topic 5 depreciation

Question 1

why are depreciation adjustments needed

Answer 1

• recognise the consumption of the economic resources in a non-current asset
• these result in both an expense, and a reduction in the asset’s reported value.

Question 2

accumulated depreciation

Answer 2

• is a contra asset account (meaning a negative account)
• contra asset accounts behave opposite to normal assets (↑ on left ↓on right like LCI)
• the account accumulates all of the depreciation that has been recorded on that particular asset since its acquisition
• every non current asset has its own accumulated depreciation account.
• shown in the balance sheet as a reduction in the value of the asset.

Question 3

depreciation meaning (from important terminology)

Answer 3

the systematic allocation of the depreciable amount of an asset over its useful life.

Question 4

useful life

Answer 4

the period over which an asset is expected to be available for use by an entity.

Question 5

residual value

Answer 5

the estimated amount that an entity would currently obtain from disposal of the asset at the end of its useful life.

Question 6

depreciable amount

Answer 6

the cost of an asset, or other amount substituted for its cost, less its residual value.
Depreciable amount = Cost − Residual value

Question 7

carrying amount

Answer 7

the amount at which an asset is recognised after deducting accumulated depreciation.

Question 8

calculating depreciation

Answer 8

• requires judgement
• involves estimates
• should be reviewed annually

Question 9

straight line method (depreciation)

Answer 9

allocates an equal amount each period of the asset’s life.

Question 10

3 things needed to know for straight line depreciation

Answer 10

• the cost of the asset
• any estimated residual value
• the expected life (in years)

Question 11

formula for straight line method depreciation

Answer 11

(cost - residual value)/useful life = annual depreciation amount

Question 12

how to record depreciation in the entries

Answer 12

Dr ↑ expense (depreciation of equipment) Cr ↑ accumulated deprecation (negative asset)

Question 13

whats seen in the balance sheet for depreciation

Answer 13

the carrying amount (or book value) of the asset = the cost of any depreciable asset - its related accumulated depreciation.

Question 14

consequences of not recording depreciation on the 4 financial statements

Answer 14

• income statement - expenses would be understated
• statement of changes in equity - equity would be overstated
• balance sheet - assets and equity would be overstated
• statement of cash flows - no effect

Question 15

depreciation adjustments recognise what

Answer 15

• recognise the consumption of the economic resources in a non-current asset
• they record an expense (Dr - depreciation) and record the reduction in value via a negative asset account (Cr - accumulated depreciation)

Question 16

note about depreciation

Answer 16

note the time period recording depreciation for - may be less than a full year.

Question 17

offering credit to customers or clients

Answer 17

• whenever a business provides goods or services on credit, there is always a risk a proportion of the accounts receivable will not pay their accounts.
• these can occur despite screenings before credit is approved.

Question 18

doubtful debt

Answer 18

one that may not be collectible

Question 19

bad debt

Answer 19

one that is written off as uncollectible

Question 20

why is it important to adjust for doubtful and bad debts

Answer 20

to provide an accurate representation of expenses and assets

Question 21

2 ways to account for bad and doubtful debts:

Answer 21

• The Direct Write-Off Method
• The Allowance Method

Question 22

the direct write off method

Answer 22

• no allowance is made in advance.
• The Bad Debts Expense is recognised only when an account is considered uncollectible.
• this often happens in a different accounting period to which the income was earned, meaning the asset is overstated in the interim.

Question 23

entry for the direct write off method

Answer 23

Dr ↑ Bad Debts (Expense)
Cr ↓ Accounts Receivable (Asset)

Question 24

the allowance method

Answer 24

• allows for a proportion of Accounts Receivable to be considered doubtful in the same accounting period that the related income was earned.
• if a customer is declared a bad debt later on (after attempts to collect the outstanding balance fail), a portion of the allowance is ‘used up’.

Question 25

balance day adjusting entry for the allowance method

Answer 25

Dr ↑ Doubtful Debts (Expense) Cr ↑ Allowance for Doubtful Debts (negative Asset) the amount raised as an allowance is an estimate.

