## **Learning Outcomes**

After reading this article, you will be able to define provisions and estimation techniques, explain the calculation and purpose of depreciation and amortisation at period end, perform key adjustments, and recognise their impact on financial statements. You will distinguish between estimates and provisions, apply correct accounting entries, and identify common period-end exam traps.

## **ACCA Maintaining Financial Records (FA2) Syllabus**

For ACCA Maintaining Financial Records (FA2), you are required to understand how provisions, estimates, depreciation, and amortisation are treated at period end, and how their accounting impacts the preparation of accurate financial statements.

- Identify and differentiate between liabilities, accruals, and provisions (IAS 37)
- Calculate and record depreciation for tangible non-current assets (IAS 16) using straight line and reducing balance methods
- Calculate and record amortisation for intangible assets
- Make and record period-end estimates and adjustments in the financial records
- Recognise the impact of estimation and provisions on the statement of profit or loss and the statement of financial position
- Apply the accruals principle for depreciation, amortisation, and provisions at period end
- Present provisions, depreciation, and amortisation correctly in financial statements

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which statement best describes a provision under IAS 37?
   a) A liability with certain timing and amount
   b) A liability of uncertain timing or amount
   c) Income received in advance
   d) An expense paid in advance

2. Depreciation expense should be recorded:
   a) When the asset is disposed of
   b) Evenly over an asset’s useful life
   c) Only in the period of acquisition
   d) When cash is paid

3. True or false? Amortisation applies only to tangible non-current assets.

4. Briefly explain how an increase in a provision affects the statement of profit or loss.

## **Introduction**

Period-end financial statements must present a true view of an entity’s assets, liabilities, and results. This requires recognising not only actual transactions, but also relevant estimates and adjustments—including provisions, depreciation, and amortisation. These are essential to ensure expenses are matched to the periods benefiting from them and uncertainty is properly disclosed.

This article explains how to identify and account for provisions and estimates, with focus on depreciation of tangible assets and amortisation of intangible assets at the period end. You will learn the key definitions, calculations, and entries, along with practical example questions in the style of the ACCA FA2 exam.

> **Key Term: provision**
> A liability of uncertain timing or amount, recognised when an entity has a present obligation, it is probable an outflow will occur, and the amount can be reliably estimated.
>
> **Key Term: estimate**
> An approximate value determined using management’s judgement where precise information is not available, applied to items such as provisions and depreciation.
>
> **Key Term: depreciation**
> The systematic allocation of the depreciable amount of a tangible non-current asset over its useful life.
>
> **Key Term: amortisation**
> The systematic allocation of the depreciable amount of an intangible asset over its useful life.

## Depreciation and Amortisation: Purpose and Calculation

Depreciation and amortisation spread the cost of assets over the years that benefit from their use, following the accruals concept. Failure to record these systematically results in misstated profits and asset values.

### Depreciation

Depreciation applies to tangible non-current assets (e.g., property, plant, machinery) with limited useful lives.

- **Straight line method**: Charges a constant annual amount.
- **Reducing balance method**: Charges a fixed percentage on the asset’s carrying value each year.

Depreciation is recognised from when the asset is available for use. Land is generally not depreciated unless it has a finite useful life (e.g., mining sites).

### Amortisation

Amortisation applies to intangible assets (e.g., patents, licences). The process is identical to depreciation, but for non-physical assets. Amortisation is not charged on intangible assets with indefinite useful lives or that are not yet available for use.

> **Key Term: accrued expense**
> An expense incurred but not yet paid or invoiced, requiring recognition at period end.

## Provisions and Period-End Estimates

Business judgement is often required to estimate future expenses or obligations, such as warranty claims or legal settlements. Where these obligations exist at the period end, and the amount/timing is uncertain, a provision is required. Management should base estimates on the best available evidence, and disclose the basis of significant judgements.

### Creating a Provision

- Recognise a provision only if:
  - A present legal or constructive obligation exists
  - Settlement is probable
  - The amount is reliably estimable

> **Key Term: constructive obligation**
> An obligation arising from an entity’s actions, established by pattern of past practice, published policies, or specific statements.

### Impact on Financial Statements

Provisions and estimation adjustments affect profit and net asset values. Increasing a provision increases expenses and decreases profit for the period.

## Period-End Adjustments: Accounting Entries

At the period end, estimate and record provisions, depreciation, and amortisation to match expenses to relevant periods.

- **Depreciation/amortisation**:
  - Debit: Depreciation or Amortisation expense (statement of profit or loss)
  - Credit: Accumulated depreciation or amortisation (statement of financial position)

- **Provision** (creation or increase):
  - Debit: Relevant expense (e.g., warranty, legal claim)
  - Credit: Provision (statement of financial position)

- **Provision** (decrease):
  - Debit: Provision (statement of financial position)
  - Credit: Relevant expense (statement of profit or loss)

## Recording and Presenting Adjustments

- Calculate annual depreciation and amortisation using chosen method and estimated useful life.
- Review and update provisions to reflect new evidence at year end.
- Accumulated depreciation (or amortisation) is deducted from the asset’s cost to show carrying amount.
- Provisions are shown as liabilities—classified as current or non-current based on expected timing.

### **Worked Example 1.1**

A company purchases machinery for \$50,000. The machine is expected to last 5 years with a residual value of \$5,000. Calculate annual depreciation using the straight line method, and give the journal entry (ignore tax).

> **Answer:**  
> Depreciable amount = \$50,000 – \$5,000 = \$45,000  
> Useful life = 5 years  
> Annual depreciation = \$45,000 / 5 = \$9,000  
> Journal entry:  
> Debit Depreciation expense \$9,000  
> Credit Accumulated depreciation \$9,000

### **Worked Example 1.2**

At the end of the year, management estimates legal claims of \$12,000 relating to a product defect. There is a 75% chance of payment and the amount is reliably estimated. Show the provision entry.

> **Answer:**  
> Provision for legal claim = \$12,000 recognised (since outflow is probable and can be estimated).  
> Journal entry:  
> Debit Legal expenses \$12,000  
> Credit Provision for legal claim \$12,000

### **Worked Example 1.3**

A business has a software licence costing \$6,000, valid for 3 years, with no residual value. What is the annual amortisation charge and how is the carrying amount reported after 2 years?

> **Answer:**  
> Amortisation = \$6,000 / 3 years = \$2,000 per year  
> Accumulated amortisation after 2 years = \$4,000  
> Carrying amount reported = \$6,000 – \$4,000 = \$2,000

### **Exam Warning**

Incorrect estimation or omission of period-end adjustments can overstate profit and assets. In exams, always check for required adjustments for all relevant non-current assets and provisions.

## **Summary**

Depreciation and amortisation ensure costs of long-term assets are matched to the periods in which they generate benefits. Provisions recognise uncertain obligations or expenses, based on careful estimation following reporting standards. Accurate entries at period end are critical for fair reporting and exam success.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain the purpose and calculation of depreciation and amortisation at period end
- Recognise how to distinguish provisions from other liabilities and when to estimate
- Prepare and record necessary year-end adjustments for depreciation, amortisation, and provisions
- Identify and apply the correct journal entries for impairment/provision and asset expense recognition
- Present and disclose adjustments correctly in the statement of profit or loss and statement of financial position

## **Key Terms and Concepts**

- provision
- estimate
- depreciation
- amortisation
- accrued expense
- constructive obligation

Provisions and estimates - Depreciation and amortisation at period end