weetman08.ppt

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Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Chapter 8
Non-current (fixed) assets

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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.

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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

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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.

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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.

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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.

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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.

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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.

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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.

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Non-current (fixed) Assets and Depreciation
Year Assets – Liabilities = Ownership
interest
1 ↓ ↓
2 ↓ ↓
3 ↓ ↓
etc.

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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).

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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).

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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.

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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

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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:
life
Expected
value
residual
Expected
Cost –

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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:
5
–
000
,
1
£ nil
= £200 per annum
Accounting policy:
Depreciation is charged on a straight-line
basis at a rate of 20% of cost per annum.
(Continued)

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‘Straight line’ – a graph of the net book value of
the asset at the end of each year produces a
straight line.
(Continued)

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End of
year
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
Table 8.1 Pattern of depreciation and net book value over the life of an asset

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Straight-line depreciation – graph of
net book value
Figure 8.1 Graph of net book value over Years 1 to 5, for the straight-line method of
depreciation
0
200
400
600
800
1000
1200
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
net
book
value

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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

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rate = )
( n
C
R

1 × 100%
The rate of depreciation to be applied
under the reducing balance method of
depreciation is calculated by the formula:
where n = the number of years of useful life
R = the estimated residual value
C = the cost of the asset
Reducing balance depreciation
(Continued)

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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%).
× 100% = approx 50%
Rate =
Example calculation
(Continued)
)
(15
1,000
30

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Year Net book value at
start of year
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
Reducing balance calculation
Table 8.2 Calculation of reducing-balance depreciation

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– graph of net book value
Figure 8.2 Graph of net book value over Years 1 to 5, for the reducing-balance
method of depreciation
0
200
400
600
800
1000
1200
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
net
book
value

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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.

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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.

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Income statement (profit and loss account)
Year ended 31 Dec Yr 2 Yr 3 Yr 4
£000’s £000’s £000’s
Depreciation expense 20 20 20
Balance sheet at 31 Dec
Lease at cost
60 60 60
Less: Accumulated
depreciation
20 40 60
Net book value 40 20 0

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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).

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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.

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£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
Balance sheet – end Year 2
Table 8.4 The Removals Company: Statement of financial position (balance sheet) at
end of Year 2 and Income statement (profit and loss account) for Year 2

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£000’s
Fees for removal work 120
Cash expenses (58)
Depreciation (18)
(76)
Profit for the year 44
Income statement (profit and loss
account) Year 2
Table 8.4 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)

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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
Ownership interest
OI at start 60 104
Profit and loss account 44 44
104 148
Balance sheet
Table 8.6 The Removals Company statement of financial position (balance sheet) at
end of Year 3 and Income statement (profit and loss account) for Year 3

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Year 2 Year 3
£000’s £000’s
Turnover 120 120
Cash expenses (58) (58)
Depreciation (18) (18)
76 76
Profit for the year 44 44
Income statement (profit and loss account)
Table 8.6 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)

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Presentation
See text book for more detail on
• Spreadsheets
• Presentation

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Chapter 8
Bookkeeping supplement

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Capital contributed
Capital withdrawn
Revenue
Expense
Ownership interest
Increase
Decrease
Liability
Right-hand side of the equation
Decrease
Increase
Asset
Left-hand side of the equation
CREDIT ENTRIES
DEBIT ENTRIES
Debit and credit entries in ledger accounts
Table 8.12 Rules for debit and credit entries in ledger accounts

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Date Transaction or event Amount Dr Cr
Year 2 £
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
Analysis of transactions for the Removals company, Year 2
Table 8.13 Analysis of transactions for The Removals Company, Year 2

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L1 Ownership interest L4 Accumulated depreciation of
van
L2 Cash L5 Sales
L3 Van at cost L6 Running costs
L7 Depreciation of the year
Ledger accounts required to record
transactions

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L1 OWNERSHIP INTEREST
DATE PARTICULARS PAGE DEBIT CREDIT BALANCE
Year 2 £ £ £
Jan 1 Cash L2 60,000 (60,000)
L2 CASH
Year 2 £ £ £
Jan 1 Owner’s capital L1 60,000 60,000
Jan 1 Van L3 60,000 nil
Jan–
Dec
Sales L5 120,000 120,000
Jan–
Dec
Running costs L6 58,000 62,000
Ledger accounts required to record transactions
(Continued)

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L3 VAN AT COST
Year 2 £ £ £
Jan 1 Cash L2 60,000 (60,000)
L4 ACCUMULATED DEPRECIATION OF VAN
Year 2 £ £ £
Dec
31
Depreciation for
the year
L7 18,000 (18,000)
transactions (Continued)

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L5 SALES
Year 2 £ £ £
Jan–
Dec
Cash L2 120,000 (120,000)
L6 RUNNING COSTS
£ £ £
Jan–
Dec
Cash L2 58,000 58,000

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L7 DEPRECIATION OF THE YEAR
£ £ £
Dec
31
Accumulated
depreciation
L4 18,000 18,000

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Ledger account title £ £
L1 Ownership interest 60,000
L2 Cash 62,000
L3 Van at cost 60,000
L4 Accumulated depreciation of van 18,000
L5 Sales 120,000
L6 Running costs 58,000
L7 Depreciation 18,000 _______
Totals 198,000 198,000
Trial balance at the end of Year 2 for
the Removals company
Table 8.14 Trial balance at the end of Year 2 for The Removals Company

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