Topic 8: Balance Day Adjustments, Depreciation

Question 1

What is the definition of Cash Accounting?

Answer 1

Cash accounting recognises income when cash is received and expenses when cash is paid.

Question 2

What is the definition of Accrual Accounting?

Answer 2

Accrual accounting recognises financial transactions when they occur and should be recorded in the accounting period to which they relate.

Question 3

What is the definition of a Prepaid Expense and what is its Classification?

Answer 3

A supply or service that has been paid in advance. (current asset)

Question 4

What is the definition of Stock of Supplies and what is its Classification?

Answer 4

Resources that a business has purchased ahead of time for the use of the accounting period. (current asset)

Question 5

What is the definition of an Accrued Expense and what is its Classification?

Answer 5

Expenses that have been generated in an accounting period but have not been paid by the end of that period. (current liability)

Question 6

What is the definition of Unearned Income and what is its Classification?

Answer 6

Money received from a customer for a good or service that has not been provided. (current liability)

Question 7

What is the definition of Accrued Income and what is its Classification?

Answer 7

An amount of money owed to a business where a good or service has been provided but for which cash has not been received by balance day. (current asset)

Question 8

What is the definition of Doubtful Debts and what is its Classification?

Answer 8

A record of debtors who are unlikely to pay their accounts. (expense)

Question 9

Explain Depreciation.

Answer 9

Depreciation is an expense that involves the allocation of the cost of an asset over its useful life- the period in which benefits are expected to be derived. This means that the financial reports of a business will show the gradual consumption of economic benefits from a non-current asset, or in other words, its decreasing potential to provide assistance to the business. It accounts for the loss in value of the asset through time, wear & tear and obsolescence. By depreciating the asset, this loss in value is turned into a legitimate business expense.

Question 10

What are the 3 Causes of Depreciation?

Answer 10

1. Wear & Tear: non-current assets that are mechanical and those that are electrical, that all decline in value due to wear & tear. In other words, the usage of an asset over time gradually reduces the efficiency of the asset.
2. Commercial Obsolescence: when equipment has no further use (is obsolete) due to a decline in the market demand for the good and service in the production of which the asset is used.
3. Technical Obsolescence: The asset is redundant (of no further use) because of the introduction of new technology.

Question 11

What is included in the cost of a Depreciable Asset?

Answer 11

• purchase price of the asset
• cost of transporting the asset to business premises
• cost of setting up the asset, ready for use
• cost of any permanent improvements made is added to purchase price

Question 12

Does depreciation provide CASH for the replacement of assets?

Answer 12

Depreciation does NOT set aside cash for the replacement of an asset. Depreciation is a BOOK ENTRY and does not involve a cash inflow or outflow.

Question 13

Does depreciation calculate the current market value of an asset?

Answer 13

Depreciation is NOT a way to calculate the current market value of an asset. Depreciation is a process of expense allocation net asset valuation.

Question 14

What is the definition of Straight Line Depreciation and when do we use it?

Answer 14

Straight line depreciation is when the same amount of depreciation is charged on the original cost of the asset each period. It is used when the asset is expected to contribute evenly to the income earning activities of the business over its useful life.

Question 15

What is the definition of Reducing Balance Depreciation and when do we use it?

Answer 15

Reducing balance depreciation is when a fixed percentage of depreciation is charged on the diminishing balance, not the original cost of the asset, each period. It is used when more economic benefits are expected in the early years of an asset’s life.

Question 16

How does a Loss on Sale occur and is it Over or Under depreciated?

Answer 16

A loss on sale is where the carrying amount (historical cost - accumulated depreciation) is more than the proceeds of sale (cash we receive from selling the asset). This is an example of under depreciation as too little depreciation has occurred. If the asset is sold for a lower price than its carrying amount, a loss is recognised because the company is receiving less for the asset than it has on its books.

Question 17

How does a Gain on Sale occur and is it Over or Under depreciated?

Answer 17

A gain on sale is where the carrying amount (historical cost - accumulated depreciation) is less than the proceeds of sale (cash we receive from selling the asset). Thi is an example of over depreciation as too much depreciation has occurred. If the asset is sold for a price higher than its carrying amount, a gain is recognised because the company is receiving more for the asset than it has on its books.