1

PRINCIPLES OF ACCOUNTING

Lecture 11Reporting non-current assets

Lecture Outline

Classification of Long lived assets– Tangible assets – Intangible assets

Property, Plant and Equipment (PPE)– Acquisition cost– Depreciation– Disposal

2

Classification of long lived assets

Tangible assets: have physical substance. – Land– Buildings, fixtures, and equipment– Natural Resources

Intangible assets are long lived assets without physical substance that confer specific rights on their owner

3

Acquisition of PPE

Plant assets are initially recorded at acquisition cost.Acquisition cost should include all of the costs that are normal and necessary to acquire the asset and prepare it for its intended use. – Items included in acquisition cost would generally include

purchase price, taxes paid at time of purchase, incidental costs, renovation and repairs costs incurred prior to the asset’s use, transportation charges, installation costs.

4

Which costs to be included?

A firm purchased a photocopier for $5,000 and incurred the following additional costs:– Freight on photocopier $100– Insurance in transit $20– Cost of installation & testing $100– Cost of carpet shampoo in

photocopier room prior to install $50

5

Acquisition cost

Eg., Delta purchased a new 737 aircraft from Boeing for list price of $63m; was offered a discount of $4m, paid $0.2m delivery cost and $0.8m preparation costs.

6

Recording acquisition for cash

Assuming Delta paid cash for the aircraft and related cost. The transaction is recorded as follows:Dr. Flight Equipment $60m

Cr. Cash $60m

7

Recording acquisition for debt

Assuming Delta signed a note payable for the new aircraft and paid cash for the transportation and preparation cost. The transaction is recorded as follows:Dr. Flight Equipment $60m

Cr. Cash $1mCr. Note payable $59m

8

Recording acquisition for Equity

Assuming Delta gave Boeing 400,000 shares of its $3 par value common stock with market value of $85 per share and paid the balance in cash. Dr. Flight Equipment $60m

Cr. Common stock $1.2mCr. Additional paid in capital $32.8mCr. Cash $26m

9

Recording acquisition by construction

A company may construct an asset for its own use instead of buying from a producerThe acquisition cost of that asset includes all the necessary costs associated with construction such as labor cost, materials and “ capitalised interest”.Capitalised interest represents interest expenditures included in the cost of a self-constructed asset

10

A lump-sum purchase of asset

A lump-sum purchase: the purchase price should be allocated to different items on the basis of the proportion of the fair market value. 1 Jan, Payton purchased building and land for $100,000– Estimated market value for land is $30,000 and for building is

$90,000. Total is $120,000– Allocation of purchase price :– Land: $100,000 * (30,000/120,000) = $25,000– Building: $100,000 * (90,000/120,000) = $75,000

11

Capital versus revenue expenditure

A capital expenditure is a cost that improves the asset and is added to the cost of the asset.A revenue expenditure is a cost that keeps an asset in its normal operating condition and is treated as an expense.If an expenditure increases the life of the asset or its productivity, it should be treated as a capital expenditure and added to the asset account.If an expenditure simply maintains the productive capacity of the asset during the current accounting period only, it should be treated as an expense.

12

Depreciation

DepreciationThe allocation of the cost of the asset over its useful lifeExpenseNon-cash itemProcess of allocation not valuation

13

Depreciation

Factors contributing to decline in value of a non-current asset– Wear and tear through physical use of asset– Technical obsolescence– Commercial obsolescence

Depreciation is made to ensure matching principle.

14

Depreciation

3 factors in calculating depreciation

15

Accumulated depreciation

The amount of depreciation that has accumulated since the purchase of the asset.Contra asset accountIncrease by a creditDecrease by a debitNormal balance is credit balance

16

Net book value or carrying value

This is the value of the asset after subtracting depreciation from the original cost of the asset. That is, cost less accumulated depreciationRepresents the value of the asset in the accounting records.

17

Depreciation methods

Straight-line methodReducing-balance Units of production

18

Lecture example

Truck Purchase(cost): $100,000Estimated Useful Life: 5 yearsResidual Value: $ 10,000Useful life in kilometres 90,000

Year 1 20,000 kilometresYear 2 30,000 kilometresYear 3 10,000 kilometresYear 4 20,000 kilometresYear 5 10,000 kilometres

19

Straight line method

Depreciation expense the same amount every year over the useful life of the asset.FormulaDepreciation = Cost – Residual Value

exp p.a Estimated Useful Life

20

Straight line method

Year DepreciationAccumulated depreciation Book value

1

2

3

4

5 10,00021

Reducing balance method

Applied at a particular rate – Double declining method: applied at double of the

straight line rate.

Calculated on last periods book valueAccelerated method– Why?

• Because more of the depreciation cost is allocated to the earlier years of an asset’s life and less depreciation to the latter years.

22

Reducing balance method

Reducing balance rate = double the straight-line rate.– What is the depreciation rate?

What is the depreciation expense in each of the five years?What is the book value at the end of the fifth year?

23

24

Reducing balance method

Year DepreciationAccumulated depreciation Book value

1

2

3

4

5 10,000

Units of production

This method assumes that depreciation is solely through the usage of the assetAllocates depreciation based on the units of output or use during each period of an assets useful life

25

26

Units of production

Year DepreciationAccumulated depreciation Book value

1

2

3

4

5 10,000

Comparison of depreciation method

The choice of depreciation method can have a significant impact on firms’ financial statements.The method to be selected should be chosen on the basis of best satisfying the matching principle.The choice of depreciation method should be linked to the nature of asset being considered. A business may use both methods for different assets that have different revenue-earning patterns.

27

28

Choice of depreciation method

Factor Likely choice

Simplicity Straight line method

Reporting to stockholders Straight line method

Comparability Same method with others in the same industry or line of business

Management bonus plan Straight line method

Technological competitiveness

Accelerated method

Reporting for tax purpose Accelerated method

Disposal of PPE

When an asset is disposed, all accounts related to it must be removed. The asset account and accumulated depreciation should be eliminated from the balance sheet.The gain or loss on sale of asset is recorded as Other income/ expense in the income statement.

29

Disposal of PPE

Example: 1 Jan 20X7, a machine is purchased for $20,000Estimated residual value: $2,000, estimated useful life:5 yearsAssume it is sold on 1 Jul 20X9.Accumulated depreciation up to 1 Jul 20X9 (2.5 years) = {(20,000 – 2,000)/5} * 2.5 = 9,000

30

Disposal of PPE

Proceeds from sale of the machine is $12,400Book value = Cost – Accumulated depreciation

= 20,000 – 9,000 = 11,000Gain on sale = 12,400 – 11,000 = 1,4001 Jul 20X9

Dr Accumulated depreciation 9,000Dr Cash 12,400

Cr Machine 20,000 Cr Gain on sale of asset 1,400

31

Disposal of PPE

Proceeds from sale of the machine is $10,000Book value = Cost – Accumulated depreciation

= 20,000 – 9,000 = 11,000Loss on sale = 11,000 – 10,000 = 1,0001 Jul 20X9

Dr Accumulated depreciation 9,000Dr Cash 10,000Dr Loss on sale of asset 1,000

Cr Machine 20,000

32

Intangibles

PatentsCopyrightsTrademarks, brand namesFranchises, licensesGoodwill

33

Tutorial

S9-2S9-3E9-13E9-14E9-15

34

E9-19E9-21E9-22P9-27AP9-28A