Transcript Non-current fixed assets

Slide 8.1
Chapter 8
Non-current (fixed) assets
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.2
Definitions
Asset
• Resource… from which future economic
benefits are expected to flow.
Non-current (fixed) assets
• Held for use in profit generating process.
• On a continuing basis.
• Not for sale in ordinary course of business.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.3
Classification
• Property, plant and equipment, also called tangible
non-current (fixed) assets.
• Intangible non-current (fixed) assets.
• Investments held long term.
Intangible: No physical substance
• Patents
• Trade marks
• Development costs
• Goodwill
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.4
Valuation
Normally at
• Cost less accumulated depreciation equals
• NET BOOK VALUE (NBV) or
• depreciated cost.
Revaluation of non-current (fixed) assets
• Asset is given a valuation above cost.
• Usually applied to land and buildings.
• Revaluation is a choice for the company.
• If used, revaluations must be updated regularly.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.5
Cost of non-current (fixed) assets
At acquisition
• Purchase price of an asset plus the cost of
preparing it for use.
– Legal costs of acquisition and installation and
commissioning costs.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.6
Improvements after purchase
Improvement expenditure may extend the asset’s
annual output capacity
• increasing its economic life.
• reducing associated running costs.
• improving the quality of its output.
Costs incurred to improve on the asset’s original
condition: for example
• extension to a building.
• rebuilding shop fittings to attract new type of
customer.
These costs should be added to the original cost of
the asset and depreciated over the remainder of its
useful life.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.7
Repairs, restoration
Costs incurred to maintain, repair or restore
the asset to its original condition– treated as
an expense and charged to the profit and
loss account: for example,
• replacing roof damaged in storm.
• replacing engine in bus.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.8
Depreciation
• Non-current (fixed) assets are gradually
used up in providing goods and services
over time.
• Purpose of accounting depreciation is to
spread the cost of a non-current (fixed)
asset over its expected useful life.
• Depreciation is a method of allocating cost.
• Achieves a matching of costs against the
related revenues.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.9
Depreciation (Continued)
In historical cost (traditional) accounting:
• the Net Book Value (NBV) is the result of a
calculation.
(Original cost – Accumulated depreciation)
• it is not intended to represent the asset’s
market value.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.10
Non-current (fixed) Assets and Depreciation
Year
Assets
–
Liabilities
=
Ownership
interest
1
↓
↓
2
↓
↓
3
↓
↓
etc.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.11
Yearly depreciation,
Accumulated depreciation
• Each year that a non-current (fixed) asset is in
use, a portion of its cost is deducted from the
balance sheet value. That portion of cost is
‘matched’ against the revenues of that year. This
gives the depreciation charge of the year.
(Income statement profit and loss account).
• The depreciation of the non-current (fixed) asset in
each year is added to the depreciation of earlier
years to arrive at the Accumulated depreciation.
(Balance sheet).
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.12
Calculation of depreciation
Requires three items of information:
• the cost of the non-current (fixed) asset.
• the estimated useful life.
• the estimated residual value (the value
remaining at the end of the useful life).
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.13
Total depreciation
Total depreciation of the non-current (fixed)
asset is equal to the cost of the non-current
(fixed) asset minus the estimated residual
value.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.14
Purpose and methods
The purpose of the depreciation calculation is
to spread the total depreciation over the
estimated useful life.
Methods of depreciation
(a) Straight-line method
(b) Reducing value
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.15
Straight-line depreciation
• Those who believe that a non-current (fixed)
asset is used evenly over time apply a method
of calculation called straight-line depreciation.
