Non-current assets, Study notes of Business

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Non 8 - current assets

Chapter learning objectives Upon completion of this chapter you will be able to:

 define non-current assets

 distinguish between capital and revenue expenditure

 explain the function and purpose of an asset register

 explain and illustrate the ledger entries to record the acquisition of non-current assets

 define and explain the purpose of depreciation

 explain the straight-line and reducing balance methods of depreciation and make necessary calculations

 explain and illustrate how depreciation expense and accumulated depreciation are recorded in ledger

accounts

 explain and illustrate how depreciation is presented in the income statement and statement of financial

position

 explain the relevance of consistency and subjectivity in accounting for depreciation

 make the necessary adjustments if changes are made in the estimated useful life/residual value of a non-

current asset

 explain and illustrate the ledger entries to record the disposal of non-current assets for cash

 explain and illustrate the ledger entries to record the disposal of non-current assets through part exchange

 explain and illustrate the inclusion of profits or losses on disposal in the income statement

 explain and record the revaluation of a non-current asset in ledger accounts and in the statement of financial

position

 explain the impact of a revaluation on accounting for depreciation and disposal of a non-current asset

 explain and illustrate how non-current asset balances and movements are disclosed in company financial

statements.

Non-current assets Non-current assets are distinguished from current assets by the following characteristics: they:

 are long-term in nature

 are not normally acquired for resale

 are could be tangible or intangible

 are used to generate income directly or indirectly for a business

 are not normally liquid assets (i.e. not easily and quickly converted into cash without a significant loss in

value). Capital and revenue expenditure It follows that a business' expenditure may be classified as one of two types:

A non-current asset register is maintained in order to control non-current assets and keep track of what is owned and where it is kept. It is periodically reconciled to the non-current asset accounts maintained in the general ledger.

 The cost of a non-current asset is any amount incurred to acquire the asset and bring it into working

condition

 The correct double entry to record the purchase is:

Dr Non-current asset X Cr Bank/Cash/Payables X

 A separate cost account should be kept for each category of non-current asset, e.g. motor vehicles, fixtures

and fittings. Subsequent expenditure Subsequent expenditure on the non-current asset can only be recorded as part of the cost (or capitalised), if it enhances the benefits of the asset, i.e. increases the revenues capable of being generated by the asset. An example of subsequent expenditure which meets this criterion,and so can be capitalised, is an extension to a shop building which provides extra selling space. An example of subsequent expenditure which does not meet this criterion is repair work. Any repair costs must be debited to the income statement, i.e. expensed. Test your understanding 1 Acquisition of a non-current asset

Bilbo Baggins started a business providing limousine taxi serviceson 1 January 20X5. In the year to 31 December he incurred the followingcosts: What amounts should be capitalised as 'Land and buildings' and 'Motor vehicles'? Depreciation

 IAS 16 defines depreciation as 'the measure of the cost or revalued amount of the economic benefits of the

tangible non-current asset that has been consumed during the period'.

 In simple terms, depreciation is a mechanism to reflect the cost of using a non-current asset.

 Depreciation matches the cost of using a non-current asset to the revenues generated by that asset over its

useful life.

 Depreciation must also be matched to the pattern of use of the asset. This must be regularly reviewed and

may be changed if the method no longer matches the usage of the asset.

 This is achieved by recording a depreciation charge each year, the effect of which is twofold ('the dual

effect'):

o Reduce the statement of financial position value of the non-current asset by cumulative depreciation to

reflect the wearing out.

o Record the depreciation charge as an expense in the income statement to match to the revenue generated

by the non-current asset. Depreciation Depreciation may arise from:

Useful life: the estimated number of years during which the business will use the asset. Residual value The residual value may be a second-hand value or scrap value. It is unlikely to be a significant amount and is often zero. The useful life does not necessarily equal the physical life of the asset. For example many businesses use a three- year useful life for computers. This does not mean that a computer can no longer be used after three years; it means that the business is likely to replace the computer after three years due to technological advancement. Straight-line depreciation is often expressed as a percentage of original cost, so that straight-line depreciation over four years would alternatively be described as straight-line depreciation at 25% pa. Reducing balance method Depreciation charge = X % x carrying value (CV) CV: original cost of the non-current asset less accumulated depreciation on the asset to date. Assets bought/sold in the period If a non-current asset is bought or sold in the period, there are two ways in which the depreciation could be accounted for:

 provide a full year's depreciation in the year of acquisition and none in the year of disposal

 monthly or pro-rata depreciation, based on the exact number of months that the asset has been owned.

Illustration 1 – Reducing balance method Dev, a trader, purchased an item of plant for $1,000 on 1 August20X1 which he depreciates on the reducing balance at 20% pa. What is thedepreciation charge for each of the first five years if the accountingyear end is 31 July? Solution Solution

Test your understanding 2 Karen has been running a successful nursery school 'Little Monkeys' since 20X1. She bought the following assets as the nursery grew:

 a new oven for the nursery kitchen at a cost of $2,000 (purchased 1 December 20X4).

 a minibus to take the children on trips for $18,000 (purchased 1 June 20X4).

She depreciates the oven at 10% straight line and the minibus at25% reducing balance. A full year's depreciation is charged in the year of purchase and none in the year of disposal. What is the total depreciation charge for the year ended 31 October 20X6? A $2, B $2, C $4, D $2, Test your understanding 3 The following information relates to Bangers & Smash, a car repair business:

Santa charges depreciation on a monthly basis.

 What is the depreciation charge for the year ended 31st August 20X5?

 Show the relevant ledger accounts and statement of financial position presentation at that date.

