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FIRST TERM E-LEARNING NOTE

 

SUBJECT: FINANCIAL ACCOUNTING CLASS: SS2

 

SCHEME OF WORK

 

WEEK  TOPIC

1 Final Accounts – Special transactions; Bad Debts, Closing entries e.t.c.

2 Final Accounts – Provision for doubtful debts

3 Final Accounts – Provision for discounts

  1. Final Accounts – Accruals and Prepayments

6 Depreciation of Fixed Assets

7-8 Depreciation of Fixed Assets

9 Depreciation of Fixed Assets

10 Final Accounts – Working exercises

 

ecolebooks.com

 

WEEK ONE

FINAL ACCOUNTS – SPECIAL TRANSACTIONS; BAD DEBTS, CLOSING ENTRIES

CONTENT

  • SPECIAL ITEMS OF EXPENSES/LOSSES
  • BAD DEBTS RECOVERED
  • CLOSING ENTRIES
  • ADJUSTMENTS IN THE FINAL ACCOUNT

     

    SPECIAL ITEMS OF EXPENSES /LOSSES

    1.  GOODS STOLEN OR DESTROYED

     Goods may have been stolen (pilfered) or destroyed during the financial year. When this occurs, the following entries will be passed

    Dr  Profit and Loss Account

    Cr  Purchases Account

    2.  GOODS WITHDRAWN BY THE OWNER FOR PERSONAL USE

     The owner of the business can withdraw goods for his own use. The treatment in the account is that such goods are recorded at the cost price. The entries to be passed are;

    Dr  Drawings Account

    Cr  Purchases Account

    3.  BAD DEBTS

     These are debts which have became irrecoverable i.e. debts that cannot be collected again from a customer. Bad debts occur as a result of the inability of the customer to pay his debt. This situation can arise due to a number of factors or reasons among which are the death of a customer, the insolvency, bankruptcy or liquidation of the customer, poor economic/political situation of a country, poor debt management on the part of the creditor etc.

     Accounting treatment of bad debts.

    Dr  Bad Debts Account

    Cr  Debtors Account

     This will reduce the value of debtors in the ledger

     

     The Bad Debts Account will have a debit balance and will appear among other items in the trial balance.

     

    On the preparation of the final account

     Dr  Profit and Loss Account

     Cr  Bad Debts Account

    Bad debt is thus a loss to the business organization

     

BAD DEBTS RECOVERED

Occasionally, a bad debt previously written off may be paid. The accounting treatment in such a situation are:

(a)  Dr  Debtor’s Account

 Cr  Bad Debts Recovered Account

This will bring the debtors account to its original position before the bad debts were written off

(b)  Dr  Cash /Bank Account

 Cr  Debtor’s Account

(c)  On the preparation of the final accounts

 Dr  Bad Debts Recovered Account

 Cr  Profit and Loss Account

The amount recovered is an additional income for the period. This explains why it is being credited into the Profit and Loss Account.

 

EVALUATION

1.  What are the accounting entries posted whenever the owner of a business withdraws cash from the business for private use.

2.  What are the accounting entries posted whenever the owner of a business withdraws goods from the business for personal use.

 

CLOSING ENTRIES

Closing entries are those entries made at the end of the accounting period (e.g 31st December,

20xx) to close the various ledger accounts and transfer their balances to the final account.

 

ADJUSTMENTS OF THE FINAL ACCOUNT

Adjustments are closing entries or amendments made in the books of accounts at the end of

the accounting period so as to achieve a proper matching of costs and expenses with revenue.

Adjustments are required for the following:

1.  Accruals

2.  Prepayments

3.  Depreciation of fixed assets

4.  Provision for doubtful debts

5.  Provision for discounts on debtors

6.  Bad debts

7.  Closing stock

8.  Capital and revenue items of income and expenditure.

9.  Set-offs

10.  Correction of errors e.g. errors ofomissions, errors of principle, casting errors etc.

11.  Provision for contingencies e.g. legal charges, accountancy charges.

 

EVALUATION

1.  Write short notes on the following

 (a) Drawings (b) Bad debts

2.  Distinguish between closing entries and adjustments as it relates to the preparation of final accounts.

 

GENERAL EVALUATION

1 Explain the purpose of preparing each of the following (i) trading account (ii) profit and loss account (iii) balance sheet

  1. List six items found in the asset and liability sides of the balance sheet of a sole trader
  2. List and explain three classifications of ledger accounts
  3. State ten uses of the General Journal.
  4. List ten users of accounting information

 

READING ASSIGNMENT

Simplified and Amplified Financial Accounting, Page 143-150

 

WEEKEND ASSIGNMENT

1.  At the end of a trading period cost of goods sold is debited to the trading account while cost of services is debited to the (a) balance sheet (b) trading account (c) profit and loss account (d) manufacturing account

2.  The purchase of a typewriter for office use for N2,000 is debited to _____

 (a) creditors   (b) bank account   (c) purchases account (d) equipment account

3.  Books of account are opened by means of a ______________ journal

 (a) purchases   (b) principal   (c) sales (d) returns inwards

4.  Which of the following is recorded on the debit side of the Trial Balance (a) bank overdraft (b) returns outwards (c) purchases (d) capital

5.  Which of the following is not shown in the trial balance________

 (a) discounts allowed   (b) discounts received  (c) opening stock  (d) closing stock

 

THEORY

1. List any eight components of Trading Account

2.(a)  List any five items that may cause adjustments in final accounts.

(b)  Outline any four factors that may make a debt to be irrecoverable.

 

 

WEEK TWO

FINAL ACCOUNTS – PROVISION FOR DOUBTFUL DEBTS

PROVISION FOR DOUBTFUL DEBTS

Although a debt may not actually have become bad, there may be doubt as to whether it will be paid. It would be misleading to include that debt as an asset in the balance sheet pretending that the amount is not in doubt. On the other hand, since it has not yet become bad, it would be wrong to write it off. A provision is therefore made to cover such doubtful debt.