The formula is:
Cost – Expected residual value
Expected life
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.16
Straight-line depreciation
(Continued)
Non-current (fixed) asset, which has a cost of
£1,000 and an expected life of 5 years. The
expected residual value is nil. The calculation
of the annual depreciation charge is:
£1,000 – nil
= £200 per annum
5
Accounting policy:
Depreciation is charged on a straight-line
basis at a rate of 20% of cost per annum.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.17
Straight-line depreciation
(Continued)
‘Straight line’ – a graph of the net book value of
the asset at the end of each year produces a
straight line.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.18
Pattern of depreciation and net book value
End of
year
Table 8.1
Depn of the year
Total depn
Net book value of
the asset
(b)
(c)
(£1,000 – c)
£
£
£
1
200
200
800
2
200
400
600
3
200
600
400
4
200
800
200
5
200
1,000
nil
Pattern of depreciation and net book value over the life of an asset
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.19
Straight-line depreciation – graph of
net book value
1200
net book value
1000
800
600
400
200
0
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Graph of net book value over Years 1 to 5, for the straight-line method of
depreciation
Figure 8.1
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.20
Reducing-balance depreciation
• Those who believe that the non-current
(fixed) asset depreciates faster in the
earlier years of its life would calculate the
depreciation. Formula:
Fixed percentage ×
the net book value at the start of the year
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.21
Reducing balance depreciation
(Continued)
The rate of depreciation to be applied
under the reducing balance method of
depreciation is calculated by the formula:
rate =
(1n
R
)
C
× 100%
where n = the number of years of useful life
R = the estimated residual value
C = the cost of the asset
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.22
Reducing balance depreciation
(Continued)
Example calculation
n = 5 years
C = £1,000
R = £30 (The residual value must be of
reasonable magnitude. To use an amount of nil for the
residual value would result in a rate of 100%).
Rate =
(1
5
30
1,000
)
× 100% = approx 50%
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.23
Reducing balance calculation
Year Net book value at
start of year
Table 8.2
Annual depreciation Net book value at
end of year
(a)
(b) = 50% of (a)
(a–b)
£
£
£
1
1,000
500
500
2
500
250
250
3
250
125
125
4
125
63
62
5
62
31
31
Calculation of reducing-balance depreciation
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.24
Reducing balance depreciation
– graph of net book value
1200
net book value
1000
800
600
400
200
0
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Graph of net book value over Years 1 to 5, for the reducing-balance
method of depreciation
Figure 8.2
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.25
Retaining cash in the business
• Fee income £120,000. Pay wages and other costs
£58,000. Depreciation calculated as £10,000.
• How much may the owner take in drawings?
• Cash available is £62,000.
• But if that is taken for personal use there is nothing
left in the bank to put towards asset replacement.
• Take cash of £52,000 leaves £10,000 towards
asset replacement.
• Problem – business may spend the £10,000 on
other aspects of business, such as buying current
assets or repaying loans.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.26
Presentation in financial statements
Example:
On 1 January Year 2 Electrical Instruments
purchased a three-year lease of a shop for
£60,000. The accounts over the next three
years would include the following items
related to the lease.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.27
Income statement (profit and loss account)
Year ended 31 Dec
Depreciation expense
Yr 2
Yr 3
Yr 4
£000’s
£000’s
£000’s
20
20
20
Balance sheet at 31 Dec
60
60
60
Less: Accumulated
depreciation
20
40
60
Net book value
40
20
0
Lease at cost
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.28
Straight-line with residual value
The Removals Company was set up on 1
January Year 2, purchased van for £60,000,
and started to trade.
The manager estimates that:
1. The van will be used for 3 years; and
2. Estimated residual value of £6,000 (second
hand or scrap value).
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.29
Calculation
• Net cost of the van
= (£60,000 – £6,000) = £54,000.
• Net cost has to be depreciated over 3 years.
i.e. (54,000/3) = £18,000 per year.
