CHAPTER 11 Flashcards
Depreciable Asset
A non-current asset that has a finite life, and must be depreciated over its life.
Finite Life
The limited period of time (usually measured in years) for which a non-current asset will exist.
Depreciation
The allocation of the cost of a non-current asset over its useful life.
Because a non-current asset is not consumed entirely within one Reporting Period, depreciation is an attempt to calculate how much of the assets value has been consumed in the current Reporting Period. It therefore spreads out or allocates the cost of the asset over the years in which it is useful for earning revenue, rather than treating all of the cost as an expense in any one year.
Depreciation expense
That part of the cost of a non-current asset that has been consumed in the current Reporting Period.
Purpose of depreciation
Just like adjustments for accrued or prepaid expenses, depreciation is a balance day adjustment and, consequently, the purpose of depreciating non-current assets is the same as the purpose of any other balance day adjustment. All balance day adjustments, depreciation included, are made to ensure that an accurate profit is calculated, by comparing revenues earned against expenses incurred in the current Reporting Period. Depreciation does this by recognising as an expense only that part of the cost of a non- current asset that is consumed/incurred in the current Reporting Period. This will also ensure that the Income Statement upholds Relevance by including all information that is useful for decision-making.
Straight line depreciation
The straight-line method of calculating depreciation assumes that non-current assets contribute evenly to revenue, doing the same job in the last year of their life as they did in their first. As a result, it assumes that the value of a non-current asset is
consumed evenly over its life, so the depreciation expense is the same every year. If this depreciation expense was plotted on a graph, the line would be a straight line, giving the method its name.
Depreciable value
However, we may dispose of the asset while it still has some value. This amount will then not be consumed by our business, but by another entity. Thus, the residual value must be deducted from the Historical Cost, because this is the amount that will not be consumed by our business.
The amount calculated by deducting residual value from Historical Cost (in the top tine of the equation) is known as the depreciable value. it is the total value of the asset that will be consumed by the current owner/entity, and so must be allocated over its useful life.
Accumulated depreciation
The value of a non-current asset that has been consumed/incurred over its life thus far.
Carrying value
The is calculated by deducting any accumulated depreciation from the Historical Cost of the asset. It represents the unallocated cost of the asset; that is, the value of the asset that is yet to be consumed (and yet to be allocated as clepreciation expense) plus any residual value. Because this carrying value is yet to be consumed, it represents a future economic benefit, which should by now be obvious as the definition of an asset!
Cost of a non-current asset
all costs incurred in order to bring the asset into a location and condition ready for use, which will provide a benefit for the life
of the asset.
Why depreciate non-current assets if we are undermining a key qualitative characteristic?
Relevance. Depreciation ensures that the Income Statement includes ail information that is useful for decision-making about profit, by showing the consumption of non-current assets in the current Reporting Period. Similarly, by showing accumulated depreciation in the Balance Sheet, it ensures that assets are shown at their carrying value, which is vital for decision-making about their replacement.
In this sense, Relevance overrides Reliability so that the accounting reports fulfif their function of providing useful financial information: not accounting for any depreciation at all would be more incorrect than accounting for depreciation using estimates.
Referring to conservatism explain the purpose of depreciating non-current assets
The conservatism principle requires that losses be recorded when they are likely to occur so as to not overstate assets. (1 mark) As depreciation represents the cost of a non-current asset that has been consumed, the amount needs to be reported so as to not overstate the value of assets on the Balance Sheet.
Why is the residual value deducted from the historical cost
Only the depreciable cost is allocated as an expense over the estimated useful life of the non current asset since the non current asset (NCA) is estimated to still be worth something when it has finished its productive use for the business. Depreciation is the allocation of the depreciable cost of the NCA over its estimated useful life and therefore the value of the asset at the end of its life is necessary to allocate the cost over its useful life.
Historical cost
The cost of the non current asset plus any additional cost to get the asset into a condition and position for productive use or revenue generation. Examples of additional costs are freight inwards, installation and modifications.
If the amount is small, is it ok to call it an expense rather than a non current asset
Relevance
Yes, the amount is so insignificant or immaterial that it would not have an effect on managerial decisions. Because it is such a small amount it can be written off as an expense without negatively effecting decision making, the amount is so small that it is not relevant for decision making and can this be written off as an expense.
