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Adjustmentstofinancialstatements|Students|ACCAGlobal|ACCAGlobal

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ADJUSTMENTS TO FINANCIAL STATEMENTS

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Manycandidatesareunabletohandlecertainadjustmentsproperlyintheexam.Thisarticleexplainshow
totreatthemainpossibleposttrialbalanceadjustments,including:
inventory/stock
accrualsandprepayments
interest
depreciation
baddebtsandallowancesforreceivables/debtors.

Themostimportantpoint,whichmustbeunderstoodattheoutset,isthatalltheseadjustmentshavean
impactonboththeincomestatement/profitandlossaccountandinthebalancesheet.Ifthetrialbalance
balances,youranswermustbalance,andthereforeanychangestothetrialbalancemustbalance.
Havingsaidthat,itismoreimportanttocompletethequestionwithinthetimeallowed,withoutspending
timeongettingthebalancesheettobalance.

INVENTORY/STOCK
Thisisafairlyfamiliaradjustment.Thecostofgoodssoldconsistsofopeninginventorypluspurchases,
minusclosinginventory.Theclosinginventoryisthusadeduction(credit)intheincomestatement/trading
account,andacurrentasset(debit)inthebalancesheet.
Theledgeraccountbehindtheadjustmentcausesproblemsforsomecandidates.Thisishowthe
inventory/stockaccountwilllookatthetimethetrialbalanceisbeingprepared.Theentryisthetransfer
fromtheincomestatementfortheclosinginventoryofthepreviousyear(figuresinvented):

Inthecurrentyear,lastyearsclosinginventoryisthisyearsopeninginventory.Itmustbetransferredout
tothisyearsincomestatement,beforetheentryforthenewclosinginventoryismade:

Therewillsometimesbearequirementtoadjustinventory/stocktoallowfordamagedorslowmoving
items.IAS2,InventoriesandSSAP9,StocksandLongtermContractsbothrequireinventories/stockto
beincludedatthelowerofcostandnetrealisablevalue.Itmaythereforebenecessarytoreducethe
inventory/stockfiguretoreflectanetrealisablevaluebelowcostfortheitemsdetailed.

ACCRUALSANDPREPAYMENTS
Theincomestatement/profitandlossaccounthastoincludetheexpensesrelatingtotheperiod,whether
ornottheyhavebeenpaid.Thefiguresinthetrialbalancewillusuallybetheamountspaidintheperiod,
andtheyneedadjustingforoutstandingamountsandamountspaidwhichrelatetootherperiodsto
obtaintheincomestatementcharge.
Unpaidbalancesrelatingtotheperiodshouldbeincludedinthebalancesheetascurrentliabilities.Ifthe
expensehasbeenpaidinadvance,theamountprepaidisincludedinthebalancesheetasacurrent
asset.Intheincomestatement/profitandlossaccount,thetotalexpenseisneededwithaworking
showingthedetail.Dontshowtwofiguresintheoutercolumnforthesameexpenseheading.For
example,thetrialbalanceshows:
$
Wages136,000
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Insurance4,000
At31December2005,wagesowingamountedto$3,800,andinsurancepaidinadvancewas$600.This
ispresentedasfollows:
$
Incomestatement/profitandlossaccount
Wages(136,000+3,800)139,800
Insurance(4,000600)3,400
Balancesheet
Currentassets
Inventory/stock
Receivables/debtors
Prepayments600
Cash
Currentliabilities
Tradepayables/creditors
Accruals3,400

Similaradjustmentsmaybeneededforincome,suchasrentreceivable.Becarefulhere.Income
receivedinadvanceisaliabilityandshouldbeincludedalongsideaccrualsforunpaidexpenses,thereby
changingtheheadingtoAccrualsanddeferredincome.Incomeinarrearsisanassetwhichshouldbe
includedwithprepaymentsusingtheheadingPrepaymentsandaccruedincome.

INTEREST
Interestpayableisreallyanotheraccrualbutthereareoneortwospecialpoints.First,thequestionmay
notgiveexplicitinstructionstoaccrueforinterest.Thetrialbalancemaycontain:
DrCr
$$
8%Loanstock/debentures100,000
Interestonloanstock/debentures4,000
Candidatesareexpectedtonotethatonlyhalftheloaninteresthasbeenpaid,andaccruefortheother
$4,000.Examinersgenerallyindicateinsomewaythattheloanstock/debentureshavebeeninissuefor
thewholeyeariftheywantthisadjustmenttobemade.Second,theinterestisacurrentliabilityandthe
loanstock/debenturesareanoncurrentliability.Presentthemappropriatelyanddontcombinethem.

DEPRECIATION
Depreciationisaslightlymorecomplexadjustment.Depreciationspreadsthecostofnoncurrent/fixed
assetsfairlyoverassetsusefullives,sothatachargeagainstprofitappearsintheincome
statement/profitandlossaccounteachyear.
Methodsofdepreciation
Therearetwomainmethodsofdepreciationwhicharetestedinbasiclevelexaminations:
straightlinemethodapercentageofcost(orcostlessresidualvalue)ischargedeachyear
reducingbalancemethodapercentageischargedonthewrittendownvalue(costlessaccumulateddepreciationto
date).

