Candidates are expected to recognise that only half the loan interest has been paid and to accrue for the other $4,000. Examiners generally indicate in some way that the loan notes have been in issue for the whole year if they want this adjustment to be made. Secondly, the interest is a finance cost in the statement of profit or loss ($8,000), the accrued interest ($4,000) is a current liability and the loan notes ($100,000) are a non-current liability. Present them appropriately and do not combine them.
Depreciation is a slightly more complex adjustment. Depreciation spreads the cost of non-current assets over the assets’ useful lives, so that a charge against profit appears in the statement of profit or loss. This charge, each year that the asset is used by the business, should match the economic benefits that the asset’s use has generated for the business. If an asset will help the business to generate revenue for five years, then the cost of the asset is spread over the same five years – depreciation is the application of the accruals concept.
Methods of depreciation
There are two main methods of depreciation:
- straight-line method – a percentage of cost (or cost less residual value) is charged each year. This may be presented as a certain number of years of ‘useful life’ rather than as a percentage, for example either as 20%- or five-years useful life. However it is presented, under the straight-line method, the expense will be the same amount each year.
- diminishing (reducing) balance method – a percentage is charged on the carrying amount (cost less accumulated depreciation to date). Under the diminishing balance method, the depreciation expense will be higher earlier on in the asset’s life and will reduce each year. This is more complex than the straight-line method but provides a more realistic reflection of the reduction in an asset’s carrying amount for some types of assets.
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. This is usually referred to as ‘pro-rata’. The first requirement, therefore, is to read the question carefully to find out what has to be done for each non-current asset.
Statement of profit or loss
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 depreciation will have been charged against profits in earlier periods.
Statement of financial position
The statement of financial position shows the carrying amount of each class of assets. This is the cost less any accumulated depreciation (the figure in the trial balance brought forward from the end of the previous accounting period, plus the current year’s charge from the statement of profit or loss). A breakdown of the cost and accumulated depreciation would be provided in the notes to the accounts.
The underlying ledger accounts
It would be possible to use just one account for each non-current asset, showing cost and accumulated depreciation. However, they are usually kept separate in order to present the separate figures in the trial balance and the financial statements. This results in (figures invented):