Accounting for Depreciation,

Accruals and Cash Flow

Dr. Rakshitha Hitibandara
Senior Lecturer in Accounting and Finance
Teesside University Business School
Teesside University
01642 73 8583
[email protected]
Income statement Dr Assets + Expenses  = Capital + Income + Liability Cr
Sales (turnover or revenue)
(-) Cost of Sales
= Gross Profit Cost of Sales =
+ Other Income Opening Inventory
(-) Administration Expenses + Purchases
(-) Sales and Distribution Expenses
(-) Closing Inventory
Operational Profit
(-) Finance Expenses
Profit Before Tax
(-)Tax Expenses
Net Profit for the year
 What happens after Net Profit

• The profit remaining belongs to the shareholders.

• Dividends – payments made to the shareholders are now
subtracted from the profits at this point
• What is left is called retained profit
• Retained Profit is added to retain profit reserve and
recorded on the Balance sheet as a part of Capital
Assets
Non Current Assets
Current Assets

(-) Liability
Non Current Liability
Financial Position
Current Liability
=
Equity
Capital
Retain profit
(-) Drawings
 Accounting for
Depreciation
Dr. Rakshitha Hitibandara
Senior Lecturer in Accounting and Finance
Teesside University Business School
Teesside University
01642 73 8583
[email protected]
 Learnings Objectives
After this lecture you should be able to

• Define depreciation

• Explain why and how depreciation is provided

• Workout the depreciation charge using two main depreciation methods

• Do the accounting entries for depreciation and provision for depreciation

• Explain how different depreciation methods would affect the reported profit over time
 Issue of Depreciation
Depreciation is applicable for

Tangible Non-Current Assets

 Which have physical substance

 Which do not last forever

 Of which Economic benefits flow into the business over more than one accounting period

 Of which the value of the assets depreciate over the time (i.e., not exhausting within one year)

 Depreciation should charge in an appropriate way against to the income

Read Sangster & Wood (2018, Chapter )

So, when translated into its calculative elements

Depreciation is ….
‘the systematic allocation of the depreciable amount of an asset over its
useful life’ (IAS 16)
Depreciable amount

Cost of Assets - Estimate disposal value

Useful life of assets

Please go through this video
https://www.youtube.com/watch?v=XvuuiEij0mU
 Accounting for depreciation: two key activities (which we
need to practice and learn under different conditions)

• FIRST: Calculate the annual deprecation charge (i.e. the expense) using the
appropriate ‘deprecation method’.
• SECOND: Do the accounting entries
• Debit the DEPRECIATION ACCOUNT (i.e., the expense account) which will then
transferred to the income statement (i.e., profit and loss account) under appropriate
expense heading, at the end of the year
• Credit the PROVISION FOR DEPRECIATION ACCOUNT. The carried forward balance of
which will then be shown in the statement of financial position, i.e. the balance
sheet, together with the cost and the net book value of the fixed assets)
Methods of calculating the annual
depreciation charge (two most popular)
• Straight line methods (applicable if the benefit of the asset accrues
equally over its lifespan)

• Reducing balance methods (applicable if the benefit of asset is

gradually reduces when the asset get older).
 Depreciation Methods
1. Straight Line Methods

E.g. If a van was brought for £22,000 and we thought we would like keep
it for four years and then sell it for £2,000

Cost of Assets(£22,000) - Estimate Disposal value (£2,000)

Number of expected years of use (4years)

= Depreciation each year for a year is £5,000

Read: Sangster & Wood (2018, p 290)

 Records Keeping

  Depreciation     Accumulated Depreciation

A. Dep £ 5,000   Dep £ 5,000
  P/L £ 5,000 BCD £ 5,000
£ 5,000 £ 5,000 £ 5,000 £ 5,000
A. Dep £ 5,000   BBF £ 5,000
  P/L £ 5,000   Dep £ 5,000
£ 5,000 £ 5,000 BCD £ 10,000
  £ 10,000 £ 10,000
    DBF £ 10,000
   
2. Reducing Balance Methods
If a machine is bought for £10,000 and depreciating is to be charge at 20%
Depreciation for the year = Net book value x % of Depreciation

Cost £ 10,000
First year depreciation (10,000-0) x20% £ (2,000)
Netbook value £ 8,000
Second Year depreciation (8000 x 20%) £ (1,600)
Netbook value £ 6,400
Third year depreciation (6400 x 20%) £ (1,280)
Cost not apportioned, end of third year £ 5,120

Read: Sangster & Wood (2018, p 290)

 Records Keeping

  Depreciation     Accumulated Depreciation

A. Dep £ 2,000   Dep £ 2,000

  P/L £ 2,000 BCD £ 2,000

£ 2,000 £ 2,000 £ 2,000 £ 2,000

A. Dep £ 1,600   BBF £ 2,000

  P/L £ 1,600   Dep £ 1,600

£ 1,600 £ 1,600 BCD £ 3,600

  £ 3,600 £ 3,600

    DBF £ 3,600
   
References
Sangster, A. & Wood, F. 2018, Frank Wood's business accounting, Fourteenth edn, Pearson, Upper Saddle River.