Depreciationpolicies
Somebusinessesadoptapolicyofchargingafullyearsdepreciationintheyeartheassetwas
purchased,andnoneintheyearofitssale.Otherstakeproportionatedepreciationforthenumberof
monthsofownershipoftheassetintheyear.Thefirstrequirement,therefore,istoreadthequestion
carefullytofindoutwhathastobedoneforeachnoncurrent/fixedasset.
Incomestatement/profitandlossaccount
Thecurrentyearsdepreciationchargeiscalculatedandappearsasanexpense.Donotincludethe
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accumulateddepreciation.Theaccumulateddepreciationisthetotaldepreciationchargedduringan
assetslife(assumingnorevaluation)andassuchpreviouscostswillhavebeenchargedagainstprofitsin
earlierperiods.
Balancesheet
Thebalancesheetshowsthecost,accumulateddepreciation(thefigureinthetrialbalanceplusthe
currentyearschargefromtheincomestatement),andnetbookvalue.Theeasiestwaytopresentthisis
asatable,asfollows(figuresinvented):
CostAccumulatedNetbookvalue
depreciation
$$$
Buildings800,00080,000720,000
Plantandequipment390,000260,000130,000
Motorvehicles210,000100,000110,000
1,400,000440,000960,000
Theunderlyingledgeraccounts
Itwouldbepossibletousejustoneaccountforeachnoncurrent/fixedasset,showingcostand
depreciation.However,theyareusuallykeptseparate,inordertopresenttheseparatefiguresinthe
balancesheetasshownabove.Thisresultsin(figuresinvented):

Athirdaccountisrequiredtohandledisposals.Whenanoncurrent/fixedassetissold,thecostand
accumulateddepreciationrelatingtotheassetaretransferredoutoftheaccountstoadisposalaccount.
Theproceedsofsalearecreditedtotheaccount,andthebalanceontheaccountisthentheprofitorloss
onthesale,tobetransferredtotheincomestatement/profitandlossaccount.

BADDEBTSANDALLOWANCEFORRECEIVABLES/DEBTORS
Theseadjustmentsprobablycausemostdifficultyforcandidatesinanexamination.
Baddebts
Writingoffabaddebtmeanstakingacustomersbalanceinthereceivables/salesledgerandtransferring
ittotheincomestatementasanexpense,becausethebalancehasprovedirrecoverable.Therearetwo
separateexampossibilitieshere:
baddebtsappearasaniteminthetrialbalance.Thismeansthedebtshavealreadybeenwrittenoff.Inotherwords,
receivables/debtorshavealreadybeenreduced.Allthatisnecessaryistoputthefigureintheincomestatement/profit
andlossaccountasanexpense
baddebtsappearasanadjustmentoutsidethetrialbalance.Twoentriesarenowneeded.Theamountgoesintothe
incomestatementasanexpenseandisdeductedfromthereceivables/debtorsfigureinthebalancesheet.

Allowanceforreceivables/debtors
Thisallowanceissetupinordertoincludearealisticvalueforreceivables/debtorsinthebalancesheet,
withoutactuallywritingoffthedebt.Thebalanceisleftinthereceivables/salesledgersothatcollection
procedurescontinue,butthereceivables/debtorsinthebalancesheetarevaluedasiftheamountisnot
toberecovered.Thetrialbalanceshows:
DrCr
$$
Tradereceivables/debtors180,000
Allowanceforreceivables/debtors4,000
Thismeansthatthebusinessalreadyhasanallowance,takenfromtheincomestatement/profitandloss
accountinpreviousyears.Ifnothingmoreistobedone,thisshouldshowinthebalancesheet,under
currentassets:
$$
Tradereceivables/debtors180,000
Less:Allowanceforreceivables/debtors4,000176,000
Alternatively,ifpreparingacompanybalancesheetforpublication,itshouldshow:

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Tradereceivables/debtors(180,0004,000)176,000
Thefiguresinbracketsareaworking,notpartofthebalancesheet.Continuingtheexample,itismore
likelythatthequestionwillrequiretheallowancetobeadjusted.Letussaythattheallowanceistobe
increasedto$5,400.Giventhatthereisalready$4,000,$1,400shouldbetakenoutofthisyearsincome
statement/profitandlossaccount.Theresultis:
Incomestatement/profitandlossaccount
$
Increaseinallowanceforreceivables/debtors1,400
Rememberthatitisonlytheincreaseordecreaseintheallowancethatgoesintotheincome
statement/profitandlossaccount.
Balancesheet
$$
Tradereceivables/debtors180,000
Less:Allowanceforreceivables/debtors5,400174,600
Theunderlyingledgeraccounts
Thereareseveralwaysofdealingwithbaddebts,andallowancesforreceivables/debtors,inledger
accounts.Onewayistohavebothinoneaccount.However,forexaminationpurposes,itmaybeeasier
tohavetwoaccounts,onefordebtswrittenoffandonefortheallowance:

Baddebtsrecovered
Sometimes,adebtwrittenoffinoneyearisactuallypaidinthenextyearadebittocashandacreditto
baddebtsrecovered.Thecreditbalanceontheaccountisthentransferredtothecreditoftheincome
statement/profitandlossaccount(addedtogrossprofitorincludedasanegativeinthelistofexpenses).
Thisisbetterthancreditingtherecoverytothebaddebtsaccount,becausethatwouldobscurethe
expensefrombaddebtsfortheyear.

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Lastupdated:22Sep2014

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