Year-end adjustments at Spiteri Woodworks
Spiteri Woodworks is a sole trader business with a year end of 31 December 2024. The bookkeeper has produced a draft net profit of €48,600 and insists the accounts are ready for the accountant to sign off. Four matters have not been dealt with.
First, a €4,800 insurance premium was paid on 1 October 2024 and covers the twelve months to 30 September 2025; the whole amount is in the draft profit. Second, €12,000 was spent on the workshop roof: €7,000 replaced the load-bearing structure and will add about fifteen years to the building's life, while €5,000 was repainting and clearing gutters. All €12,000 is in the draft profit. Third, a machine costing €18,000 was bought on 1 July 2024; the policy is 20% reducing balance, charged from the month of acquisition. Fourth, trade receivables of €62,000 include €4,200 owed by a customer placed in liquidation in December 2024, expected to pay nothing; the existing allowance for doubtful debts is €2,500 and the owner wants it kept at 5% of remaining receivables.
1. Calculate the adjusted net profit for the year ended 31 December 2024, showing each adjustment and the reason for it.
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Start from the draft profit of €48,600 and change only what is wrong or incomplete in the draft.
| Item | € | Reasoning |
|---|---|---|
| Insurance prepaid | +3,600 | €4,800 covers 12 months from 1 October 2024. Nine months (January to September 2025) belong to the next period: 4,800 x 9/12 = 3,600. Only €1,200 is a 2024 expense. |
| Roof works | +7,000 | The €7,000 structural replacement enhances the building and is capital expenditure, so it is removed from profit. The €5,000 repainting and gutter clearance restores the original condition and stays as revenue expenditure. |
| Depreciation on machine | -1,800 | 18,000 x 20% x 6/12 (1 July to 31 December). The full €18,000 must not be charged against profit. |
| Irrecoverable debt | -4,200 | The customer is in liquidation and nothing is expected, so the receivable has no value at the year end. |
| Increase in allowance | -390 | Remaining receivables 62,000 - 4,200 = 57,800; 5% = 2,890. The existing allowance is 2,500, so only the increase of 390 is charged. |
Adjusted net profit = 48,600 + 3,600 + 7,000 - 1,800 - 4,200 - 390 = €52,810.
Note the two traps: the whole €18,000 and the whole €12,000 look like expenses in the bank account but neither may be charged in full against this year's profit.
2. The owner argues that capitalising the whole €12,000 would 'make the business look stronger', and that in any case the roof was paid for in one go. Explain why the split is required, and state the effect on 2025 profit and net assets if the €7,000 had been wrongly expensed in 2024.
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Payment in one lump sum is irrelevant: the test is whether the spending creates or enhances a resource that will produce benefit in future periods, not when the cash leaves the bank.
The €7,000 replaced the load-bearing structure and extends the building's life by roughly fifteen years, so it creates a long-term benefit and must be carried as a non-current asset and charged to profit gradually through depreciation. The €5,000 of repainting and gutter clearing only restores the building to the condition it was already in, so it produces no additional future benefit and is an expense immediately.
Effect of wrongly expensing the €7,000:
- 2024 profit is understated by €7,000 and non-current assets are understated by €7,000.
- From 2025, no depreciation would be charged on that €7,000. At, say, 15 years straight line, that is 7,000/15 = €467 a year.
- So 2025 profit is overstated by €467 and net assets remain understated by 7,000 - 467 = €6,533. The error reverses itself only over fifteen years.
So the owner's suggestion does not make the business stronger; it makes the current year look weaker, later years look stronger, and the statement of financial position understate the assets the business actually owns.
3. Explain the difference between writing off the €4,200 and creating the 5% allowance, and state how each affects profit and the receivables figure.
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These are two different responses to two different risks.
Writing off €4,200. This is a definite loss: the customer is in liquidation and nothing is expected. The debt is removed from trade receivables and charged to profit as an irrecoverable debt. Receivables fall by €4,200 and profit falls by €4,200.
The 5% allowance. The remaining €57,800 is not known to be bad, but experience shows some of it will not be collected. An allowance is a prudent estimate against the whole ledger, not a claim that any particular customer has failed. It is shown as a deduction from receivables, so net receivables become 57,800 - 2,890 = €54,910, and only the €390 increase is charged to this year's profit, because €2,500 was already charged in earlier years.
Order matters: the write-off must be made first, otherwise the 5% would be calculated on a receivable that no longer exists, and the allowance would be overstated by 5% x 4,200 = €210.
Combined effect: profit falls by 4,200 + 390 = €4,590, and trade receivables fall by 4,200 + 390 = €4,590 to €54,910 net.