PRINCIPLES OF

ACCOUNTING

Adjustments – I

Narmada Balasuriya
B.Sc. Accounting (Special) – USJ, CIMA (UK)
Department of Accounting and Finance
Faculty of Business
What are accounting adjustments?

An adjusting journal entry is typically made just prior to issuing a company's financial statements.

There are two scenarios where adjusting journal entries are needed before the financial statements
are issued:
• Nothing has been entered in the accounting records for certain expenses or revenues, but those
expenses and/or revenues did occur and must be included in the current period's income
statement and balance sheet.
• Something has already been entered in the accounting records, but the amount needs to be
adjusted.

2
Types of accounting adjustments?

1. Providing for depreciation

2. Bad Debts and Provision for Doubtful debts
3. Valuation of Inventory
4. Accrued revenues
5. Accrued expenses
6. Deferred revenues
7. Prepaid expenses
8. Error corrections

3
Providing for Depreciation

What is depreciation?
Depreciation in accounting is the systematic/methodical allocation (spread) of the cost/depreciable value of an
asset over its useful life.

Why do we depreciate assets?

According to matching concept the income must be matched with the costs/expenses incurred to earn that
income. Therefore, the cost of a non-current asset must also be allocated over its useful life in order to match with
the income earned by using the asset each year.
Depreciation is an expense charged to the income statement.

4
Providing for Depreciation

What kind of assets do we depreciate?

Depreciable assets include buildings, furniture and fittings, tools and equipment etc. (fixed assets with a limited
useful life). Land is not depreciated because land is assumed to have an unlimited useful life.

Double Entry to record Depreciation

When we record depreciation, we create a separate account called Provision for Depreciation to record the
already depreciated value of the asset.

Depreciation Expense A/c Debit Instead of Crediting or reducing the Asset account,
we create a separate account called Provision for
Provision for Depreciation A/c Credit
Depreciation to record the credit entry.

5
Depreciation – Basic Terms

Depreciable Value is the maximum value which is subjected to depreciation.

Depreciable Value = Cost – Scrap Value/Salvage value/Residual value

Scrap/Salvage Value/Residual value is the value of the particular fixed asset at the end of its useful life.
This amount must be deducted from the cost when we calculate the depreciable value. It is the amount
for which the asset will be sold in the end.

Useful life/ Economic useful life is the period for which the asset will generate economic benefits to the
business.

6
Depreciation – Methods

There are 2 main methods to calculate Depreciation.

1. Straight line Method

2. Reducing Balance Method/ diminishing balance method/declining balance method

7
Straight-line Depreciation

Under this method, an equal amount will be expensed as depreciation every year. Depreciation is calculated as
follows.

Depreciation = Cost- Residual Value

Useful Life

Or,

Depreciation = Depreciable Value

Useful Life

Or,

Depreciation = (Cost- Residual Value) * Depreciation %

8
Straight-line Depreciation

1. A van was bought for Rs.220,000 and we thought we would keep it for 4 years and then sell it for Rs.20,000.
What is the depreciation to be charged each year? (Straight line method)
2. If the van (mentioned above) would have no disposable value after four years, the charge for depreciation
would be:
3. A Motor vehicle was bought for Rs.220,000 and the salvage value is Rs.20,000. The depreciation policy of the
company is to charge 20% on motor vehicles on straight line basis.
a. What will be the depreciable value of the M/V?
b. What is the depreciation to be charged each year?
c. What is the carrying value or net book value at the end of 5 years? (show the workings in a table)

9
Straight-line Depreciation

Year Opening Value Depreciation Accumulated Closing/Carrying Value/Net Book Value of the Asset
of the Asset Expense Depreciation (Opening Value – Annual Depreciation expense)

01 220,000
02

03

04

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Straight-line Depreciation - Answer

Year Opening Value Depreciation Accumulated Closing/Carrying Value/Net Book Value of the Asset
of the Asset Expense Depreciation (Opening Value – Annual Depreciation expense)

01 220,000 50,000 50,000 170,000

02 170,000 50,000 100,000 120,000
03 120,000 50,000 150,000 70,000
04 70,000 50,000 200,000 20,000 (Scrap value)

11
Reducing Balance Method

• A fixed percentage (%) of the carrying value will be charged each year. The rupee amount of depreciation will
decrease gradually.
• In the first year, a fixed % of the cost will be charged as depreciation (as there is no depreciation resulting
from previous years). From the next year onwards, Depreciation is charged on the carrying value.
• The depreciation % is calculated by considering the residual value, therefore, there is no need to consider
residual value.