 

Provision for doubtful debt is a mere estimate of the total debt that may not be collected from the debtor. This estimated expense for bad debts which cannot be calculated with substantial accuracy is charged to the profit and loss account as an expense.

 

HOW TO CREATE AND MAINTAIN A PROVISION FOR DOUBTFUL DEBTS

A.  When the provision for doubtful debt is first created;

 Debit Profit and Loss Account

 Credit Profit for doubtful debts Account

with the full amount of the provision

In the years that follow, the entries in the accounts will be for increases or decreases in the amounts required for the provision.

B.  INCREASING THE PROSIVION FOR DOUBTFUL DEBTS

 Debit Profit and Loss Account

 Credit Profit for doubtful debts Account

with increases in the provision.

C.  DECREASING THE PROVISION FOR DOUBTFUL DEBTS

 Debit Profit for doubtful debts Account

 Credit Profit and Loss Account

with decreases in the provision.

In all the instances (A-C) as described above, the provision for Doubtful Debts is deducted

from the Debtors in the Balance Sheet.

 

EVALUATION

1.  Explain the following terms:

 (a) Bad debts   (b) Provision for doubtful debts

2.  List three types of provisions that could give rise to adjustments in the final accounts.

 

Illustration

A business starts on 1 January, 2002 and its financial year end is 31 December annually. A table of the debtors, the bad debts written off and the estimated doubtful debts at the end of each year is now given.

Year to Debtors at Bad debts Debts thought

31 December end of year written off at end of year

 (after bad debts  during the year  to be doubtful to

 written off) collect

 N N N

2002  6,000 423 120

2003  7,000 510 140

2004  8,000 604 155

2005  6,400 610 130

You are required to show for each of the year ended 31st December……

(a)  Bad Debts Account

(b)  Provision for Doubtful Debts Account

(c)  Profit and Loss Account (extracts)

(d)  Balance Sheet (extracts)

 

 

Bad Debts

 

2002  N  2002  N

Dec. 31 Sundries 423  Dec. 31 Profit and Loss  423

 

2003 2003

Dec. 31 Sundries 510  Dec. 31 Profit and Loss  510

 

2004 2004

Dec. 31 Sundries 604  Dec. 31 Profit and Loss  604

 

2005 2005

Dec. 31 Sundries 610  Dec. 31 Profit and Loss  610

 

 

Provision for Doubtful Debts

2002  N  2002  N

Dec. 31 Balance c/d 120  Dec. 31 Profit and Loss  120

 

2003 2003

Dec. 31 Balance c/d 140  Jan 1 Balance b/d 120

Dec 31 Profit and Loss   20

  1. 140

 

2004 2004

Dec. 31 Balance c/d 155  Jan 1 Balance b/d 140

Dec. 31 Profit and Loss   15

  1. 155

 

2005 2005

Dec. 31 Profit and Loss   25  Jan. 1 Balance b/d 155

” ” Balance c/d 130

 155 155

 

Profit and Loss Account (extracts) for the year ended 31st December

 N N

2002  Bad Debts 423

Provision for 120

Doubtful debts

 

2003  Bad Debts 510

 Increase in

Provision for

Doubtful debts 20

 

2004  Bad Debts 604

 Increase in provision

 For Doubtful debts   15

 

2005  Bad Debts 610 2005  Reduction in provision

for Doubtful Debts 25

 

Balance Sheet (extracts) as at 31st December

N N

 2002 Debtors 6,000

Less: Provision

For Doubtful Debts   120 5,880

 

 2003 Debtors 7,000

Less: Provision for

Doubtful Debts   140 6,860

 

 2004 Debtors 8,000

Less: Provision for

Doubtful Debts   155 7,845

 
 

 2005 Debtors 6,400

Less: Provision for

Doubtful Debts   130 6,270

 

EVALUATION

1.  Differentiate between provision for bad debts and provision for depreciation.

2.  List two characteristics of provisions in financial accounting.

 

GENERAL EVALUATION

  1. State five differences between cash discount and trade discount
  2. Identify any seven prime books of account and highlight the uses of each ofthem where necessary
  3. List five advantages of using the imprest system to record petty cash transactions
  4. Explain the following types of errors (a) omission (b) principle (c) commission (d) original entry (e) complete reversal of entry (f) compensating error
  5. Explain how the following items are treated in Profit and Loss Account and Balance

    Sheet (a) provision for doubtful debts (b) bad debts recovered

 

READING ASSIGNMENT

Simplified and Amplified Financial Accounting Page 143-150

 

WEEKEND ASSIGNMENT

1.  A decrease in the provision for doubtful debts results in _______

(a) an increase in net profit   (b) a decrease in gross profit (c) an increase in gross profit (d) a decrease in net profit

2.  The term bad debts means debt ________

(a) recorded in a wrong account  (b) owed by an employee (c) paid with fake currency (d) that cannot be collected again from the debtor

3.  The gross profit for a trading period is calculated as _________

(a) Net sales less net purchases (b) Net sales less cost of sales (c) Net sales less closing stock (d) Net sales plus cost of goods sold

Use the information below to answer questions 4 and 5

 N

 Provision for bad debts 1,000 Cr

 Bad Debts 500 Dr

 Debtors   50,000 Dr

Additional bad debts to be written off  500

New provision for bad debts to stand at 5% of debtors.

4.  In the balance sheet the net figure for debtors is ________

 (a) N47,025 (b) N46,550 (c) N45,600 (d) N43,225

5.  The total amount of bad debts to be charged as expenses in the profit and Loss Account is _________

 (a) N2,000   (b) N1,500   (c) N1,000   (d) N500

 

THEORY

Mr. Okonkwo’sbooks of account shows the information for four years ended 31st December, 2000. The balance of debtors and bad debts were given for the four years.

Debtors Bad

Balance Debts

N  N

 31st December, 1997 40,000  2,000

 31st December, 1998 30,000  1,000

 31st December, 1999 50,000  2,500

 31st December, 2000 60,000  3,000

Provision for doubtful debts brought forward at 1st January, 1997 was N600.

Mr. Okonkwo makes provision for doubtful debts at the rate of 10% on total debtors outstanding after deducting bad debts for the period.