Solution Solution Cash register Depreciation charge: 10% x $5,000 x 9/ = $ Delivery van Depreciation charge: 15% x $22,000 x 5/ = $1,

 Residual value and useful life should be reviewed at each year end and changed if expectations differ from

previous estimates. Illustration 3 Changes to estimates Alfie purchased a non-current asset for $100,000 on 1 January20X2 and started depreciating it over five years. Residual value wastaken as $10,000. At 1 January 20X3 a review of asset lives was undertaken and theremaining useful life was estimated at eight years. Residual value wasestimated as nil. Calculate the depreciation charge for the year ended 31 December 20X3 and subsequent years. Solution to changes in estimates Test your understanding 5 Alberto bought a wood-burning oven for his pizza restaurant for$30,000 on 1 January 20X0. At that time he believed that the oven's useful life would be 20 years after which it would have no value. On 1 January 20X3, Alberto revises his estimations: he now believes that he will use the oven in the business for another 12 years after which he will be able to sell it second-hand for $1,500. What is the depreciation charge for the year ended 31 December 20X3?

A $2,

B $2,

C $1,

D $2,

9 Disposal of non-current assets Profit/loss on disposal Note: A disposals T account is required when recording the disposal of a non-current asset. This is an income statement account which reflects any profit or loss on disposal. Disposal for cash consideration This is a three-step process: (1) Remove the original cost of the non-current asset from the 'non-current asset' account. Dr Disposals original cost Cr NC assets original cost (2) Remove accumulated depreciation on the non-current asset from the 'accumulated depreciation' account. Dr Acc'd dep'n acc'd dep'n Cr Disposals acc'd dep'n (3) Record the cash proceeds. Dr Cash proceeds Cr Disposals proceeds The balance on the disposals T account is the profit or loss on disposal:

Disposals There are two debits to the non-current asset account in respect of the new asset:

 PEA

 cash balance.

Together these are the cost of the new asset. If preferred you can show the total as one debit (however do not forget to record both credits). Test your understanding 7 Bindi Bobbin runs a business altering and repairing clothes. When she started business on 1 January 20X2, she bought a Soopastitch IIsewing machine for $2,500. She depreciates sewing machines using the straight-line method at a rate of 20% pa, and she charges a full year of depreciation in the year of acquisition and none in the year of disposal. The business has now grown such that she needs a faster machine,and she will upgrade to the Soopastitch V during December 20X5. The Soopa stitch salesman has offered her a part exchange deal as follows: Part exchange allowance for Soopa stitch II $ Balance to be paid in cash for Soopa stitch V $4, Show the ledger entries for the year ended 31 December 20X5 to reflect this transaction. Revaluation of non-current assets

 Some non-current assets, such as land and buildings may rise in value over time. Businesses may choose

to reflect the current value of the asset in their statement of financial position. This is known as revaluing the asset.

 The difference between the CV of the asset and the revalued amount (normally a gain) is recorded in a

revaluation reserve in the capital section of the statement of financial position.

 This gain is not recorded in the income statement because it is unrealised, i.e. it is not realised in the form of

cash.

 IAS 1 requires that a revaluation gain is disclosed in "other comprehensive income" on the statement of

comprehensive income. Fair values If the fair value of a non-current asset can be measured reliably, it can be carried at its fair value at the date of revaluation, less any subsequent depreciation and impairment losses. The revaluation should be repeated regularly to ensure that the fair value of the asset does not differ materially from the carrying amount. An upward revaluation should be credited to revaluation surplus,unless it reverses a previous downward revaluation which was charged as an expense. A downward revaluation should be charged as an expense, unless it reverses a previous upward revaluation, when it may be charged against the revaluation surplus for that same asset. If one asset in a class is revalued, all assets of that class must be revalued. This is to prevent selective revaluation of only those assets that have increased in value. Illustration 4 Revaluation of non-current assets Vittorio owns land which originally cost $250,000. No depreciation has been charged on the land in accordance with IAS 16.Vittorio wishes to revalue the land to reflect its current market value,which he has been advised is $600,000. What is the double entry to record this revaluation? Land revaluation Solution The land is currently held at cost of $250,000. This needs to be increased by $350,000 to reflect the new valuation of $600,000.Therefore the double entry required is: Dr Land cost $350,

Extract from the Statement of comprehensive income: Other comprehensive income: Gain on property revaluation $450, In summary: Revaluation surplus = Revalued amount - NBV For a non-depreciated asset: For a depreciated asset: The revaluation gain is disclosed on the face of the statement of comprehensive income under "other comprehensive income" and in the statement of changes in equity (SOCIE).

Test your understanding 8 Max owns a fish-finger factory. The premises were purchased on 1January 20X1 for $450,000 and depreciation charged at 2% pa straightline. Max now wishes to revalue the factory premises to $800,000 on 1 January 20X7 to reflect the market value. What is the balance on the revaluation reserve after this transaction? A $350, B $395, C $404, D $413, 11 Depreciation and disposal of a revalued asset Depreciation of a revalued asset

 When a non-current asset has been revalued, the charge for depreciation should be based on the revalued

amount and the remaining useful life of the asset.

 this charge will be higher than depreciation prior to the revaluation.

 the excess of the new depreciation charge over the old depreciation charge should be transferred from the

revaluation reserve to accumulated profits (within the capital section of the statement of financial position): Dr Revaluation reserve X Cr Accumulated profits X Illustration 6 Depreciation of a revalued asset Eddie owns a retail unit in central Springfield. He bought it 25years ago for $100,000, depreciating it over 50 years. At the start of20X6 he decides to revalue the unit to $800,000. The unit has a remaining useful life of 25 years. What accounting entries should be made in 20X6? Solution On revaluation at start of 20X Dr Retail unit cost $700, Dr Accumulated depreciation $50, Cr Revaluation reserve $750, Depreciation for 20X