Adjustments: depreciation, accruals, prepayments, bad and doubtful debts, inventory valuation
What the examiner tests
This domain tests year-end adjustments and their effect on profit, assets and liabilities.
Core rules
- Depreciation: straight line = (cost − residual value) ÷ useful life. Reducing balance = fixed percentage of carrying amount. Depreciation is an expense, not a cash fund.
- Accruals: an expense incurred but unpaid is a current liability and is added to the expense. A prepayment is a current asset and is deducted from the expense.
- Bad debts are written off to profit and loss. A provision for doubtful debts is calculated on receivables after bad debts are written off; only the increase or decrease goes to profit and loss.
- Inventory is valued at the lower of cost and net realisable value (NRV), applied consistently.
Worked example
Equipment costs N$20,000, has residual value N$2,000 and a four-year life. Straight-line depreciation = (20,000 − 2,000) ÷ 4 = N$4,500 each year. After two years the carrying amount is N$11,000. Insurance of N$4,800 was paid for the 12 months to 31 March; the year end is 31 December. Three months are prepaid: 4,800 × 3/12 = N$1,200. Insurance expense for the year is N$3,600 and the prepayment is a current asset. Receivables after write-offs are N$40,000; a 5% provision is N$2,000. If the opening provision was N$1,500, the increase of N$500 is an expense.
Traps
Do not depreciate land. Do not ignore residual value in the straight-line method. Do not calculate a doubtful debts provision on receivables before bad debts are removed. Do not value inventory at cost when NRV is lower. Reverse accrued expenses and prepayments correctly at the start of the next period.