 

You are required to prepare the following accounts for the years ended 31st December, 1997, 1998, 1999 and 2000.

(a)  Bad Debts Account

(b)  Provision for doubtful debts Account

(c)  Profit and Loss Account

(d)  Balance Sheet (extract)

 

 

WEEK THREE

FINAL ACCOUNTS – PROVISION FOR DISCOUNTS

If a trader usually allows and receives cash discounts the debtors and creditors balances in the

Balance Sheet at the end of the year may be overstated unless it is recognized that discounts

are likely to be deducted from them. This is done by creating provision for discounts on

debtors and provision for discounts on creditors.

 

PROVISION FOR DISCOUNTS ON DEBTORS

This is a charge made against profit in order to provide for an expected loss in the shape of discounts that will have to be allowed to the firms debtors to facilitate prompt payment of their accounts.

 

The provision for discount on debtors should be calculated on the net amount /figure of debtors after deducting any provision for doubtful debts. This treatment should be obvious in that discounts are not allowed on doubtful debts.

 

The Accounting entries involved when the provision for discount allowed is first created:

Debit Profit and Loss Account

Credit Profit for discounts allowed with the full amount of the provision.

 

In the years that follow the entries in the accounts will be for increases or decreases in the amounts required for the provision.

 

To record these subsequent entries the procedure is similar to the doubtful debts provision.

 

EVALUATION QUESTIONS

1.  Explain the following terms

 (a) Discounts Allowed (b) Cash Discounts

2.  State two differences between Discount Allowed and Discount Received

 

PROVISION FOR DISCOUNTS ON CREDITORS

It is also the practice of some businesses to recognize the fact that the amount of creditors at the balance sheet date does not represent the amount which will be paid. This is because where advantage is taken of cash discount arrangements, a smaller sum will be payable to discharge the debts.

 

The provision for discounts on creditors thus created is an addition to the profits and is to provide for those discounts expected to be received on payment of the firms creditors.

 

The accounting entries involved when the provision for discount received is first created:

 Debit  Profit for discount received

 Credit  Profit and Loss Account

 

In the years that follow the entries in the accounts will be for increases or decreases in the amount required for the provision. This will be treated along similar lines as outlined above.

 

It should be stated that creating a provision for discount received contravenes the accounting convention of conservatism as it clearly anticipates income that has not arisen. However, it can be argued that if a firm creates a provision for discounts on debtors, it should also take into account discounts on creditors.

 

EVALUATION QUESTION

1.  Differentiate between provision for bad debts and provision for discounts on debtors.

2.  List four items of current assets in the balance sheet of a business.

 

GENERAL EVALUATION

  1. What is the effect of understatement of closing stock on: (a) cost of sales (b) grossprofit (c) net profit
  2. State five causes of a decline in the net profit of a business
  3. Differentiate between ”Discount Allowed” and ”Discount Received”
  4. State five characteristics of the imprest system of keeping petty cash records
  5. List four characteristics of each of the following (a) fixed assets (b) current assets(c) intangible assets

 

READING ASSIGNMENT

Simplified and Amplified Financial Accounting Page 143-150

 

WEEKEND ASSIGNMENT

1.  The total debtors account of a trading concern is N13,000. Out of this 2% is irrecoverable. 5% of the balance is not likely to be collected. What is the provision for doubtful debts

 (a) N910 (b) N650 (c) N637 (d) N260

2.  An allowance given to a customer by a supplier for prompt payment is ______

 (a) trade discount (b) discount received (c) cash discount (d) cash rebate

3.  Which of the following is the effect of an increase in the provision for discount allowed_______

 (a) increase in net profit  (b) decrease in gross profit (c) decrease in net profit

 (d) increase in gross profit

4.  The opening balance of debtors is N100,000 and that of provision is to be at 2 ½ % of debtors, how much would be charged in the Profit and Loss Account

 (a) N3,500 (b) N2,500 (c) N1,500 (d) N1,000

5.  Omolomo Limited gave Omolope a discount of 10% on purchases. If the discount enjoyed in the year amounted to N250, what is the total purchases ____

 (a) N2,750 (b) N2,500 (c) N2,250 (d) N2,000

 

THEORY

The existing provision for doubtful debts in the books of Segun Enterprises was N4,480. On 31STDecember, 2005, the trade debtors stood at N78,400.

Using journal entries and ledger entries, you are required to:

(a)  Reduce the provision for doubtful debt to N3,920

(b)  Create a provision for discounts on debtors at 2 ½ %.

(c)  Show how the items would appear in the Profit and Loss Account and Balance Sheet.

 

 

WEEK FOUR AND FIVE

FINAL ACCOUNTS – ACCRUALS AND PREPAYMENTS

ACCRUALS

The accrual concept states that revenue and expenditure of a period should be matched together – whether or not such revenue or expenditure had actually been received or paid for.

 

This means that items of expenditure or income shown in the final account should be for sums actually related to the period covered by the financial statements prepared in the final account. Therefore statements such as the Trading and Profit and Loss Account should be prepared on the accruals, or matching basis so that expenses are matched to the revenue earned: that is, expenses are shown in the Profit and Loss Account as they have been incurred rather than as they have been paid. Similarly, incomes are shown in the Profit and Loss Account as they have been earned rather than as they have been received.

 

Accrual can be divided into

(a)  Accrued expenses

(b)  Accrued income (i.e income received in arrears)

 

ACCRUED EXPENSES: These are expenses which accrued but have not been paid for or

discharged. They are also referred to as expenses owing or creditors for expenses e.g.

Accrued electricity.

 

Ilustration:

Supposing rent for 9 months (says N18,000) had actually been paid, that of the remaining 3

months (say N6,000) not yet paid must also be charged to Profit and Loss Account making the

total rent N24,000 (i.e. N18,000 + N6,000) for the 12 months accounting period for which the

Profit and Loss Account is prepared.

