Tussock & Brass Ltd: four year-end adjustments and a proposed depreciation change
Tussock & Brass Ltd is a New Zealand company with a 31 March balance date. Draft profit before tax is NZD186,000. Four items have not yet been adjusted:
- Accounts receivable are NZD180,000. The allowance for doubtful debts has a credit balance of NZD3,000 and the policy is an allowance of 2% of accounts receivable.
- A NZD250,000 term loan was drawn down on 1 July 2024 at 6% per annum. Interest of NZD9,000 has been recorded in finance costs for the year.
- Plant had a carrying amount of NZD420,000 at 1 April 2024. The draft accounts include the prior year's straight-line charge of NZD42,000, but the accountant now considers 12% diminishing value on carrying amount better reflects the pattern of use.
- On 25 March 2025 the directors declared a final dividend of 8 cents per share on 200,000 ordinary shares, paid 20 April 2025. The constitution allows the board to declare dividends without shareholder approval.
The company tax rate is 28%. The board wants the final reported profit and to know whether the dividend affects the 31 March statement of financial position.
1. Calculate adjusted profit before tax, income tax expense and profit after tax, explaining each adjustment.
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Adjustments
| Item | Effect on profit before tax |
|---|---|
| Doubtful debts: required allowance 2% × 180,000 = 3,600; existing 3,000; increase 600 | −600 |
| Interest: 250,000 × 6% × 9/12 = 11,250 accrued; 9,000 paid; shortfall 2,250 | −2,250 |
| Depreciation: 420,000 × 12% DV = 50,400; draft 42,000; additional charge 8,400 | −8,400 |
| Dividend of 16,000 (200,000 × $0.08) | nil - a distribution to owners, not an expense |
Result
- Adjusted profit before tax: 186,000 − 600 − 2,250 − 8,400 = NZD174,750
- Income tax expense: 174,750 × 28% = NZD48,930
- Profit after tax: NZD125,820
Reasoning
The accrual basis requires expenses to be matched to the period that consumed the benefit, and NZ IAS 10 requires the balances to reflect conditions existing at balance date.
- The allowance is a change in an estimate of a present condition (receivables that may not be collected), so it is adjusted now, not next year.
- The loan was outstanding for nine months, so nine months of interest is the period's cost regardless of when invoices arrive. The unpaid 2,250 is an accrued liability.
- Depreciation is an allocation of the plant's depreciable amount over its useful life. The 8,400 difference understates this year's consumption if it is not adjusted.
- The dividend is shown separately so students do not mistakenly treat it as an expense - a classic error that would understate profit by 16,000.
2. Explain how the dividend should be treated at 31 March 2025, and its effect on the statement of financial position and disclosures.
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Recognition
The dividend was declared on 25 March - before balance date - and the board has authority to declare it without further approval. The declaration creates a present obligation arising from a past event, so it meets the definition of a liability at 31 March 2025.
Journal: Dr Retained earnings 16,000 / Cr Dividends payable 16,000
Effect on the statement of financial position
- Equity falls by 16,000 (retained earnings).
- Current liabilities rise by 16,000 (dividends payable).
- Total assets unchanged, so the current ratio falls and equity gearing worsens. This matters to a lender reading the statement.
What it does not do
It does not reduce profit after tax of 125,820, because a dividend is a distribution to owners, not an expense. It reduces retained earnings directly.
Disclosure and the contrast case
Note the dividend declared and the amount per share. If the dividend had been declared on, say, 10 April - after balance date - NZ IAS 10 would make it a non-adjusting event: no liability at 31 March, disclosed only in the notes. The 20 April payment is simply settlement of the liability already recognised; it confirms rather than creates the obligation. Getting this cut-off wrong changes both equity and the current ratio in the year presented to the bank.
3. The board proposes changing the depreciation rate to 8% diminishing value for the year ending 31 March 2026 'to improve reported profit'. Discuss whether this is acceptable and how it should be accounted for and disclosed.
Read the worked answer
Nature of the change
Changing the rate or method of depreciation is a change in accounting estimate under NZ IAS 8, not a change in accounting policy, provided it arises from revised information about the useful life or the pattern of consumption of the asset.
Accounting treatment
Apply it prospectively from the date of change: the remaining carrying amount is depreciated over the revised remaining useful life. Prior periods are not restated and no prior-period adjustment is made. Disclose the nature of the change and its amount, so readers can see the effect on the current and future periods.
Is this proposal acceptable?
The test is the reason, not the number. It is acceptable if there is evidence the plant is now consumed more slowly - for example, lower utilisation after the loss of a contract, a maintenance overhaul extending life, or a genuine reassessment of the asset's remaining life. The rate should follow the evidence.
It is not acceptable if the only justification is 'to improve reported profit'. Financial statements must give a true and fair view; deliberately changing an estimate to hit a profit target misstates the consumption of the asset, is not neutral, and would be challenged by the auditor and by any lender relying on the accounts. It also flatters this year at the cost of later years - profit is shifted, not created.
Recommendation
Ask the accountant for a documented reassessment of the plant's remaining useful life (maintenance records, utilisation data, expected contract life). If that supports 8%, make the change and disclose it properly. If it does not, keep the current rate and address profit through operations - and note that previous changes to the useful life were applied the same way, so the board should not expect a precedent of restating.