Question 26

allowance method continued: entry after the customer is declared to be a bad debt

Answer 26

the entry simply removes the customer's account balance and reduces the allowance: Dr ↓ Allowance for Doubtful Debts (negative Asset) Cr ↓ Accounts Receivable this could be recorded at any time during the period.

Question 27

allowance for doubtful debts

Answer 27

- is a contra asset account (negative asset account) - the account shows the value of receivables that the business has chosen to report as 'risky' or 'doubtful', though there is no certainty about the amounts being collected or not. - it is shown in the Balance Sheet as a reduction in the value of the Accounts Receivable

Question 28

estimating the allowance for doubtful debts

Answer 28

the amount set aside as an allowance in case receivables become uncollectible can be estimated in 2 ways: - based on Credit Sales/Service income - based on a % of Accounts Receivable

Question 29

estimating the allowance for doubtful debts: based on Credit Sales/Service income way

Answer 29

- if a business recorded (for eg) $2m of income earned on credit during the year, they would allow for a % (eg 1.5%) to be considered doubtful. - the % is determined based on past history, customer details, other conditions.

Question 30

estimating the allowance for doubtful debts: based on a % of Accounts Receivable

Answer 30

- if a business had a closing balance of Accounts Receivable of $550,000, they may allow for a % (eg 4%) to be considered doubtful. - the % is determined based on past history, customer details, other conditions.

Question 31

adjusting entry for estimating the allowance for doubtful debts: based on Credit Sales/Service income way

Answer 31

Dr ↑ Doubtful Debts Expense Cr ↑ Allowance for Doubtful Debts

Question 32

adjusting entry for estimating the allowance for doubtful debts: based on a % of Accounts Receivable

Answer 32

Dr ↑ Doubtful Debts Expense Cr ↑ Allowance for Doubtful Debts but this amount is NOT the adjustment, it is what they want the Allowance account to be raised to.

Question 33

Aged analysis of accounts recievable balance

Answer 33

- a more complex way to estimate the balance of the Allowance account. - focuses on how long balances have been outstanding to estimate the proportion that are uncertain. - eg a business may estimate that only 1% of customers who have balances less than 30 days outstanding will be doubtful. however, 40% of customers whose balances have been outstanding for more than 90 days are doubtful.

Question 34

when a debt is written off (what happens0

Answer 34

- this could happen at any time of the year - the amount is removed from both the Accounts Receivable and the Allowance for Doubtful Debts accounts.

Question 35

2 notes to remember about adjusting entries

Answer 35

- every adjusting entry involves one income statement account (I, E) and one balance sheet account (A, L) (excluding equity) - no adjusting entry ever involves cash

Question 36

consequences of not recording accrued income adjustment at the end of the period on the 4 financial statements

Answer 36

- income statement - income would be understated - statement of changes in equity - equity would be understated - balance sheet - assets and equity would be understated - statement of cash flows - no effect

Question 37

consequences of not recording accrued expenses adjustment at the end of the period on the 4 financial statements

Answer 37

- income statement - expenses would be understated - statement of changes in equity - equity would be overstated - balance sheet - liabilities would be understated and equity would be overstated - statement of cash flows - no effect

Question 38

consequences of not recording prepaid income adjustment at the end of the period on the 4 financial statements

Answer 38

- income statement - income would be understated - statement of changes in equity - equity would be understated - balance sheet - liabilities would be overstated and equity would be understated - statement of cash flows - no effect

Question 39

consequences of not recording prepaid expenses adjustment at the end of the period on the 4 financial statements

Answer 39

- income statement - expenses would be understated - statement of changes in equity - equity would be overstated - balance sheet - assets and equity would be overstated - statement of cash flows - no effect

Question 40

consequences of not adjusting prepaid expenses recorded as an expense at the end of the period on the 4 financial statements

Answer 40

- income statement - expenses would be overstated - statement of changes in equity - equity would be understated - balance sheet - assets and equity would be understated - statement of cash flows - no effect

Question 41

the allowance method (what happens after a customer is declared a bad debt)

Answer 41

- when a customer is declared to be a bad debt later on, the debt is 'written off'. - NO new expense is recorded bc it has already been allowed for. - the entry simply removes the customer's account balance and reduces the allowance