Depreciation= Carrying Value * Depreciation %

Carrying value is the value of an asset after deducting the accumulated depreciation. In other words, it
represents the value which is yet to be consumed.
Carrying Value = Cost- Depreciation already charged or Accumulated depreciation 12
Reducing Balance Method

Aruna purchased a notebook PC for Rs.260,000. It has an estimated life of 4 years and a scrap value of
Rs.20,000. You are required to calculate the depreciation using both methods, showing clearly the
balance remaining in the computer account at the end of each of the 4 years under each methods.
(Assume that 47.34% per annum is to be used for the reducing balance method)

1
3
Reducing Balance Method

Year Opening Value Depreciation Accumulated Closing/Carrying Value/Net Book Value of the Asset
of the Asset Expense Depreciation (Opening Value – Annual Depreciation expense)

01 260,000
02

03

04

14
Reducing Balance Method

Year Opening Value Depreciation Accumulated Closing/Carrying Value/Net Book Value of the Asset
of the Asset Expense Depreciation (Opening Value – Annual Depreciation expense)

01 260,000 260,000 * 47.34% 123,084 260,000-123,084 = 136,916

=123,084
02 136,916 136,916 * 47.34% 123,084 + 64,816 136,916 – 64,816 = 72,100
= 64,816 =187,900

03 72,100 72,100 * 47.34% = 222,032 37,968

34,132
04 37,968 37,968 * 47.34% = 240,006 19,994 (Residual Value)
17,974

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Straight-line Depreciation

Year Opening Value Depreciation Accumulated Closing/Carrying Value/Net Book Value of the Asset
of the Asset Expense Depreciation (Opening Value – Annual Depreciation expense)

01

02

03

04

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Disposal of Assets

Disposal of assets means the sale of fixed assets. To record asset disposals, we must create a separate account
called asset disposal account.

1. Transfer the cost of the asset to the asset disposal account

Asset Disposal A/c Debit

Asset A/c Credit

2. Transfer the accumulated depreciation as at disposal date to asset disposal account

Accumulated Depreciation A/c Debit

Asset Disposal A/c Credit

1
7
DR CR

DR CR

DR CR

18
 Disposal of Assets
3. Record the sales proceeds (money received by selling) in the disposal account

Cash/Bank/Receivables A/C Debit

Asset Disposal A/c credit

4. Calculate the gain or loss on disposal

DR CR
Gain on Disposal (Other income)

Asset Disposal A/c Debit

P/L A/c Credit

Loss on Disposal (Other Expense)

P/L A/c Debit

Asset Disposal A/c Credit 19

Gain on Disposal of Assets

DR CR

20
Loss on Disposal of Assets

DR CR

21
Disposal of Assets

XY LTD purchased a machine for Rs.200, 000 on 1st January 2014. The residual value is Rs.20, 000. The company
depreciates machinery on straight line basis at 20%. The balances of the Machinery (Asset) account and Provision
for depreciation account as at 1st January 2018 were as follows.

Machinery Asset (Cost) Rs. 200,000

Provision for Depreciation- Machinery Rs. 144,000

XY LTD decided to sell the asset on 30th June 2018 for Rs.80, 000 in cash.
Also, a new machine was purchased on 1st August 2018 for Rs. 200,000. The residual value of this machine is
20,000.
Show the ledger entries in the relevant ledger accounts to record the above events for the year ended 31st
December 2018. 22
 Machine
 
1-JanB/B/F  200,000  30/6 Asset Disposal  200,000
   Cash   200,000     
           
           
           
           
           
           
           
Provision for Depreciation - Machine
            
6/30Disposal account  162,000 1-JanB/B/F 144,000
         6/30 Depreciation exp  18,000
           Depreciation exp. 15,000
           
           
           
           
           
            23
           
 Depreciation Expense - Machine
 
30-6Provision for depreciation 18,000     
 Provision for depreciation
     15,000    
           
           
           
           
           
           
           
Asset Disposal Account
            
30/6Machinery 200,000  Provision for depreciation 162,000
           Cash 80,000
   Gain    42,000    
           
       242000     242000
           
           
           
            24
           
 PRINCIPLES OF
ACCOUNTING

Adjustments – II

Narmada Balasuriya
B.Sc. Accounting (Special) – USJ, CIMA (UK)
Department of Accounting and Finance
Faculty of Business
Bad Debts

• Bad debts are receivable amounts which are written off as irrecoverable due to reasons such as bankruptcy of

the customer, death, dishonesty of customer etc.

• Bad debt is an expense categorized under selling and distribution expenses in the income statement.

• Journal Entry to record Bad debts;

Bad Debt A/C Debit

Trade Receivables A/C Credit

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Example 1

Nimal is a trade debtor of ABC Business. He owed Rs.100,000 to ABC. This amount was identified as irrecoverable

due to bankruptcy of Nimal and it was decided to write this off from the books. Write the journal entry to record

this.

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Recovery of Bad Debts Written Off

Sometimes, bad debts written off (probably in a previous period) can be fully or partially recovered later. This may
occur after legal action has been taken to recover a receivable or due to some other action.

Journal Entry to record recovery of Bad Debts

First, we must bring back the trade debtor which was written off as bad debt.
Trade Receivable A/C Debit
Can be treated as
Bad Debt Recovery A/C Credit
other income

Then, we must record the receipt of money from the debtor.

