Chapter 11 NCA part 2

Question 1

Define the term depreciation

Answer 1

-Depreciation is the allocation of the cost of a non-current asset over its estimated useful life.(1m)
Depreciation is considered as a part of the cost of non-current asset that has been used up to generate income. Thus, depreciation is an expense and is presented in the statement of financial performance.(2m)

Question 2

Using an appropriate accounting theory, explain why a business should depreciate its non-current assets

Answer 2

According to the matching theory, the portion of the cost of using the non-current asset(depreciation expense) should be matched against the income earned from using the non-current asset in the same financial period to determine the profit for the period.

Question 3

What are the causes of depreciation?

Answer 3

1. Wear and tear
   -a non-current asset may decrease in value due to physical wear and tear from usage and exposure.
   2.Obsolescence
   -A non-current asset may decrease in value due to the emergence of new technology 3.Usage
   -A non-current asset may decrease in value when the benefits of the non-current asset are consumed by the business
   4.Legal limits
   -A non-current asset may decrease in value over time as it approaches its limits or rights on the use of the asset. Example leasehold property can only be occupied for a limited period of time with the exception of land, which has unlimited useful life.

Question 4

Define accumulated depreciation

Answer 4

-Accumulated depreciation is the total depreciation to date of a non-current asset.(1m)
It is a contra-asset and is deducted from the original cost of the non-current assets in the statement of financial position to arrive at the net book value. (2m)

Question 5

Using appropriate accounting theory, explain how a business should value its non-current assets

Answer 5

Non-current assets should be valued at their net book value. This is according to the prudence theory which states that assets and profits should not be overstated, and expenses and losses should not be understated. Thus, business provides for accumulated depreciation which will be deducted from the original cost of the non-current assets. This is to ensure that non-current assets are not overstated and reflects their net book value.

Question 6

Explain why different methods of depreciation are used for different non-current assets

Answer 6

The method of depreciation used should reflect an accurate pattern of usage of the non-current asset.
The straight-line method is used for non-current asset which provides the same benefits throughout its estimated useful life, such as fixtures and fittings when the business uses the non-current asset uniformly throughout its estimated useful life. Hence, an equal amount of depreciation expense is recorded every financial period.
On the other hand, the reducing-balance method is used for non-current asset which provides more benefits in its earlier years, such as motor vehicle when the business uses the non-current asset more in its earlier years and less as it gets older and become less efficient. Hence, a higher amount of depreciation expense is recorded in the earlier years and reduces as time goes by.

Question 7

Should a business change its depreciation methods every year? Explain your answer with reference to an accounting theory.

Answer 7

Consistency Theory
No, unless there is a change of usage pattern, a business should use the same method of depreciation and rate of depreciation every financial period to enable meaningful comparison of net book value of non-current assets over time.
This is based on the consistency theory which states that once an accounting method is chosen , this method should be applied to all future accounting periods to enable meaningful comparison.