Year-end adjustments: depreciation, bad debts and stock deficit

Three losses that never touch the bank

The adjustments in this lesson share one feature: the business is worse off, but no money leaves the bank account on the day the entry is made. Each one records a loss that has already happened quietly during the year.

Depreciation

A delivery vehicle is not used up in one day, it is used up over years. Depreciation spreads the cost of a fixed asset across the years that get the benefit, so each year carries a fair share.

The cost price method (also called the straight-line method) charges the same amount every year: a fixed percentage of the original cost.

The diminishing balance method charges a percentage of the asset's remaining book value, so the amount gets smaller each year.

The expense is called Depreciation. The running total of all depreciation charged so far is kept in a separate account called Accumulated depreciation, which is subtracted from the cost to give the asset's carrying value.

Bad debts

A debtor who genuinely cannot pay is no longer an asset. The amount owing is removed from Debtors control and written off as an expense called Bad debts. The business is not choosing to give money away, it is admitting that an asset it recorded earlier turned out to be worth nothing.

Trading stock deficit

The Trading stock account says what should be on the shelves. A physical stock count says what is actually there. When the count is lower, the difference is a trading stock deficit: stock lost through breakage, theft or errors. The stock account is written down to the counted figure and the shortfall becomes an expense.

Working the three together

Worked example. Mokoena Deliveries closes its books on 28 February.

Depreciation. A vehicle was bought for R240 000 exactly two years ago. Depreciation is 20% per year on cost.

1. Depreciation for this year = 240 000 x 20% = R48 000
2. Accumulated depreciation after two years = 48 000 x 2 = R96 000
3. Carrying value = 240 000 - 96 000 = R144 000

The vehicle is still shown at cost R240 000, less accumulated depreciation R96 000.

Bad debts. A debtor owing R1 800 has closed down and cannot pay. The R1 800 is removed from Debtors control and recorded as a Bad debts expense. Total assets fall by R1 800 and so does profit.

Trading stock deficit. The Trading stock account shows R86 000. The physical count comes to R84 300.

1. Deficit = 86 000 - 84 300 = R1 700
2. Trading stock is written down to R84 300 and R1 700 becomes a Trading stock deficit expense.

Together these three adjustments reduce profit by 48 000 + 1 800 + 1 700 = R51 500, and not one cent of that left the bank on 28 February.

Why record a loss with no cash

Profit is meant to measure whether the business is better or worse off, not how much cash moved. A vehicle worth less than it was, a debtor who will never pay and stock that has disappeared are all real reductions in what the business owns. Leaving them out would report a profit the owner cannot actually rely on.

Core checkpoint: you can calculate depreciation on cost, find carrying value, write off a bad debt, calculate a trading stock deficit from a count, and explain why each reduces profit without reducing the bank.