Cash/Bank Debit
Trade Receivable A/C Credit
28
Example 2

Nimal was a trade debtor of ABC Business. He owed Rs.100,000 to ABC. This amount was identified as

irrecoverable due to bankruptcy of Nimal and it was written off from the books in a previous period . In the

current accounting period, Nimal contacted ABC Business and paid Rs. 100,000 as settlement of his debt. Write

the journal entries to record this recovery of bad debt and show them in ledger accounts.

29
 Bad Debt Recovery
 
     
           
           
           
           
           
           
           
           
Trade Receivables
            
 
           
           
           
           
           
           
           
            30
           
Doubtful Debts

• A doubtful debt is a receivable that might become a bad debt at some point in the future. This is a

loss/expense for the business.

• According to Prudence concept, the business should make a provision out of its current year profits to prepare

the business for this loss. If the business fails to do this, both accounts receivable and net profit figure will be

overstated.

• So, it is important to analyze the debtors and decide a provision against the possibility of some of the

remaining debts (after deducting the bad debts) proving bad in the future.

• Doubtful debt is an expense categorized under selling and distribution expenses in the income statement.

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Provision for Doubtful Debts

• This is an account which represents a reduction in the trade receivable asset  Contra-Asset Account

• Therefore, it carries a credit balance.

• The balance of this account will be changed according to the requirement of that period after considering the

collectability of debts.

• Provision for doubtful debt amount is shown on the face of the balance sheet as a deduction from the total

trade receivables figure.

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 Doubtful Debt Expense/

Under provision

Doubtful Debt Over

Provision for Doubtful Debts
Current Year Profits Provision

33
 Income Statement Extract

Selling and Distribution Expenses

Bad Debt Expense XXX
Doubtful Debt Expense/underprovision/ (Overprovision) XXX/ (XXX)

34
 Balance Sheet Extract

Current Assets
Trade Receivables XXX
(-) Provision for Doubtful Debts (XXX)
XXX

35
36
Example 3

The trade receivables balance of Pfizer PLC is Rs.1,500,000 as at 31st December 2020. One of the trade receivable
balances of Rs.50,000 was identified as bad debts during the year but this amount was not yet adjusted in the
above balance. It is the company’s practice to maintain a provision for doubtful debts at 10% of the remaining
trade receivables balance. The company has not made any provision for doubtful debts in the previous accounting
periods.

Required;
1. Calculate the remaining trade receivables balance.
2. Calculate the doubtful debt expense
3. Show the ledger entries in the relevant ledger accounts
4. Show the extracts of the income statement and balance sheet.

37
 Bad Debts
 
     
           
           
           
           
           
           
           
           
Trade Receivables
            
 
           
           
           
           
           
           
           
            38
           
 Doubtful Debts
 
     
           
           
           
           
           
           
           
           
Provision for Doubtful Debts
            
 
           
           
           
           
           
           
           
            39
           
Example 4

The trade receivables balance of Moderna PLC is Rs.1,800,000 as at 31st December 2020. One of the trade
receivable balances of Rs.70,000 was identified as bad debts during the year but this amount was not yet
adjusted in the above balance. It is the company’s practice to maintain a provision for doubtful debts at 10% of
the remaining trade receivables balance. The opening balance (balance as at 1st January 2020) of the provision for
doubtful debts is Rs.200,000.

Required;
1. Calculate the remaining trade receivables balance.
2. Calculate the doubtful debt expense to be charged to income statement for the current year.
3. Is there an under or over provision?
4. Show the ledger entries in the relevant ledger accounts
5. Show the extracts of the income statement and balance sheet. 40
 Bad Debts
 
     
           
           
           
           
           
           
           
           
Trade Receivables
            
 
           
           
           
           
           
           
           
            41
           
 Doubtful Debts
 
     
           
           
           
           
           
           
           
           
Provision for Doubtful Debts
            
 
           
           
           
           
           
           
           
            42
           
Example 5

The trade receivables balance of Sinopharm PLC is Rs.1,000,000 as at 31st December 2020. One of the trade
receivable balances of Rs.70,000 was identified as bad debts during the year but this amount was not yet
adjusted in the above balance. This trade receivable amount was previously identified as doubtful, and a specific
provision had been made for the total receivable amount. The opening balance (balance as at 1 st January 2020) of
the provision for doubtful debts is Rs.200,000. The company has decided to maintain the provision for doubtful
debts balance at 10% of the remaining trade receivables balance.

Required;
1. Calculate the remaining trade receivables balance
2. What is the required balance in the provision for doubtful debts as of 31st December 2020?
3. What is the available balance in the provision for doubtful debts account?
4. What is the under or over provision amount? 43
 Bad Debts
 
     
           
           
           
           
           
           
           
           
Trade Receivables
            
 
           
           
           
           
           
           
           
            44
           
 Doubtful Debts
 
     
           
           
           
           
           
           
           
           
Provision for Doubtful Debts
            
 
           
           
           
           
           
           
           
            45