This included two board tables at normal selling price of £20,800 each, which the
directors have decided should be reduced in price to £5,000 each.

Inventory $ %
Selling price 325,000 130%
mark-up 75,000 30%
Cost price 250,000 100%
2 tables $ %
Selling price 41,600 130%
mark-up 9,600 30%
Cost price 32,000 100%
revised selling price 10,000
Inventory at lower of cost or NRV 250,000
SP-cost (22,000)
Statement of financial position value 228,000
Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

ii. The land was valued at £600,000 at 31 December 2009. The directors decided to reflect the revalued
amount in the balance sheet.

Dr Land 360,000
Cr Revaluation reserve 360,000

S of FP

Land 600,000 Rev. Reserve 360,000

Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

iii. On 1 February 2009, the company sold a vehicle for £20,000. While the proceeds of sale were credited to the Disposal account,
no other entries were made in the books of account in relation to this transaction. The vehicle had cost £88,000 in August 2006. The
company charges a full year’s depreciation in the year of acquisition and no depreciation in the year of disposal. The company’s
depreciation policy is as follows: Vehicles 25% straight line.

Vehicles Cost AccDepn NBV

TB 568,000 264,000
disposal (88,000) (66,000)
480,000 198,000
depreciation: 25% 120,000
Statement of financial position 480,000 318,000 162,000

Sale of non-current asset

Vehicle sold: Net book value (NBV) 22,000
Proceeeds of sale 20,000
Loss on sale 2,000 IS
Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

iv. The company’s depreciation policy is as follows:

Land: nil
Buildings: 4% straight line
Equipment: 40% reducing balance
Vehicles: 25% straight line.

Buildings Cost AccDepn NBV

TB 500,000 180,000
Depreciation charge for the Y 20,000
Statement of financial position 500,000 200,000 300,000 IS

Equipment Cost AccDepn NBV

TB 392,000 152,000 240,000
Depreciation charge for the Y 96,000
Statement of financial position 392,000 248,000 144,000
Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

v. Trade receivable at 31 December 2009 (366,000) include a debt of £16,000 from a customer recently
declared bankrupt. The company has decided to maintain the provision for doubtful debts at 4% of
remaining trade receivables. Provision for doubtful debts at 1.1.09 = 16,000 cr

 Statement of Financial Position

 Trade receivables (366,000 – 16,000) 350,000
 Less: provision for bad and doubtful debts
(4 percent × 350,000) (14,000)
336,000
 Income statement (under expenses)
 Bad debts written off 16,000
 Decrease in provision for bad and doubtful debts (2,000)
14,000
Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

vi. The balance of prepayments at 1.1.09 (12,000 dr) refers to insurance charges. Prepaid insurance,
included in general distribution costs at 31 December 2009 amounted to £24,000.

Opening balance 12,000

Closing balance 24,000 S of FP
Prepayments
Increase 12,000 24,000 IS
Distr. Costs
200,000-12,000=
Dr Prepayments 12,000 188,000

Cr General distribution costs 12,000

Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

vii. The balance of accruals at 1.1.09 (18,000 cr) refers to electricity charges. After the year end, the
company received an electricity invoice for £30,000 covering the period 1 November 2009 to 31 January
2010. Electricity charges are included in other administrative expenses.

Opening balance 18,000

Closing balance 20,000 IS
Admin. expense
Increase 2,000 360,000+2,000=
362,000

Dr Administrative expenses 2,000

Cr Accrual 2,000 S of FP
Accrual
20,000
Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

viii.Corporation tax for the year ended 31 December 2009 is estimated to be £190,000.

IS
Corp. Tax
12,000 (underprovision)
+190,000=
Dr Corporation tax 190,000 202,000
Cr Tax liability 190,000

S of FP
Tax liability
190,000
Prepare an income statement for the year ended 31 December 2009 and a statement of financial
position at that date, in good style, for the directors.

You are given the following information:

ix. The company issued 100,000 additional shares at 50p (pence) each on 30 December
2009 for £140,000. This transaction has not been recorded in the accounting records.
* 100 pence = 1 pound

Equity
+140,000

Share capital Share premium

ob50,000+50,000= ob350,000+90,000=
100,000 440,000
Prepare an income statement for the year ended 31 December 2009 and a statement of
financial position at that date, in good style, for the directors.

Ko-Furn Limited: Income statement for the y/e 31.12.09 £ £

Sales 2,924,000
Cost of goods sold
opening inventory 214,000
+ purchases 976,000
1,190,000
- closing inventory (228,000)
962,000
Gross Profit 1,962,000
Expenses
Wages & salaries 540,000
Distribution costs 200,000-12,000 188,000
Other administrative expenses 360,000+2,000 362,000
Loss on sale of non-current asset 2,000
Depreciation: Buildings 4% S/L 500000 x 4% 20,000
Depreciation:Equipt 40% reducing bal (392-152) x 40% 96,000
Depreciation: Vehicles 120,000
Bad debt written off 16,000
Provision for bad debts: (366,000-16,000) x 4% - 16,000) (2,000)
1,342,000
Profit before tax 620,000
Corporation Tax this year 190,000
underprovision 2008 12,000 202,000
Profit for the year (after tax) 418,000
Prepare an income statement for the year ended 31 December 2009 and a statement of
financial position at that date, in good style, for the directors.
Ko-Furn Limited: Statement of financial position at 31.12.0
£ £ £
Non-current assets cost Acc depn nbv
Freehold land, at valuation 600,000 - 600,000
Buildings 500,000 200,000 300,000
Equipment 392,000 248,000 144,000
Vehicles: 480,000 318,000 162,000
1,972,000 766,000 1,206,000
Current assets
Inventory, at cost 228,000
Trade receivables 350,000
less bad debt provision (14,000)
336,000
Prepaid insurance 24,000
Cash 408000+140000 548,000
1,136,000
Total assets 2,342,000
Liabilities & equity
Current liabilities
Trade payables 248,000
Accrued electricity 20,000
Taxation 190,000
458,000
Equity
Share capital 100,000
Share premium 440,000
Revaluation reserve 360,000
Retained profit (606,000+418,000- dividends paid 40,000) 984,000
1,884,000
Total Liabilities & equity 2,342,000