Assume:
• During the year cash receipts from sales were
£120,000
• and cash expenses were £58,000 for wages,
petrol and running costs.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.30
Balance sheet – end Year 2
£000’s
Van at cost
60
Less:
Accumulated depreciation
(18)
Net book value
42
Cash
62
104
Ownership interest at start
60
Profit for the year
44
104
The Removals Company: Statement of financial position (balance sheet) at
end of Year 2 and Income statement (profit and loss account) for Year 2
Table 8.4
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.31
Income statement (profit and loss
account) Year 2
£000’s
Fees for removal work
120
Cash expenses
(58)
Depreciation
(18)
(76)
Profit for the year
44
The Removals Company: Statement of financial position (balance sheet) at
end of Year 2 and Income statement (profit and loss account) for Year 2 (Continued)
Table 8.4
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.32
Balance sheet
Year 2
Year 3
£000’s
£000’s
Van at cost
60
60
Less: Accumulated depreciation
18
36
Net book value
42
24
Cash
62
124
104
148
OI at start
60
104
Profit and loss account
44
44
104
148
Ownership interest
The Removals Company statement of financial position (balance sheet) at
end of Year 3 and Income statement (profit and loss account) for Year 3
Table 8.6
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.33
Income statement (profit and loss account)
Year 2
Year 3
£000’s
£000’s
Turnover
120
120
Cash expenses
(58)
(58)
Depreciation
(18)
(18)
76
76
44
44
Profit for the year
The Removals Company statement of financial position (balance sheet) at
end of Year 3 and Income statement (profit and loss account) for Year 3 (Continued)
Table 8.6
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.34
Presentation
See text book for more detail on
• Spreadsheets
• Presentation
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.35
Chapter 8
Bookkeeping supplement
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.36
Debit and credit entries in ledger accounts
DEBIT ENTRIES
CREDIT ENTRIES
Asset
Right-hand side of the equation
Increase
Decrease
Liability
Ownership interest
Decrease
Expense
Capital withdrawn
Increase
Revenue
Capital contributed
Left-hand side of the equation
Table 8.12
Rules for debit and credit entries in ledger accounts
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.37
Analysis of transactions for the Removals company, Year 2
Date
Transaction or event
Year 2
Amount
Dr
Cr
£
1 Jan
Owner contributes cash
60,000
Cash
Ownership
interest
1 Jan
Purchase furniture van
60,000
Van at cost
Cash
All year
Collected cash from
customers
120,000
Cash
Sales
All year
Paid for running costs
58,000
Running
costs
Cash
31 Dec
Calculate annual
depreciation
18,000 Depreciation
expense
Accumulated
depreciation
Table 8.13
Analysis of transactions for The Removals Company, Year 2
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.38
Ledger accounts required to record
transactions
L1 Ownership interest
L4 Accumulated depreciation of
van
L2 Cash
L5 Sales
L3 Van at cost
L6 Running costs
L7 Depreciation of the year
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.39
Ledger accounts required to record transactions
(Continued)
L1 OWNERSHIP INTEREST
DATE
PARTICULARS
PAGE
DEBIT
Year 2
Jan 1
CREDIT
£
Cash
L2
BALANCE
£
£
60,000
(60,000)
L2 CASH
DATE
PARTICULARS
PAGE
Year 2
DEBIT
CREDIT
£
Jan 1
Owner’s capital
L1
Jan 1
Van
L3
Jan–
Dec
Sales
L5
Jan–
Dec
Running costs
L6
BALANCE
£
60,000
£
60,000
60,000
120,000
nil
120,000
58,000
62,000
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.40
Ledger accounts required to record
transactions (Continued)
L3 VAN AT COST
DATE PARTICULARS
PAGE
DEBIT
Year 2
Jan 1
CREDIT
£
Cash
L2
BALANCE
£
£
60,000
(60,000)
L4 ACCUMULATED DEPRECIATION OF VAN
DATE PARTICULARS
PAGE
Year 2
Dec
31
DEBIT
CREDIT
£
Depreciation for
the year
L7
BALANCE
£
£
18,000
(18,000)
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.41
Ledger accounts required to record
transactions (Continued)
L5 SALES
DATE
PARTICULARS
PAGE
DEBIT
Year 2
Jan–
Dec
CREDIT
£
Cash
L2
BALANCE
£
£
120,000
(120,000)
L6 RUNNING COSTS
DATE
PARTICULARS
PAGE
DEBIT
CREDIT
£
Jan–
Dec
Cash
L2
58,000
BALANCE
£
£
58,000
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.42
Ledger accounts required to record
transactions (Continued)
L7 DEPRECIATION OF THE YEAR
DATE PARTICULARS PAGE
DEBIT
£
Dec
31
Accumulated
depreciation
L4
18,000
CREDIT
£
BALANCE
£
18,000
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 8.43
Trial balance at the end of Year 2 for
the Removals company
Ledger account title
L1 Ownership interest
L2 Cash
L3 Van at cost
L4 Accumulated depreciation of van
L5 Sales
L6 Running costs
L7 Depreciation
Totals
Table 8.14
£
£
60,000
62,000
60,000
18,000
120,000
58,000
18,000
198,000
_______
198,000
Trial balance at the end of Year 2 for The Removals Company
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011