Similar adjustments may be needed for income, such as rent receivable. Be careful here. Income received in advance is a liability and should be included alongside accruals for unpaid expenses, thereby changing the heading to ‘Accruals and deferred income’. Income in arrears is an asset which should be included with prepayments using the heading ‘Prepayments and accrued income’.
Interest payable is really another accrual but there are one or two special points. First, the question may not give explicit instructions to accrue for interest. The trial balance may contain:
8% Loan stock/debentures 100,000
Interest on loan stock/debentures 4,000
Candidates are expected to note that only half the loan interest has been paid, and accrue for the other $4,000. Examiners generally indicate in some way that the loan stock/debentures have been in issue for the whole year if they want this adjustment to be made. Second, the interest is a current liability and the loan stock/debentures are a non-current liability. Present them appropriately and don’t combine them.
Depreciation is a slightly more complex adjustment. Depreciation spreads the cost of non-current/fixed assets fairly over assets’ useful lives, so that a charge against profit appears in the income statement/profit and loss account each year.
Methods of depreciation
There are two main methods of depreciation which are tested in basic level examinations:
- straight line method – a percentage of cost (or cost less residual value) is charged each year
- reducing balance method – a percentage is charged on the written down value (cost less accumulated depreciation to date).
Some businesses adopt a policy of charging a full year’s depreciation in the year the asset was purchased, and none in the year of its sale. Others take proportionate depreciation for the number of months of ownership of the asset in the year. The first requirement, therefore, is to read the question carefully to find out what has to be done for each non-current/fixed asset.
Income statement/profit and loss account
The current year’s depreciation charge is calculated and appears as an expense. Do not include the accumulated depreciation. The accumulated depreciation is the total depreciation charged during an asset’s life (assuming no revaluation) and as such previous costs will have been charged against profits in earlier periods.
The balance sheet shows the cost, accumulated depreciation (the figure in the trial balance plus the current year’s charge from the income statement), and net book value. The easiest way to present this is as a table, as follows (figures invented):
Cost Accumulated Net book value
$ $ $
Buildings 800,000 80,000 720,000
Plant and equipment 390,000 260,000 130,000
Motor vehicles 210,000 100,000 110,000
1,400,000 440,000 960,000
The underlying ledger accounts
It would be possible to use just one account for each non-current/fixed asset, showing cost and depreciation. However, they are usually kept separate, in order to present the separate figures in the balance sheet as shown above. This results in (figures invented):