7. Fixed asset or depreciation

Question 1

What are the two types of expenditure in question?

Answer 1

Capital expenditure and revenue expenditure

Question 2

What is capital expenditure on assets, expenditure incurred in?

Answer 2

• 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.

Question 3

What is revenue expenditure on assets, where is the expenditure incurred in?

Answer 3

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

Question 4

What can fixed assets be classified into?

Answer 4

Tangible and intangible

Question 5

What are tangible fixed assets?

Answer 5

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

Question 6

What are intangible fixed assets?

Answer 6

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

Question 7

How is the purchase of a fixed asset recorded?

Answer 7

Dr Asset cost account
Cr Bank account/creditor

Question 8

Define depreciation

Answer 8

Per FRS 102: the systematic allocation of the depreciable amount of an asset over its useful life

Question 9

What is the aim of depreciation?

Answer 9

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)

Question 10

What are the 3 factors we need to consider to determine the amount of the depreciation expense?

Answer 10

1. The carrying amount of the asset
2. the length of the asset’s expected useful life to the entity
3. the estimated residual value of the asset at the end of its useful life to the entity

Question 11

What is the carrying amount of the asset?

Answer 11

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.

Question 12

What is fair value?

Answer 12

the amount an asset can be sold for at an arm length’s transaction between willing parties (basically MV)

Question 13

What is an asset’s useful life?

Answer 13

the period of time over which the present owners derive economic benefit.

Question 14

What are five ways to describe useful life?

Answer 14

1. PREDETERMINED; as in the case or leade or property
2. DEPLETION - extraction of resources from the asset itself e.g. oil fields
3. PHYSICAL DETERIORATION - erosion through use or passing of time primarily through process of rust, rot, general decay
4. TIME - flow of benefits directly related to time e.g. patents and copyrights
5. ECONOMIC OBSOLENCE - useful life may be reduced by economic or technological obsolescence

Question 15

what is estimated residual value?

Answer 15

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

Question 16

What are the two main methods of calculating depreciation?

Answer 16

1. straight line method
2. reducing balance method

Question 17

Explain the straight line method and what is the formula?

Answer 17

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

Question 18

What is the reducing balance method?

Answer 18

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.

Question 19

Explain how depreciation can be recorded

Answer 19

• it is an expense in the P&L account and thus, there has to be a corresponding depreciation expense account in the records.

Question 20

Given depreciation is charged as an expense on the P&L, does it have an impact on the cash within the business?

Answer 20

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

Question 21

What is the provision for depreciation account (accumulated depreciation)?

Answer 21

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

Question 22

what is the double entry necessary to record the depreciation charge each year in the ledgers?

Answer 22

Dr depreciation account (P&L)
Cr provision for depreciation account (balance sheet)

Question 23

What does the depreciation account record?

Answer 23

It records the expense for the year and is closed off to the P&L account

Question 24

What does the provision for depreciation account record?

Answer 24

It records the total accumulated depreciation to date and appears on the balance sheet as a reduction in the value of the fixed assets

Question 25

What is the practice (for depreciation) for assets only owned for part of the year?

Answer 25

-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.

Question 26

Explain the disposal of a fixed asset

Answer 26

-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

Question 27

What is the profit or loss on disposals for tax purposes?

Answer 27

-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

Question 28

Explain part exchange of a fixed asset

Answer 28

-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