 

The Rent Account will appear as follows:

 

Rent

 N N

July 2 Cash 18,000 Dec. 31  Profit and Loss  24,000

Dec. 31 Accrued Rent c/d   6,000

 24,000  24,000

Jan. 1 Accrued Rent b/d   6,000

 

The credit balance of N6,000 on the Rent Account is an accrued expenses and is shown as a current liability in the Balance Sheet as at 31st December …….

 

ACCRUED INCOME: These are incomes which are due in respect of the current trading period but such income have not been received at the close of final account preparation. It is also refered to as income receivable e.g. interest receivable, rent receivable, commission receivable.

 

Ilustration

In the year ended 31st December, 2005,Modupe had received interest of N4000 on her fixed

deposit account with First Bank Nig. Plc. At that date, interest for the half year to 31st

December, 2005 was due from the bank. The entries in the Interest Receivable account of

Modupe at 31st December, 2005 are as follows:

Interest Receivable

 

2005  N 2005 N

Dec. 31 Profit and Loss  8,000 Sept. 15  Bank 4,000

Dec. 31  Interest accrued c/d  4,000

 8,000  8,000

2006

Jan 1  Balance b/d 4,000

 

The balance of N4,000 on the Interest Receivable Account is shown as a current asset in the

Balance Sheet as at 31st December, 2005.

 

EVALUATION

1.  List six uses of the General Journal.

2.  State two similarities and two differences between the Trading Account and the Profit and Loss Account.

 

PREPAYMENTS

Prepayments are payments made in advance of the benefits to be derived from them. It

represents amount paid in current period for services to be received in a subsequent period.

Prepayment can be divided into

(a)  Prepaid expenses

(b)  Income received in advance

 

PREPAID EXPENSES: 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. Therefore expenses paid in advance are deducted from total payments in line with the requirements of the matching concept.

 

Illustration:

Supposing N15,000 is paid for electricity and it is for 15 months, the amount to be charged to the Profit and Loss Account at the end of the year is not N15,000 but N12,000

i.e. N15,000 x 12 months

15

while the N3,000 balance is regarded as prepayment or payment in advance.

 

 

The Electricity (or Lighting and Heating)Account will appear as follows:

 

Electricity

 

20×5  N 20×5 N

Jan. 23 Cash 15,000 Dec. 31  Profit and Loss 12,000

” ” Prepaid Electricity c/d3,000

 15,000  15,000

20×6

Jan. 1   Prepaid Elect. b/d 3,000

 

The debit balance of N3,000 on the Electricity Account is a prepaid expense and is shown as a current asset in the Balance Sheet as at 31st December, 20×5.

 

INCOME RECEIVED IN ADVANCE: These are income received by the organization duringthe current period but which relate to the next (or subsequent) trading period e.g. rent received in advance.

 

Illustration:In the year ended 31st December, 2007, Elizabeth had received N30,000 for rent from a tenant. At that date rent for the half year has been prepaid by the tenant. Show the Rent Receivable Account in the books of Elizabeth.

 

Rent Receivable

 

2007  N 2007 N

Dec. 31 Profit and Loss  20,000 Jul. 8   Bank 30,000

Dec. 31 Balance c/d 10,000

 30,000 30,000

2008

Jan 1. Balance b/d  10,000

 

The credit balance of N10,000 on the Rent Receivable Account is an income received in advance and is shown as a current liability in the Balance Sheet of Elizabeth as at 31st December, 2007.

 

EVALUATION

1.  Why is it necessary to make adjustments in the final accounts for accruals and prepayments?

2.  How will you account for the following when preparing the final accounts.

 (i)  Accrued Expenses

 (ii)  Prepayments

 (iii)  Rent Receivable Outstanding

b.  What accounting concepts underly your treatment of these items.

 

GENERAL EVALUATION

  1. Explain the following : (a) bank loan (b) bank overdraft (c) standing order (d) credittransfer
  2. List five source documents used in preparing the Cash Book.
  3. List four accounts found in each of the following (a) nominal ledger (b) private ledger

    (c) general ledger

  4. Describe three features of each of the following financial statements: (a) Trading Account (b) Profit and Loss Account (c) Balance Sheet
  5. State seven reasons for preparing a bank reconciliation statement.

    READING ASSIGNMENT

    Simplified and Amplified Financial Accounting, Page 185-202

     

    WEEKEND ASSIGNMENT

    1.  Prepayment is treated in the balance sheet of a firm as a ________

     (a) fixed asset (b) long-term liability   (c) current asset (d) current liability

    2.  Rent prepaid as at 1st January, 2002 was N10,000. Annual rent payable is N80,000 and rent accrued as at 31st December, 2002 was N15,000. How much was paid for rent in 2002

     (a) N80,000   (b) N75,000   (c) N55,000  (d) N35,000

    3.  Resources consumed but to be paid for within the next accounting period are classified in the balance sheet as ________

     (a) current liabilities   (b) current assets (c) long-term liabilities (d) capital

    Use the following information to answer questions 4 and 5

    Rent receivable accrued 1/01/2005 D3,000

    Rent received during the year 2005 D5,000

    Rent receivable accrued 31/12/2005 D2,500

    4.  The entry for rent received in the profit and loss account for the year ended 31st December, 2005 is __________

     (a) Credit profit and loss account with D4,500 (b) Credit profit and loss account with D2,500 (c) debit profit and loss account with D2,500 (d) debit profit and loss account with D4,500

    5. The balance in the rent receivable account as at 31/12/2005 is shown in the balance sheet as (a) fixed asset (b) current asset (c) current liability (d) long term liability

     

    THEORY

    Write up the ledger accounts of Adesua. Enterprises for the year ended 31st December, 2007.

    (a)  Motor Expenses:

     Paid for the year to 31st December 2007 N80,000; Owing at 1st January, 2007 N4000; Prepaid at 31st December, 2007 N5,000

    (b)  Rates:

     Paid in the year to 30th June 2005 N4,500; Rates prepaid as at 30th June 2004 N1000

     Rates owing at 30th June 2005 N2,500

 

 

WEEK SIX

TOPIC: DEPRECIATION OF FIXED ASSETS

CONTENT

  • Causes of Depreciation
  • Reasons for charging depreciation
  • Factors to be considered in the computation of depreciation
  • Methods of providing for depreciation

 

NOTES

Depreciation may be defined as the permanent and continuing diminution (or lessening) in the quality, quantity or value of an asset.

