7 - Fixed Assets & Depreciation Flashcards
Examples of capital expenditure
- Acquisition of assets required for continuing use in the business (fixed assets in Companies Act 2006), property, plant and equipment (in FRS Section 17) e.g. buildings, motor vehicles, fixtures, fittings, equipment, computers, and machinery
- Alteration or improvement of asstes for the purpose of increasing revenue earning capacity
Benefit for more than one period, not immediately expensed or charged to P&L
Examples of revenue expenditure
- Purchase of assets required for conversion into cash (i.e. goods for resale)
- Manufacturing, selling and distribution of goods and day-to-day administration of business
- Maintenance of fixed assets (i.e. repairs) which just maintains revenue earning capacity (rather than increasing it)
Expensed or charged to the P&L account when incurred
Define tangible fixed assets
Assets which can be physically seen or touched, i.e. buildings, plants and motor vehicles. Have physical substance, held for use in production or supply of goods or services, or for administrative purposes on a continuing basis in reporting of an entity’s activities
Define intangible fixed assets
Assets which cannot be physically seen or touched, i.e. goodwill, copyrights and patents. Non-monetary fixed assets that don’t have physical substance, identifiable as capable of being sold separately from the entity, or are controlled by the entity through custody or legal rights
How is a purchase of a fixed asset recorded?
Define depreciation
- systematic allocation of depreciable amount of an asset over its useful life
- depreciable amount is cost to entity of using fixed asset over useful life
- cost of asset should be charged or expensed to P&L account over the same years as expense (the period the entity expects to benefit from the asset)
What are the factors that determine the rate of depreciation?
- carrying amount of the asset
- 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 meant by the useful life of an asset?
The period over which the present owner will derive economic benefit - doesn’t matter if can be used by another entity after no longer useful to the original entity
How can an asset’s useful life be determined?
- Predetermined (lease of property)
- Depletion (extraction of resources from asset itself, i.e. coal seams, oil fields, sand and gravel quarries)
- Physical deterioration (erosion through use of passing of time, i.e. due to rust, rot, general decay through exposure to the elements)
- Time (e.g. patents and copyrights)
- Economic obsolescence (reduced by economic or technological obsolescence e.g. computers)
Define estimated residual value
Estimated amount entity could currently obtain for asset at end of its useful life, taking into account age and expected condition of asset at end of its useful life
What are the two methods of calculating depreciation?
- straight line method
- reducing balance method
How can the straight line method be used to calculate depreciation?
Annual charge = (cost - residual value if any)/useful life
How can the reducing balance method be used to calculate depreciation?
Applies a fixed percentage to asset’s net book value (asset’s cost less accumulated depreciation). As a percentage of the reducing balance is taken, the depreciation charge will decrease each year.
If asset likely to depreciate quickly in its early life (i.e. motor vehicle) the reducing balance method may be appropriate
Mr Watson charges 45% using the reducing balance method for the depreciation of his van. A van purchased on 1 January 2020 cost £11,000. Show the relevant depreciation expense for 2020 and 2021.
2020 depreciation = 45% x £11,000 = £4,950
2021 depreciation = 45% x (£11,000 - 4,950) = £2,723
Why is depreciation not allowable for tax purposes?
Can be largely determined by business through choice of method and rate of depreciation. Therefore, can be used to manipulate profits hence can not reduce profits for tax purposes. Replaced by capital allowances which represent tax equivalent of depreciation, but charged at rates set by the government
Double entry to record the depreciation charge
Create a separate account called provision for depreciation a/c
Mr Watson has purchased a machine for £10,000 on 1 January 2020. It is anticipated the machine will have a useful life of 3 years and be worth £1,000 scrap value. A straight line method of depreciation is appropriate
£3,000 p.a.
How is depreciation calculated when assets are only owned for part of the year?
Depreciation charge should be approtioned for number of months owned. Accepted practice to charge full year’s depreciation in year of purchase and no charge in year of disposal.
How do you record the disposal of a fixed asset?
Mr Watson sells a van for £700 during 2021. It originally cost £2,000 and so far depreciation has amounted to £1,500. Review the entries in the disposal account, motor van account and provision for depreciation account.
NBV = cost - acc depreciation = £500
If a fixed asset is scrapped how is it treated?
Treat as a normal disposal but without any sales proceeds
How would you do the double entry to record the part exchange of a fixed asset?
Proceeds are not cash but instead a part exchange allowance against the purchase price of the new asset
How would you do the double entry to record the part exchange of a fixed asset?
Proceeds are not cash but instead a part exchange allowance against the purchase price of the new asset
Mr Watson has part exchanged a van (originally costing £2,000 with accumulated depreciation of £1,500) for a new one during 2021.
The garage gave him an allowance of £700 against the price of the new van which was £5,000. He paid the balance by cheque. Complete all double entries.
NBV = £500
