Final Accounts and Depreciation
Trading account, profit and loss account and balance sheet, the usual year-end adjustments, capital versus revenue items, and straight-line and diminishing-balance depreciation.
4 min readUpdated
Final accounts
Final accounts of a trading concern are prepared from the trial balance in three steps.
1. Trading account - finds gross profit.
- Cost of goods sold (COGS) = Opening stock + Net purchases + Direct expenses - Closing stock
- Gross profit = Net sales - COGS
- Direct expenses: carriage inwards, wages, freight, import duty, factory power.
2. Profit and loss account - finds net profit.
- Net profit = Gross profit + Other incomes - Indirect expenses (salaries, rent, depreciation, bad debts, carriage outwards and so on)
3. Balance sheet - a statement (not an account) of assets, liabilities and capital on the closing date.
Adjustments
Each adjustment given outside the trial balance has two effects.
| Adjustment | In trading or P&L account | In balance sheet |
|---|---|---|
| Closing stock | Credit of trading account | Current asset |
| Outstanding expense | Added to the expense | Current liability |
| Prepaid expense | Deducted from the expense | Current asset |
| Accrued income | Added to the income | Current asset |
| Income received in advance | Deducted from the income | Current liability |
| Depreciation | Expense in P&L | Deducted from the asset |
| Further bad debts | Expense in P&L | Deducted from debtors |
| Provision for doubtful debts | Expense in P&L | Deducted from debtors |
Expense for the year = Amount paid + Closing outstanding - Opening outstanding. Salaries paid Rs 220,000, outstanding at the end Rs 20,000 and at the start Rs 15,000 give a charge of Rs 225,000.
Provision is calculated on debtors after deducting further bad debts. Debtors Rs 205,000, further bad debts Rs 5,000, provision 5%: 5% of 200,000 = Rs 10,000.
Capital versus revenue
| Capital expenditure | Revenue expenditure |
|---|---|
| Acquires or improves a fixed asset; benefit lasts beyond one year | Maintains the asset or runs the business; benefit used up in the year |
| Shown in the balance sheet | Charged to trading or P&L account |
| Purchase price, installation, legal fees on acquisition, overhaul of a second-hand asset before first use | Repairs, repainting, salaries, rent, insurance |
Depreciation
IAS 16 (NAS 16 in Nepal) defines depreciation as the systematic allocation of the depreciable amount of an asset over its useful life. Depreciable amount = Cost - Residual value. Land normally has an unlimited life and is not depreciated.
Straight-line method (SLM) - equal charge every year.
Annual depreciation = (Cost - Residual value) / Useful life
Cost Rs 500,000, scrap Rs 50,000, life 10 years: (500,000 - 50,000) / 10 = Rs 45,000 a year.
Diminishing-balance (written-down value) method - a fixed rate on the opening book value, so the charge falls each year.
Cost Rs 400,000 at 15%:
| Year | Opening value | Depreciation | Closing value |
|---|---|---|---|
| 1 | 400,000 | 60,000 | 340,000 |
| 2 | 340,000 | 51,000 | 289,000 |
| 3 | 289,000 | 43,350 | 245,650 |
Shortcut: book value after n years = Cost x (1 - rate)^n.
Disposal: Profit or loss = Sale proceeds - Book value. A machine costing Rs 300,000, depreciated at 10% straight-line for 4 years, has a book value of 300,000 - 120,000 = 180,000. Sold for Rs 170,000, the loss is Rs 10,000.
Worked net profit
Gross profit Rs 180,000; commission received Rs 6,000; salaries paid Rs 60,000 with Rs 5,000 outstanding; rent paid Rs 24,000 including Rs 4,000 prepaid; depreciation 10% on furniture of Rs 100,000.
Net profit = 180,000 + 6,000 - 65,000 - 20,000 - 10,000 = Rs 91,000.
Exam pointers
- Carriage inwards goes to the trading account; carriage outwards to P&L.
- Outstanding expenses are liabilities; prepaid expenses and accrued incomes are assets.
- Deduct further bad debts before calculating the provision.
- SLM depreciation is on cost less scrap; diminishing-balance is on opening book value.
- Installation and pre-use overhaul are capital; routine repairs and repainting are revenue.
- The balance sheet is a statement, not an account.
Check what stuck
Questions written from this note, with the answer explained after you mark them.
Try 5 questions now
No account needed. Mark them and see each answer explained.
Sources
- IAS 16 Property, Plant and Equipment, IFRS Foundation
- IAS 16 standard text (definitions of depreciation and depreciable amount), IFRS Foundation
- IAS 1 Presentation of Financial Statements, IFRS Foundation
Rates, limits and figures change. Confirm anything time-sensitive against the latest official notice before the exam.