 

 

CAUSES OF DEPRECIATION

  1. Physical factors – Assets may depreciate in value as a result of physical factors like humidity (or dampness), heat, erosion, evaporation of liquids, rust, rot and decay etc
  2. Wear and Tear – An asset may depreciate as a result of constant usage.
  3. Passage of Time – or Effluxion of Time; Assets like patents, copyrights, leaseholds etc have a fixed period of legal life.They therefore depreciate as a result of passage of time. The depreciation of these intangible assets is known as AMORTISATION
  4. Obsolescence – Assets may be rendered out of use as a result of new technology or invention or change in fashion. The value of such obsolete assets (e.g. Black and White TV) will reduce drastically over a short period of time.
  5. Inadequacy or Superfluity – Assets may be out of use because of increase in the output of a firm. In such a situation, assets will be replaced with new and bigger ones.
  6. Depletion – Some natural resources like gold, crude oil, iron ore deposits, quarries etc reduces in value as they are being exploited or mined. These assets are known as WASTING ASSETS. The more they are extracted, the less the reserve that remains.

 

REASONS OR ADVANTAGES OF CHARGING DEPRECIATION

  1. Since it reduces net profit, the tax to be paid will be reduced
  2. The business will have fund to replace the asset at the end of the useful life
  3. The value of the assets will not be overstated in the Balance Sheet
  4. Rather than charging the cost of an asset to the profits in the year of purchase,the cost of an asset is spread over its useful life – this is a demonstration of the matching concept in accounting.
  5. To ascertain the profit or loss on the disposal of assets.

 

FACTORS TO BE CONSIDERED IN THE COMPUTATION OF DEPRECIATION

  1. The historical (or original) cost of the asset
  2. The estimated useful life of the asset
  3. The estimated scrap value (or salvage) value of the asset
  4. The method of depreciation to be used e.g. straight line, reducing balance, revaluation method etc
  5. The internal causes of depreciation
  6. The external causes of depreciation .

 

METHODS OF PROVIDING FOR DEPRECIATION

  1. Straight line Method
  2. Reducing Balance Method (or Diminishing Balance Method)
  3. Sum of the years digit
  4. Revaluation Method
  5. Depletion Unit Method

    Other less common methods include:

  6. Sinking Fund Method
  7. Insurance Policy Method
  8. Annuity Method etc

 

EVALUATION QUESTIONS

1 Define the term depreciation

2 State four causes of depreciation of assets.

 

 

STRAIGHT LINE MEHOD

Under this method, an equal amount is charged for depreciation yearly throughout the useful of an asset.

Formula = Cost – Scrap Value

No. of years

Illustration:

The cost of a machine is N50,000. The residual value is N8,000 and is expected to last for 7 years. Calculate the depreciation charge for each of the seven year.

Solution:

Depreciation = Cost – Scrap Value

Estimated Useful life

 

= 50,000 – 8,000

7

= 42,000

7

= N6,000

N.B. The N6,000 is debited to Profit and Loss Account and credited to the Provision for Depreciation on Machine Account

 

ADVANTAGES OF THE STRAIGHT LINE METHOD

  1. It is simple (or easy) to calculate
  2. It is widely used
  3. It is time oriented
  4. It is judicially recommended – Edwards v. Sauntons Hotels

 

DISADVANTAGES OF THE STRAIGHT LINE METHOD

  1. It is not suitable (or ideal) for all type of fixed assets. For example, it cannot be used for loose tools
  2. It is not scientific – as it does not take the efficiency of the asset into consideration
  3. The assumption of equal depreciation per year is unrealistic

 

EVALUATION

  1. List and explain five factors that would be considered in the computation of the annual depreciation of an asset.
  2. Differentiate between the terms – Depreciation and Amortization

 

GENERAL EVALUATION

  1. State six characteristics of depreciable assets
  2. Explain three differences between a trial balance and a balance sheet
  3. List seven errors that will affect the agreement of the trial balance
  4. Explain the following : (i) real account (ii) nominal account (iii) personal account
  5. List eight items that cause disagreement between Cash Book and bank statement balance

READING ASSIGNMENT

Simplified and Amplified Financial Accounting Page 151 – 167

 

WEEKEND ASSIGNMENT

. 1 Which of the following fixed assets is not depreciable (a) building (b) tools (c) land (d)

furniture

2 Patents and Trade marks are classified under (a) Fixed Assets (b) Current Assets

(c)Wasting Assets (d) Intangible Assets

3 Which of the following does not lead to depreciation of assets (a) Wear and tear (b)

Devaluation of Naira (c) Obsolescence (d) Usage

4 Which of the following does not belong to the group (a) straight line (b) insurance

policy (c) accumulated depreciation (d) diminishing balance

5 Depreciation is (a) the cost of replacing fixed assets (b) the cost of repairs incurred on a

fixed asset (c) a charge for the wear and tear of a fixed asset (d) the loss incurred on the

sale of a fixed asset

THEORY

  1. Give two examples of assets associated with Depreciation and Amortization
  2. A machine cost N60,000. It will be kept for 5 years and then sold at an estimated figure of N10,000. Show the calculations for depreciation for each year using the Straight Line Method.

 

WEEK SEVEN AND EIGHT

TOPIC: DEPRECIATION OF FIXED ASSETS

CONTENT

  • Methods of providing for depreciation

REDUCING BALANCE METHOD (or DIMINISHING BALANCE METHOD)

Under this method, a fixed percentage is written off the reducing (or diminishing) balance of the asset yearly.

This method charges higher depreciation in the early years of the asset and lower in the later years

The depreciation rate (%) to be applied is computed using the formula below:

S

Depreciation rate (%) = 1 – C

where:

n = No. of years

s = Scrap value

c = Cost

Illustration:

A machine costing N10,000 will realize N256 in four years time. Show the yearly depreciation to be charged for each of the four years using diminishing balance method.

