Chapter 11 Exercise Reviews

Question 1

Define Depreciation

Answer 1

The process of allocating the cost of a non-current asset (as an expense) over its useful life

Question 2

Explain why GST paid on the purchase of the non - current asset is not included in the calculation of depreciation

Answer 2

The GST is not included in the cost of the asset as it does not affect the economic benefit provided by the office furniture. It will not provide an economic benefit for the life of the asset but will reduce the GST liability only when the asset is purchased.

Question 3

Referring to one accounting principle, explain why it is necessary to depreciate non - current assets

Answer 3

Reporting Period

To ensure that the cost incurred in relation to a non-current asset is reported as an expense in each Reporting Period over its useful life. This ensures that profit is calculated accurately.

Question 4

Explain why the residual value is deducted from the historical cost of the asset in the calculation of depreciation expense

Answer 4

The residual value will not be consumed by the current owner/entity so it must not be allocated as an expense of that business/entity. It will be consumed by the next owner.

Question 5

Explain the effect of depreciation on the firms bank balance

Answer 5

No effect: Depreciation is a non-cash expense/does not involve a cash inflow or outflow. It refers to the consumption of the value of a non-current asset.

Question 6

Referring to 1 qualitative characteristic, explain why the asset must be shown in the balance sheet at its carrying value

Answer 6

Relevance

Given that part of the value of the asset has been consumed, it is more useful for decision-making to show the asset at its carrying value than its Historical Cost. The Historical Cost alone is no longer useful for decision-making.

Question 7

Define
1- Historical Cost
2- Accumulated Depreciation
3- Carrying Value

Answer 7

1- Historical Cost – the original purchase price of the asset

2- Accumulated Depreciation – the value of the asset that has been consumed/allocated as an expense over its life so far

3- Carrying value – the value of the asset that is yet to be consumed/allocated as an expense, plus any residual value

Question 8

Explain why the software license fee should not be included in the cost of the asset

Answer 8

The licence fee will not provide an economic benefit for the life of the asset – it only lasts for 12 months so it is a current asset rather than a non-current asset.

Question 9

Explain how the software license fee would be reported in the balance sheet

Answer 9

Current Asset

Question 10

Shelves fitted into van

Explain your treatment of fitting shelves

Answer 10

Included in the cost of the van as it is necessary to bring the asset into a condition and location ready for use, and will bring a benefit for the life of the asset because the shelves are fitted in the van.

Question 11

Referring to 1 accounting principle, explain why office furniture should be depreciated

Answer 11

Reporting Period

To ensure that the cost incurred in relation to a non-current asset is reported as an expense in each Reporting Period in which the asset earns revenue. This ensures that profit is calculated accurately.

Question 12

Referring to 1 accounting principle, explain why the original purchase price of the asset is disclosed in in the balance sheet

Answer 12

Historical Cost

The original purchase price of the asset is verifiable by reference to the source document.

Question 13

Explain the purpose of balance day adjustments

Answer 13

To ensure profit is calculated accurately by comparing revenues earned and expenses incurred in the current Reporting Period

Question 14

Discuss whether the amount of drawings taken by the owner is appropriate

Answer 14

$16 000 is very low for an entire year (just over $300 per week), especially considering this might be the owner’s main source of income (his salary). However, the business suffered a Net Loss (of $8 250) so Drawings will cause Owner’s Equity to decrease. Further, the business has a Bank overdraft (of $5 300), meaning the Drawings might make it difficult for the business to meet its cash requirements.

Question 15

Referring to 1 accounting principle, explain the purpose of closing entries

Answer 15

Reporting Period

To transfer revenue and expense amounts to the Profit and Loss Summary account in order to calculate profit for the current Reporting Period.
Or
To reset revenue and expense accounts to zero in readiness for the next Reporting Period.

Question 16

Explain what the income statement reveals about the businesses reputation
no advertising

Answer 16

The firm’s reputation must be strong because there is no Advertising expense listed under Other Expenses and yet it has still earned $120 000 in Sales revenue.

Question 17

Items that can be used to support the view that the firms financial position is sound

Answer 17

• Current assets
  There are enough current assets to cover current liabilities (and non-current liabilities).
• Owners Equity
  Owner’s equity has increased
• Vehicle
  Vehicle is relatively new
• Loan
  The Loan – NAB will be repaid in just over two years
• Bank
  Bank is in positive

Question 18

Referring to 1 qualitative characteristic, explain why the van should not be valued at its historical cost

Answer 18

Relevance

When acquired by the business, the shop fittings had an agreed value of $9 400. This value is more useful for decision-making by the business. ($12 000 was paid by the owner – a separate entity to the business).

Question 19

The delivery van was not used for two months, explain whether is should still be depreciated for those two months

Answer 19

Yes:
straight line depreciation allocates the cost according to time not usage, i.e. the life of the asset is measured in years, not units of use.

Question 20

*Explain why depreciation expense is considered relevant

Answer 20

The allocation of depreciation provides a more accurate matching of revenues and expenses so that net profit can be calculated accurately, therefore ensuring reports contain all information that is useful for decision making

Question 21

*Explain why depreciation expense may not be considered reliable

Answer 21

Depreciation is based on estimates such as useful life and residual value, and therefore cannot be verified by source documents. Depreciation is based on personal opinion and therefore is not free from bias

Question 22

*Explain why non-current assets should be depreciated

Answer 22

To ensure that the cost incurred in relation to a non-current asset is reported as an expense in each Reporting Period over its useful life. This ensures that profit is calculated accurately.

Question 23

*With reference to a qualitative characteristic explain why the amount for the new equipment ($480) could be treated as an expense, rather than a non - current asset

Answer 23

The amount of the asset is insignificant and treating it as an expense would not impact on management decision making. Because of the small amount involved it can be written off as an expense