Rowan Ford: Year-End Adjustments and Profit Measurement
Rowan Ford is a sole trader with a 31 December year end. Draft net profit for the year ended 31 December 2024 is £58,200. The following have not yet been adjusted. Rent account payments are £21,000; at 1 January 2024 rent accrued was £1,200 and rent prepaid was £600; at 31 December 2024 rent accrued is £1,800 and rent prepaid is £700. Insurance of £9,600 was paid for the 12 months to 31 March 2025. Plant cost £240,000 with accumulated depreciation £96,000 at 1 January 2024; new plant costing £60,000 was bought on 1 July 2024. Depreciation policy is 20% straight-line on cost, full year in the year of acquisition. Draft profit includes depreciation of £48,000. Receivables before adjustments are £126,000. A customer owing £4,500 is irrecoverable. An allowance for receivables of 5% of remaining receivables is required; the opening allowance was £6,000 and no entries have been made for the year. Goods costing £1,800 were taken by Rowan for personal use and recorded only in purchases.
1. Explain why the rent adjustment is not simply the closing accrual less the closing prepayment. Show the balance sheet amounts for rent at 31 December 2024.
Read the worked answer
Accrual principle. The income statement must show the rent expense for the period, not the cash paid. The opening accrual and opening prepayment relate to 2023 and must be reversed before calculating the 2024 charge. The closing accrual and prepayment relate to 2024 and must be carried forward. Simply taking the closing accrual less the closing prepayment would miss the opening balances and would misstate both profit and the balance sheet.
Working. Payments £21,000 + closing accrual £1,800 − opening accrual £1,200 + opening prepayment £600 − closing prepayment £700 = £21,500.
Balance sheet at 31 December 2024. Rent accrued £1,800 is a current liability. Rent prepaid £700 is a current asset. These are separate from the expense in the income statement.
Effect of error. If the opening balances were ignored, the expense would be £22,000 (21,000 + 1,800 − 700 − ?), which is wrong. The correct charge is £21,500, so profit would be misstated if the full cash payment or a partial adjustment were used.
2. Discuss the depreciation policy choice. If depreciation were pro-rated for the new plant, calculate the alternative profit and carrying amount, and recommend how to respond to the owner's request to maximise profit for the bank.
Read the worked answer
Policy choice. The policy must reflect the pattern of consumption of the asset's benefits and be applied consistently. Full-year depreciation in the year of acquisition is a common simplifying policy, but it must be disclosed and applied consistently. Pro-rating more closely matches the six months of use in 2024, but changing policy is not a free choice; a change must be justified as a change in estimate or policy and disclosed under IAS 8/IAS 16.
Alternative calculation. Existing plant: 20% × £240,000 = £48,000. New plant: 20% × £60,000 × 6/12 = £6,000. Total £54,000. The draft charge was £48,000, so the additional charge is £6,000, not £12,000. Alternative profit = £45,325 + £6,000 = £51,325. Carrying amount = cost £300,000 − accumulated depreciation (£96,000 + £54,000) = £150,000. Under the full-year policy, carrying amount is £300,000 − (£96,000 + £60,000) = £144,000.
Recommendation. Do not select a depreciation policy simply to improve the bank's view. Choose a defensible policy, apply it consistently and disclose it. If the owner wants to change policy, document the commercial rationale and the effect. Presenting a higher profit by under-depreciating would mislead the bank and breach the integrity principle.