SOLUTION:

S

Depreciation Rate (%) = 1 – C

256

= 1 – 10,000

4

= 1 – 10

= 0.6

= 60%

The depreciation charge applicable to each of the four years will be:

N

Cost 10,000

Year 1 Depreciation = (60% X 10,000) 6,000

REDUCED BALANCE (i.e. NBV) 4,000

Year 2 Depreciation = (60% X 4,000) 2,400

REDUCED BALANCE (i.e. NBV) 1,600

Year 3 Depreciation = (60% X 1,600) 960

REDUCED BALANCE (i.e. NBV) 640

Year 4 Depreciation = (60% X 640) 348

SCRAP VALUE ( i.e. NBV) 256

 

ADVANTAGES OF THE DIMINISHING BALANCE METHOD

1.  It is widely used.

2.  Depreciation is more scientifically provided for.

3.  It recognizes the efficiency of an asset by charging higher amounts in the early years and lower amounts in the later years.

4.  Higher depreciation amounts and low maintenance cost in the early years even out with low depreciation amounts and higher maintenance cost in the later years

 

DISADVANTAGES OF THE DIMINISHING BALANCE METHOD

  1. Calculating the rate of depreciation may be difficult
  2. It is not ideal for all fixed assets. For example it cannot be used for loose tools.

 

SUM OF THE YEARS DIGIT

Under this method, the years in the life of the asset are represented with digits and are added. The fraction of the asset cost is then charged to the years in reverse order.

 

Illustration:

A machine cost N10,000 and has a life span of four years after which it can be sold for N256. Calculate the yearly depreciation charge for each of the four year using the sum of the years digit method.

 

SOLUTION:

Amount = Cost – Scrap Value

= N10,000 – N256

= N9,744

No. of years = 4

Add up the years thus: 1 + 2 + 3 + 4 = 10

i.e. Sum of the four years = 10

 

Reverse the digit for each of the year

Year Digit

1 4

2 3

3 2

4 1

Calculation of depreciation charge:

Year 1 = 4 X 9,744 = N3,898

10

 

Year 2 = 3 X 9,744 = N2,923

10

 

Year 3 = 2 X 9,744 = N1,949

10

 

Year 4 =1 X 9,744 = N974

 

10

 

 

N.B

The sum of the years digit is similar in some respect to the diminishing balance method as it charges higher depreciation in the early years of the asset.

Therefore the advantages and disadvantages of the sum of the years digit are the same as for the Diminishing Balance Method.

 

 

EVALUATION QUESTIONS

1.  Explain the following methods of depreciation:

(a) reducing balance method (b) sum of the years digit

2.  Write short notes on the following:

(a) Depreciation (b) Salvage value (c) Obsolescence

 

REVALUATION METHOD

Under this method the asset is revalued each year, any difference being charged to the profit and loss account.

 

This method is good for assets which cannot be easily depreciated because of their nature e.g. loose tools (i.e. bolts, nuts, hammer, chisel, screws) livestock, farm crops/plantations e.t.c.The value of the assets at the beginning and end of the year will be estimated and used in the calculation of the depreciation.

 

Illustration:

On 1st January 2005, the value of loose tools was N25,000. Purchases of loose tools during the year was N7,000. On 31st December 2005, the loose tools were revalued at N24,000

Required: Calculate the depreciation on loose tool for the year.

 

SOLUTION:

N

Balance of loose tools 1 Jan 2005 25,000

Add : Purchases of loose tools in 2005 7,000

32,000

Less: Balance of loose tools 31 Dec 2005 24,000

Depreciation on loose tools for 2005 8,000

 

ADVANTAGES OF THE REVALUATION METHOD

It is suitable (or ideal ) for loose tools, livestock e.t.c.

 

DISADVANTAGES OF THE REVALUATION METHOD

1.  It cannot be used for all classes of assets.

2.  Revaluation of assets on yearly basis may be cumbersome

 

DEPLETION UNIT METHOD (or PRODUCTION UNIT METHOD )

This method is used for wasting assets such as quarry, mine, timber, and other assets ( like machines) whose useful life can be estimated in hours.

 

Illustration

A machine costing N100,000 can work for 800 hours. If it works for 120 hours in 2005 and 200hours in 2006. Calculate the depreciation charges for each year.

 

 

SOLUTION

Calculation of Depreciation on Machine

2005 120 X N100,000 = N15,000

800

 

2006 200 X N100,000 = N25,000

800

 

EVALUATION QUESTIONS

1.  List five methods of providing for depreciation of assets.

2.  Mention three characteristics of depreciable assets

 

GENERAL EVALUATION

  1. What is depreciation
  2. Explain the following methods of calculating depreciation (i) staight line (ii) reducing balance (iii) sum of the years digit
  3. What is the difference between depreciation and amortization
  4. State ten uses of the general journal
  5. Explain the principle of double entry system

 

READING ASSIGNMENT

Simplified and Amplified Financial Accounting Page 151 – 167

 

WEEKEND ASSIGNMENT

A machine cost N12,000 and has a useful life of 4 years and an expected disposal  valueof N400

1.  Using the straight line method, the annual depreciation is (a) N3,100 (b) N3,000

(c)N2,900 (c) 2,300

2.  The accumulated depreciation at the end of year three using the straight line method

Is (a) N6,900 (b) N8,700 (c) N9,300 (d) N9,600

3.  Using the reducing balance method and ignoring residual value, what will be the depreciation charge for year 2 at 20% (a) N3,000 (b) N2,900 (c) N2,400 (d) N1,920

4.  Using the reducing balance method and ignoring residual value, what is the net book value at the end of year 2 (a) N10,480 (b) N10,080 (c) N9,680 (d) N7,680

5..  Which of the following is true of the straight line method of depreciation (a) accurate depreciation charges are made yearly (b) the scrap value is zero (c) yearly depreciation charge decreases (d) yearly depreciation charges are constant

 

THEORY

1.  List four advantages enjoyed by a firm that charges depreciation of fixed assets in its final account

2.  A motor car cost N51,200. It will be kept for 5 years and then sold at an estimated figure of N12,150. Show the calculations of the figures for depreciation for each year using

(a)  Straight line method

(b) Reducing balance method at 25% rate of depreciation

 

 

 

 

 

WEEKNINE

TOPIC: DEPRECIATION OF FIXED ASSETS

 

ACCOUNTING TREATMENT OF DEPRECIATION

There are two ways of treating depreciation in the ledgers. These are the Old Method and the Modern Method. However, the Modern Method which is preferred by accountants will be considered.

