5.4.1 The main elements of a statement of financial position (3)
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1.
A company owns a factory building valued at £500,000. It also owns machinery valued at £150,000. The factory building is expected to depreciate at 5% per year, and the machinery is expected to depreciate at 10% per year. Calculate the depreciation expense for each asset in the first year. Explain why depreciation is an important concept in accounting.
Factory Building Depreciation:
Depreciation = (Original Value * Depreciation Rate)
Depreciation = (£500,000 * 0.05) = £25,000
Machinery Depreciation:
Depreciation = (Original Value * Depreciation Rate)
Depreciation = (£150,000 * 0.10) = £15,000
Therefore, the depreciation expense for the factory building in the first year is £25,000, and the depreciation expense for the machinery is £15,000.
Importance of Depreciation:
- Matching Principle: Depreciation allows businesses to match the cost of an asset with the revenue it generates over its useful life. This provides a more accurate picture of profitability.
- Realistic Financial Reporting: Depreciation reflects the gradual decline in the value of assets, providing a more realistic view of the company's financial position than if assets were reported at their original cost.
- Tax Benefits: Depreciation is a tax-deductible expense, which reduces a business's taxable profit and lowers its tax liability.
- Asset Replacement Planning: Depreciation helps businesses plan for future asset replacement by providing information about when assets will need to be replaced.
2.
Question 1
ABC Ltd has the following statement of financial position as at 31 December 2023:
Assets
- Cash at Bank: £15,000
- Debtors: £22,000
- Inventory: £18,000
- Fixtures & Fittings: £35,000
- Land: £40,000
Liabilities
- Creditors: £12,000
- Loan Payable: £25,000
Calculate the total assets and the total liabilities of ABC Ltd.
Total Assets: £15,000 + £22,000 + £18,000 + £35,000 + £40,000 = £120,000
Total Liabilities: £12,000 + £25,000 = £37,000
Therefore, the total assets of ABC Ltd are £120,000 and the total liabilities are £37,000.
3.
Question 2: Explain how a business can improve its management of trade receivables. Provide at least three specific methods.
Answer:
A business can improve the management of trade receivables through several methods:
- Credit Checks: Implementing thorough credit checks on new customers to assess their creditworthiness before extending credit. This reduces the risk of bad debts.
- Clear Credit Terms: Establishing clear and concise credit terms (e.g., payment deadlines, discounts for early payment) and communicating them effectively to customers.
- Invoice Promptly: Sending invoices promptly after goods or services are delivered to ensure timely payment.
- Follow-up on Overdue Invoices: Implementing a system for regularly following up on overdue invoices, including sending reminders and potentially charging late fees.
- Offering Incentives: Providing discounts for early payment can encourage customers to pay quickly.