Depreciation, Revenue Expenditure and the 'Immaterial' Argument
Adunni Foods Ltd is a family-owned food manufacturer in Ibadan with a 31 December year end. Its draft profit before tax for 2024 is ₦8,400,000, and total assets are ₦150,000,000. The accountant is the managing director's son; you have been engaged as an independent consultant to review three items.
(1) A delivery van bought on 1 April 2022 for ₦12,000,000 has an estimated residual value of ₦2,000,000 and a five-year life. Depreciation is straight-line, with a full month charged in the month of purchase. During 2024, ₦600,000 spent on engine repairs was debited to the motor vehicle account, and the draft depreciation charge of ₦2,120,000 was computed on the resulting figure.
(2) Insurance of ₦250,000 covering January to March 2025 was paid in December 2024 and charged wholly against 2024 profit.
(3) From 2025 the directors want to switch to reducing-balance depreciation at 40% a year, arguing that it 'matches how vans actually lose value'.
The MD wants the accounts signed as drafted, saying 'these are small numbers and the bank will not ask'.
1. Compute the corrected profit before tax for 2024, showing each adjustment, its amount and its direction.
Read the worked answer
Step 1 – Depreciation on the correct cost Correct depreciable amount = ₦12,000,000 − ₦2,000,000 = ₦10,000,000 ÷ 5 years = ₦2,000,000 a year (2024 is a full year). Draft charge = (₦12,600,000 − ₦2,000,000) ÷ 5 = ₦2,120,000. Overcharge = ₦120,000 → add back.
Step 2 – The repairs are revenue expenditure Routine engine repairs do not replace a component or restore economic benefits beyond the original standard, so they fail the recognition criteria (IAS 16.7 and 16.13). Remove ₦600,000 from the asset and expense it: deduct ₦600,000. Net effect of Steps 1 and 2 = −₦480,000.
Step 3 – Prepayment The ₦250,000 relates to 2025 and must be carried forward: add back ₦250,000.
Corrected profit before tax ₦8,400,000 − ₦480,000 + ₦250,000 = ₦8,170,000.
Note on presentation Both errors arose in 2024, so there is no prior-period restatement; they are corrected in the current year. Had the repairs been capitalised in 2022 or 2023, IAS 8 would require the comparative figures and opening retained earnings to be restated, with the correction disclosed. Tax follows the accounting treatment: the capitalised repairs will also have inflated the capital allowance claim, which should be reviewed.
2. The directors want to move to 40% reducing balance from 2025. Classify the change under IAS 8, state how it is applied, and compute the 2025 depreciation charge.
Read the worked answer
Classification Under IAS 8.36 a change in the method of depreciation is a change in accounting estimate, not a change in accounting policy, because the measurement basis (historical cost) is unchanged and only the pattern of consumption is revised. The common instinct to treat it as a policy change and restate comparatives is wrong. A genuine policy change would be, for example, moving from the cost model to the revaluation model under IAS 16.
Application Account for it prospectively from 1 January 2025: no prior-year adjustment, no restatement, no opening retained earnings entry. Disclose the nature and amount of the change (IAS 8.39).
Computation Carrying amount at 1 January 2025 (corrected): Cost ₦12,000,000 Less 2022: 9/12 × ₦2,000,000 = ₦1,500,000 Less 2023: ₦2,000,000 Less 2024: ₦2,000,000 Accumulated depreciation ₦5,500,000 NBV = ₦6,500,000
2025 charge = 40% × ₦6,500,000 = ₦2,600,000, leaving ₦3,900,000, which is above the ₦2,000,000 residual value, so no floor adjustment is needed.
Guard rails The rate must be reviewed at each year end (IAS 16.51) because a reducing-balance charge never reaches the residual on its own; the residual and remaining useful life must be reassessed annually, and the charge capped so the asset is not depreciated below residual.
3. Evaluate the MD's 'immaterial' argument and state what you should do as the consultant.
Read the worked answer
Quantify first Net effect on profit = ₦8,170,000 − ₦8,400,000 = −₦230,000, about 2.7% of draft profit. That is close to conventional quantitative thresholds, so it cannot be dismissed casually.
Why size alone is not the test IAS 1.7 says information is material if omitting or misstating it could influence users' economic decisions, and IAS 8 requires materiality to be judged in the light of surrounding circumstances, not just arithmetic. The relevant points here are qualitative:
- The gross misstatement is ₦600,000 of expenses understated and assets overstated - errors cannot be netted against the insurance prepayment to look small.
- The practice, if repeated, systematically understates costs and inflates the asset base and the depreciation base, which feeds directly into the proposed change of method.
- It has a tax consequence (inflated capital allowances), creating an exposure beyond the accounts.
- The preparer is the MD's son, so this is a management-override and related-party risk, which raises the presumption of materiality rather than lowering it. The bank covenant and any lender relying on the accounts are the affected users.
What you do Correct the accounts. If refused, put your view in writing to the directors, quantify the effect, record that you were instructed not to adjust, and consider the consequences for your report and for continuing the engagement. A member cannot be associated with misleading information; integrity, objectivity and professional competence under the ICAN Code all bite here.