 

MODERN METHOD

An asset account is opened and a separate provision for depreciation account is also opened. The depreciation for each year is debited to the Profit and Loss Account and credited to the Provision for Depreciation Account

Therefore the following accounts should be prepared:

  1. Asset account ( e.g. Machinery Account)
  2. Provision for Depreciation Account
  3. Profit and Loss Account
  4. Balance Sheet

Illustration

A machine cost N100,000. It is expected to have a useful life of five years at the end of which time it is expected to be sold for N20,000 (its residual value)

 

You are required to show the necessary ledger accounts assuming the machine is depreciated on the straight line basis.

 

SOLUTION

Annual Depreciation Charge = Cost – Scrap Value

Estimated useful life

= 100,000 – 20,000

5

= 80,000

5

. = N16,000

Ledger Accounts:

 

Machinery

N N

Year 1 Cash 100,000 Year 1 Balance c/d 100,000

Year 2 Balance b/d 100,000 Year 2 Balance c/d 100,000

Year 3 Balance b/d 100,000 Year 3 Balance c/d 100,000

Year 4 Balance b/d 100,000 Year 4 Balance c/d 100,000

Year 5 Balance b/d 100,000 Year 5 Balance c/d 100,000

 

 

Profit Loss Account (extracts)

N N

Year 1 Provision for dep. of machinery 16,000

Year 2 Provision for dep. of machinery 16,000

Year 3 Provision for dep. of machinery 16,000

Year 4 Provision for dep. of machinery 16,000

Year 5 Provision for dep. of machinery 16,000

 

Provision for Depreciation of Machinery

 N N

Year 1 Balance c/d 16,000 Year 1 Profit and Loss A/c  16,000

Year 2 Balance c/d 32,000 Year 2 Balance b/d 16,000

Profit and Loss A/c 16,000

 32,000 32,000

Year 3 Balance c/d 48,000 Year 3 Balance b/d 32,000

Profit and Loss A/c 16,000

 48,000 48,000

Year 4 Balance c/d 64,000 Year 4 Balance b/d 48,000

Profit and Loss A/c 16,000

 64,000 64,000

Year 5 Balance c/d 80,000 Year 5 Balance b/d 64,000

Profit and Loss A/c 16,000

 80,000 80,000

 

Notes:

*  The fixed asset account continues to show the machine at cost each year of its life. Fixed assets accounts sometimes include the words ‘at cost’ in their titles to emphasise this point.

*  The balance on the Provision for Depreciation of Machinery Account increases each year.

*  A provision in accounting is an amount set aside for a particular purpose.

*  A separate Provision for Depreciation account must be opened for each class of fixed assets.

*  The balance on the Provision for Depreciation account is deducted from the cost of the fixed asset in the Balance Sheet.

*  The balance remaining after depreciation has been deducted from cost is known as NET BOOK VALUE (NBV) or WRITTEN DOWN VALUE(WDV) of the asset. It is the amount of the cost of the asset which has not yet been charged against profit in the Profit and Loss Account.

 

Balance Sheet (extract)

FIXED ASSETS Cost Dep. NBV

Year 1 Machinery 100,000  16,000 84,000

Year 2  Machinery 100,000  32,000 68,000

Year 3 Machinery 100,000  48,000 52,000

Year 4 Machinery 100,000  64,000 36,000

Year 5 Machinery 100,000  80,000 20,000

 

EVALUATION QUESTION

1.  A lorry cost N160,000. It will be kept for 4 years and then sold at a scrap value of N256. Show the necessary accounts using diminishing balance method.

 

GENERAL EVALUATION

  1. What are books of prime entry?
  2. List any seven books of prime entry
  3. State six reasons for keeping accounting records
  4. Explain six factors that are taken into consideration in determining annual depreciation charge
  5. State six errors that would not affect the agreement of the trial balance

READING ASSIGNMENT

Simplified and Amplified Financial Accounting, Page 151-167

 

WEEKEND ASSIGNMENT

1.  The amount set aside out of profit for a specific purpose is _______

 (a) depletion (b) reserve (c) provision (d) depreciation

2.  Which of the following terms describes the provision made for the loss in the value of an asset that has a legal life span?

 (a) capitalization  (b) depreciation  (c) depletion  (d) amortization

3.  Which of the following is not a cause of depreciation?

 (a) inflation   (b) obsolescence (c) erosion and decay (d) wear and tear

Use the information below to answer questions 4 and 5

A motor van costs N60,000,000 at 1st January, 2004. It was depreciated at 8% using the fixedinstallment method.

4.  What was the accumulated depreciation as at December 31st, 2005?

 (a) N9,600,000  (b) N9,216,000  (c) N4,800,000 (d) N4,416,000

5.  What was the net book value of the motor van as at December 31st, 2005?

 (a) N55,584,000  (b) N55,200,000  (c) 50,784,000 (d) N50,400,000

 

THEORY

A machine costing N40,000 and with an expected useful life of five years is to be depreciated by the reducing balance method. The annual rate of depreciation is 30%.

 

Required:

1.  Prepare the Provision for Depreciation of Machinery account for years 1 to 5

2.  Prepare a Balance Sheet extract to show the fixed asset of machinery at the end of each of the five years.

 

 

WEEK TEN

FINAL ACCOUNTS – FULLY WORKED EXERCISES

Illustration:

The following trial balance has been extracted from the ledgers of Mr. Johnson as at 31st

December, 2003.

