7. Fixed asset or depreciation Flashcards
What are the two types of expenditure in question?
Capital expenditure and revenue expenditure
What is capital expenditure on assets, expenditure incurred in?
- the acquisition of assets for continuing use in the business (Fixed assets as per Companies Act 2006 or property, plant and equipment in FRS 102 section 17).
- alteration/improvement of assets for purpose of increasing their revenue earning capacity
Intended that expenditure will benefit the entity for more than one period and thus, cap ex not immediately expensed or charged to P&L account.
What is revenue expenditure on assets, where is the expenditure incurred in?
This is expenditure which is expensed or charge to the P&L account when such expenditure is incurred.
Expenditure incurred in:
1. purchase of assets required for conversion into cash e.g. goods
2. the manufacturing, selling and distribution of goods and day to day administration of the business
3. maintenance of fixed assets, which just maintains their revenue earning capacity rather than increasing it
What can fixed assets be classified into?
Tangible and intangible
What are tangible fixed assets?
assets which can physically be seen and touched e.g buildings. They have physical substance and are held for use in production or supply of goods or services or for administrative purposes on a continuing basis in the reporting entity’s activities
What are intangible fixed assets?
assets which cannot physically be seen or touched e.g. goodwill. these are non-monetary assets but are identifiable as they are capable of being sold separately by the entity or are controlled through custody or legal rights
How is the purchase of a fixed asset recorded?
Dr Asset cost account
Cr Bank account/creditor
Define depreciation
Per FRS 102: the systematic allocation of the depreciable amount of an asset over its useful life
What is the aim of depreciation?
To spread the cost of the fixed asset over the period over which the entity expects to benefit from the use of the asset (its useful life)
What are the 3 factors we need to consider to determine the amount of the depreciation expense?
- The carrying amount of the asset
- the length of the asset’s expected useful life to the entity
- the estimated residual value of the asset at the end of its useful life to the entity
What is the carrying amount of the asset?
The asset is valued to the business as:
1. historic cost (original purchase price)
2. asset’s revalued amount. businesses may revalue their fixed value to FAIR VALUE e.g. freehold and leasehold property. these revalued amounts can be incorporated in their financial statements instead of historic costs.
What is fair value?
the amount an asset can be sold for at an arm length’s transaction between willing parties (basically MV)
What is an asset’s useful life?
the period of time over which the present owners derive economic benefit.
What are five ways to describe useful life?
- PREDETERMINED; as in the case or leade or property
- DEPLETION - extraction of resources from the asset itself e.g. oil fields
- PHYSICAL DETERIORATION - erosion through use or passing of time primarily through process of rust, rot, general decay
- TIME - flow of benefits directly related to time e.g. patents and copyrights
- ECONOMIC OBSOLENCE - useful life may be reduced by economic or technological obsolescence
what is estimated residual value?
estimated amount the entity could currently obtain for the asset at the end of its useful life, taking into account the age and expected condition of the asset at the end of its useful life
What are the two main methods of calculating depreciation?
- straight line method
- reducing balance method
Explain the straight line method and what is the formula?
method identified an equal depreciation charge against each period of the asset’s useful life
Annual charge = cost less residual value(could be nil)/useful life
What is the reducing balance method?
Applies a fixed percentage to asset’s net book value, where NBV is asset’s cost less accumulated depreciation. As a percentage of reducing balance is taken, depreciation will decrease each year.
Explain how depreciation can be recorded
- it is an expense in the P&L account and thus, there has to be a corresponding depreciation expense account in the records.
Given depreciation is charged as an expense on the P&L, does it have an impact on the cash within the business?
No it does not; the ongoing charge to the P&L is designed to reduce the cost of the asset which has been recorded in the accounts, over its useful life
What is the provision for depreciation account (accumulated depreciation)?
It is a balance sheet ledger account used to reduce the value of an asset in the balance sheet, since the original cost is being written down. The balance is set against the debit balance on the asset cost account in the balance sheet to reach the net book value
what is the double entry necessary to record the depreciation charge each year in the ledgers?
Dr depreciation account (P&L)
Cr provision for depreciation account (balance sheet)
What does the depreciation account record?
It records the expense for the year and is closed off to the P&L account
What does the provision for depreciation account record?
It records the total accumulated depreciation to date and appears on the balance sheet as a reduction in the value of the fixed assets
What is the practice (for depreciation) for assets only owned for part of the year?
-In theory, the depreciation charge should be apportioned for the number of months it is owned
-An accepted practice is to charge a full year’s depreciation in the year of purchase and no charge in the year of disposal.
Explain the disposal of a fixed asset
-If disposed of or sold, it is likely the proceeds will differ from the NBV.
-Since we are replacing the NBV of the asset in the BS with cash received, the difference will signify a profit or loss on disposal
-We also need to remove the asset and its associated accumulated depreciation from the books of the business
-all info is collected into an ASSET DISPOSAL ACCOUNT
What is the profit or loss on disposals for tax purposes?
-the profit or loss will not represent income which is taxable or an expense which is allowable
-the profit/loss is also disallowed for tax purposes and an appropriate adjustment is made to remove the entry.
-Any cash proceeds will be used to calculate a taxable gain upon disposal
Explain part exchange of a fixed asset
-This is when an asset is disposed of partly in exchange for a new one, with the balance being made up in cash
-the proceeds are not cash but a part exchange allowance against the purchase price of the new asset