ACCA
https://www.accaglobal.com/ie/en/student/exam-support-resources/fundamentals-exams-study-resources/f7/t
echnical-articles/measure-depreciation1.html

Bibliography

BeU, P.W., 2018. Depreciation accounting and evaluation of decisions and performance. Toward Greater Logic and Utility
in Accounting: The Collected Writings of Philip W. Bell, p.103.

Benesh, B.K. and Bryant, M.K., 2019. Depreciation Handbook. LexisNexis.

 Accrual Accounting
Dr. Rakshitha Hitibandara
Senior Lecturer in Accounting and Finance
Teesside University Business School
Teesside University
01642 73 8583
[email protected]
Accrual Accounting. Cash accounting is
Definition: Accounting method that an accounting method in which
records revenues and expenses when payment receipts are recorded during
they are incurred, regardless of when the period they are received, and
cash is exchanged. The term expenses are recorded in the period in
"accrual" refers to any individual entry which they are actually paid. In other
recording revenue or expense in the words, revenues and expenses are
absence of a cash transaction. recorded when cash is received and
paid, respectively.
 Cash vs Profit

• Cash outflow vs resource consumed

you can spend cash to acquire a resource but not consume the resource
until a future time
• Income earned vs cash receipt
you can earn income by completing an income earning activity but not
receive the cash until a future time
• Taking out a loan causes an inflow of cash BUT that cash is not earned as
income
 Therefore
• Cash flows and profit flows are not the same.

• Profit flows try to measure income earned within a per

whether or not it has resulted in the receipt of cash and
expenses incurred, in the sense of resources consumed, within
that period whether or not corresponding cash payments have
been made.

• This is referred to as an accruals approach

 Is cash the same as profit?

• Is it the same thing?

• Example 1
• Bob the builder does minor building repairs on a cash in hand basis, he pays
his suppliers as late as possible – usually after 2 months, so always seems to
have plenty of cash
• When his accountant completes his accounts at the end of the year, they
show that he has actually made a loss and has been under-pricing jobs.
• He has cash but is making a loss
 Is cash the same as profit?

• Example 2
• A company wins a very profitable 3 year contract to build
a new sports stadium. It expects to make £3m profit from
the job but 50% of the payment is on completion.
• After 18 months it finds it is unable to pay its workforce,
and it goes into liquidation.
• It is profitable but has no cash
 Main Differences between
Cash and Profit
Profit Cash

Sales Value of goods Cash received from

Passed to customer customer

Cost of Sales Costs relating to the Cost of goods paid

goods sold during period for during period

Expenses Costs of resources used Resources paid for

during period during period

Assets Depreciation charge Paid or received for

purchases or disposals

Shares / Loans Dividend / Interest for Cash payments received or

for period made in period
 Interpretation

• What do these two measures tell us about the business?

• Are they both useful or can we dispense with one or the

other?
 Both are necessary

• Profit gives a long term view of changes in the entity’s

wealth

• Cash gives an immediate view of the ability of an entity to

pay for what it needs
 Cash Management

• Accurate and frequently updated forecasts

• Avoid “surprises” – extra costs
• Effective investment of spare funds
• Effective currency hedging
 Cash Management

• Credit management
• Credit sale
• What steps should a business take to maximise its cash flow from customers?
 Cash Management

• Credit management
• Key steps
• Credit checking
• Clear sales contracts
• Timely and accurate invoicing
• Detailed reporting
• Clear follow-up resources and process for overdue debts
 Cash Management

• Credit management
• Credit purchase
• Our payments to suppliers – should we pay as late as possible? Why not?
 Cash Management

• Credit management
• Our payments to suppliers – should we pay as late as possible? Why
not?
• Business reputation – small business support
• May be put on “stop list”
• Supplies may be delayed/restricted
• Reduction in credit rating
• Difficult to move to other suppliers
Thank you