 DR CR

₦ ₦

Purchases / Sales 142,448 233,120

Returns   5,000 3,000

Discounts   2,412 1,368

Debtors /Creditors 38,600 23,280

Furniture and Fittings 5,000

Carriage inwards 2,500

Carriage outwards 5,176

5% Loan from Co-operative Society   15,000

Drawings   862

Land and Buildings 40,000

Rents, Rates and Insurance 11,946

Postages and Stationery 2,426

Motor Vehicles 20,000

Advertising   3,704

Provision for doubtful debts 500

Salaries and Wages 26,152

Bad Debts   2,468

Cash in Hand   624

Cash at Bank   6,108

Stock as at 1st January, 2003 14,308

Equipment at cost 97,400

Accumulated depreciation on Equipment 43,300

Capital 107,566

427,134 427,134

Additional Information:

(a)  Stock at close N16,442

(b)  Outstanding expenses:

Advertising N354

Salaries and wages  N848  

Interest on loan  N750

(c)  Rent, Rates and Insurance paid in advance N426

(d)  Depreciation:

Equipment 10% on cost

Furniture and Fittings 5%

Land and Buildings 10%

Motor Vehicles 25%

(e)  Salaries and wages includes N3,600 paid to Mr. Johnson.

(f)  Records to typewriter bought on credit on 31st December, 2003 for N10,000 have not been made in the books.

(g)  Mr. Johnson decided on 31st December, 2003 to write off a further amount of N2,000 as bad debt.

(h)  Mr. Johnson’s children consumed goods worth N5,500 during the year.

(i)  Provisions for doubtful debts 5%: discount allowance 10%

 

Prepare:

i.  Trading, Profit and Loss Account for the year ended 31st December, 2003.

ii.  A Balance Sheet as at that date.

 

EVALUATION

1.  Explain the following:

 (a)  Cost of goods available for sale (b) Cost of goods sold (c) Gross profit

2.  Write short notes on the following:

 (a)  Intangible assets (b) Wasting assets

 

 

SOLUTION:

Mr. Johnson

Trading Profit and Loss Account for the year ended 31st December, 2003

  ₦   ₦ ₦  ₦

Opening Stock   14,308  Sales 233,120  

Add: Purchases 142,448 Less: returns inwards 5,000

228,120

Add: Carriage inwards  2,500

 144,948

Less: children consumption 5,500

 139,448

Less: returns outwards 3,000 136,448

150,756

Less:Closing stock  16,442

Cost of Goods Sold 134,314

Gross Profit c/d 93,806

228,120 228,120

 

Discount Allowed 2,412   Gross Profit 93,806

Carriage outwards 5,176   Discount Received 1,368

Postage & Stationery 2,426

Rent, Rates & Insurance (11,946-426) 11,520

Advertising (3,704 + 354) 4,058

Salaries & Wages (26152 + 848 – 3600) 23,400

Loan interest accrued  750

Increase in provision for doubtful debt 1,330

Provision for discounts allowed

(10/100 x (36,600 – 1830) 3,477

Bad debts: 2468 + 2000 4,468

Depreciation:

Equipment 9,740

 Land and Building  4,000

 Motor Vehicle 5,000

 Furniture and fittings   250   18,990

 

Net Profit   17,167

95,174 95,174

 

Balance Sheet as at 31st December, 2003

  ₦  FIXED ASSETS  CostDep.  NBVCapital 107,566  N N  N

Add Net Profit 17,167  Land & Building  40,000 4,000  36,000

124,733  Motor Vehicles  20,000 5,00015,000

Furniture & fittings5,000 250  4,750

Less: Drawings

(5,500 + 3,600 + 862) 9,962  Equipment  107,40053,040  54,360

114,771 172,40062,290  110,110

 

CURRENT LIABILITIES: CURRENT ASSETS:

5% Co-operative loan 15,000  Stock 16,442

Creditors 23,280 Debtors 38,600

Creditors for Typewriter  10,000 less: Bad Debts   2,000

Outstanding Expenses: 36,600

Interest on loan  750 less: Provision for

Salaries & wages  848 doubtful debts  1,830

Advertising 354 34,770

50,232 less: Provision for

 discounts allowed   3,477 31,293

 

 Insurance Prepaid 426

 Cash at Bank 6,108

 Cash in Hand 624

  54,893

 

165,003  165,003

 

EVALUATION QUESTIONS

1.  List six items each found in the asset and liability sides of the balance sheet of a sole proprietor.

2.  State four reasons for charging depreciation.

 

GENERAL EVALUATION

  1. Explain the following types of accounts and in each case, state the rules regarding the recording of transactions in their debit and credit sides: (a) personal accounts (b) real accounts (c) nominal accounts (d) liabilities account (e) asset account
  2. State seven reasons why an accountant will consider end – of – year adjustments while preparing the final accounts
  3. State five differences between book – keeping and accounting
  4. List seven source documents that are used in preparing the cash book
  5. Explain five differences between a trial balance and a balance sheet

     

    READING ASSIGNMENT

    Simplified and Amplified Financial Accounting, Page 185-202

    WEEKEND ASSIGNMENT

    1.  The Salary of a shopkeeper who sells goods would be charged in the __________

     (a) balance sheet  (b) sales account  (c) profit and loss account  

     (d) trading account

     

    2.  The balance of the Sales Account is transferred to the Trading Account by _____

     (a) debiting the Profit and Loss Account  (b) debiting the Trading Account

     © debiting the Sales Account   (d) crediting the Sales Account

    3.  Discount allowed is a charge to _________—

     (a) Trading Account  (b) Balance Sheet  (c) Profit and Loss Account

     (d) Current Account

    4.  Patents and Trade-marks are classified under__________

     (a) fixed assets (b) current assets  (c) intangible assets

     (d) wasting assets

    5.  Which of the following is a nominal account?

     (a) Machinery (b) Debtors  (c) Goodwill   (c) Salaries

     

    THEORY

    1.  Give five examples each of the following classes of account

     (a) Real accounts  (b) Nominal accounts (c) Personal accounts

    2.  State five reasons why a trader would grant discounts to his customers.




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