5. Non-current assets Flashcards
How is PP&E valued?
The value of Property, Plant & Equipment is usually recorded at their original cost. The PP&E acquisition cost (gross value) depends on how the firm acquired the asset:
- Purchased: recorded at their purchase cost.
- Developed in house (built by company): recorded at construction cost.
- Business combination: recorded at their appraised value at the time of the transaction.
What is depreciation?
A process used to recognise the costs of tangible non-current assets.
Depreciation is an annual expense (in SoPL) and a reduction in the net value of a non-current asset (in SoFP) over time, normally due to wear and tear.
The process of depreciation is intended to recognise the cost of ownership of property, plant and equipment and to match it against the benefits gained from using it throughout its useful life.
What is residual value?
The scrap or resale value of an asset at the end of its useful economic life.
What is the useful economic life of an asset?
The period in which the firm expects to receive an economic benefit from the asset (not necessarily the actual usable life of the asset, company may choose to sell them after a certain time even if they are still usable).
What is the straight line method? In what situations is this most appropriate?
A depreciation calculation method in which the costs (depreciable amount) is spread out evenly over the asset’s useful economic life. This is most appropriate when the benefits from using the asset are spread out evenly too.
What is the reducing balance method? In what situations is this most appropriate?
A depreciation calculation method in which most of the costs of ownership are taken in the earlier years and then tail off as the asset ages. This method is appropriate for assets where the benefits generated from using the asset - usually the revenues - are front-loaded; they are expected to start high and then taper off over time.
How do the results from the straight-line method compare to those of the reducing balance method?
The straight-line method results in a lower depreciation charge in earlier years and thus:
- Higher profits in early years
- Higher asset value in early years
What is impairment of PP&E?
Impairment expense is any reduction in the value of an asset for reasons excluding normal wear and tear (so not depreciation).
Impairment charges are expenses in SoPL that occur when the estimated future economic benefits of an asset decrease.
What are some causes of impairment of an item in PP&E?
- Physical damage (valuation fallen below asset’s carrying value)
- Valuation loss (e.g., worsening market conditions, competition, falling demand)
