Depreciation, Accruals, Prepayments and Adjustments
Depreciation
Fixed assets wear out. Depreciation spreads their cost over useful life. Two methods:
- Straight line: (cost − residual value) ÷ useful life, same charge each year.
- Reducing balance: a fixed percentage of the net book value, so the charge falls each year.
The ledger entries are: debit depreciation expense, credit accumulated depreciation. Accumulated depreciation is a credit balance deducted from cost to give net book value. A disposal account collects the asset's cost and accumulated depreciation; the difference is the profit or loss on disposal.
Accruals and prepayments
Under the matching principle, the expense charged to the income statement is the amount used in the period.
- Accrual (expense owing): debit expense, credit accruals. It is a current liability.
- Prepayment (paid in advance): debit prepayments, credit expense. It is a current asset.
- Accrued income: debit accrued income, credit income.
- Income received in advance: debit income, credit deferred income.
Traps
- Charging the whole insurance premium paid in the year, ignoring the prepaid part.
- Deducting the accrual from the expense rather than adding it.
- Calculating reducing-balance depreciation on cost instead of net book value.
- Forgetting that a disposal needs both cost and accumulated depreciation removed.
Worked example
Rent paid during the year is $9,000, and $1,500 is owing at year end. The charge is $10,500. Debit rent $1,500, credit accruals $1,500. The accrual appears as a current liability in the statement of financial position.