CHAPTER 15

Question 1

Why business’s purchase non current assets on credit

Answer 1

Given the large outlays of cash that are sometimes necessary to purchase non-current assets (such as vehicles, furniture or equipment), many businesses now choose to purchase these items on credit. This allows them to repay the creditor in instalments rather than in one large payment.

Question 2

What ledger account is used for purchasing non current assets on credit

Answer 2

Where a firm purchases an asset other than stock a separate sundry creditor account, which names the sundry creditor must be created in the General Ledger. The sundry creditor is still a current liability, but has its own account in the General Ledger, and would be reported separately in the Balance Sheet.

Question 3

How are payments of sundry creditors recorded in the cash flow statement and the cash payments journal

Answer 3

Because they are separate to the Creditors Control account, payments made to these sundry creditors must be recorded in the Sundries (rather than the Creditors Control) column of the Cash Payments Journal. And because such a payment would be a cash outflow related to the purchase of a non-current asset it would be reported as an Investing outflow in the Cash Flow Statement.

Question 4

The cost of a non current asset

Answer 4

All costs incurred in order to bring the asset into a location and condition ready for use that will provide a benefit for the life of the asset. This will obviously include the supplier’s price but may also include costs such as delivery, modification and installation. Where these other costs exist they must be included in the cost price of the asset recorded in the General Journal.

Question 5

The assumption made under the straight line method of depreciation

Answer 5

The assumption made by this method of depreciation is that the asset being depreciated will contribute evenly to revenue, doing the same job when it is old as when it is new.

Question 6

Reducing balance method of depreciation

Answer 6

The reducing balance method of depreciation assumes that the asset will contribute more to revenue at the start of its life, when it is new, efficient and productive. As a consequence, this method allocates more depreciation expense at the start of the asset’s life. Under this method, as the asset ages, its contribution to revenue decreases and so too does the depreciation expense.

Question 7

Advantage of the reducing balance method

Answer 7

Using the reducing balance method ensures that the depreciation expense and the revenue the asset earns are matched in each Reporting Period. Both are higher at the start, but reduce over the life of the asset.

Question 8

Main difference between the two different methods of depreciation

Answer 8

Under the straight-.line method depreciation expense isthe same each year because it is calculated as a percentage of the Historical Cost of the asset. By contrast, the reducing balance method calculates depreciation expense as a percentage of the carrying value.

Question 9

Calculating depreciation expense using reducing balance formula

Answer 9

Depreciation expense ($ per annum) = Carrying value x Depreciation rate

where carrying value = Historical Cost - accumulated depredation

Question 10

3 similarities between the two methods of depreciation

Answer 10

the General Journal entries required to record depreciation expense; that is
DR Depreciation - Non.-Current Asset CE)
CR Accumulated Depreciation - Non-Current Asset (- A)
o

the reporting of depreciation expense in the Income Statement (as Other Expense’) and accumulated depreciation in the Balance Sheet (as a negative asset)

• the effect on the accounting equation and Balance Sheet; that is
• an increase in accumulated depreciation leading to a decrease in assets
• an increase in expenses leading to a decrease in Net Profit and decrease in
  owner’s equity

Question 11

1 difference between the two methods of depreciation

Answer 11

Using the straight-line method, depreciation expense will be the same each year. This does not mean that the asset is not ageing, or that its productive capacity is not being consumed, just that it is being consumed evenly.

Using the reducing balance method, depreciation expense will be higher at the start and decrease as the asset ages.

Question 12

Graphics

Answer 12

Photo in favourites. By the way ‘The Handmaid’s Tale’ is a fantastic tv show.

Question 13

Selecting a depreciation method

Answer 13

• If the asset contributes evenly to revenue, and its cost is consumed evenly, over its life, the straight-line method should be used.
• If the asset contributes more to revenue, and its cost is consumed more, at the start of its life and less as it ages, the reducing balance method should be used.

Question 14

Consistency and comparability in regards to depreciation

Answer 14

While this choice exists, the accounting principle of Consistency demands that once a method is chosen, that method should be used from one period to the next. This allows reports to be compared from one period to the next, maintaining Comparability. Changing depreciation methods is possible, but the change must be clearly disclosed in the reports.

Question 15

Recording the disposal of a non-current asset involves three steps:

Answer 15

1 transferring the carrying value (the cost price of the asset)
2 recording the proceeds from the sale (the selling price of the asset)
3 transferring the profit or loss on disposal of the asset.

Question 16

How many General journal entries when disposing a non current asset

Answer 16

4 (see chapter 15 if you can’t remember what they are)

Question 17

Loss on disposal of asset

Answer 17

When the proceeds from the sale of the asset is less than its carrying value .

Question 18

Profit on disposal of asset

Answer 18

where the proceeds from the disposal of an asset are
greater than its carrying value

Question 19

Trade in

Answer 19

In some situations a firm will not sell an asset for cash, but rather use that asset as a trade in on a newer model. This would mean that rather than receiving cash for the sale of the asset, the firm would receive a reduction in the amount payable (to the sundry creditor) for the purchase of a new asset.

Question 20

Reasons for a loss on disposal

Answer 20

A loss on the disposal of a non-current asset occurs when the carrying value of the asset is greater than the proceeds from its sale (its resale value). That is, we had valued the asset at more than it was really worth.

Question 21

Under depreciation

Answer 21

Occurs when insufficient depreciation has been allocated over the life of the asset so that the carrying value is overstated. This could be caused by the residual value or useful life being overstated (perhaps because the asset was damaged, superseded by a newer model or not in demand).

Question 22

Why overstating life or residual would result in under depreciation

Answer 22

Overstating the residual value or useful life would mean not enough depreciation would have been allocated over the life of the asset. As a result, the carrying value of the asset would be greater than its resale value.

Question 23

Reasons for a profit on disposal

Answer 23

In contrast to a loss, a profit on the disposal of a non-current asset occurs when the carrying value of the asset is less than the proceeds from its sale. This means the asset was valued at less than it was worth.

Question 24

Over depreciation

Answer 24

Occurs when excess depreciation has been allocated over the life of the asset so that the carrying value of the asset is understated. This could be caused by the estimated useful life or residual value being understated perhaps due to high demand or good condition.

Question 25

Why understating residual value or useful life could result in excess depreciation and a understated carrying value.

Answer 25

Understating the residual value or useful life would mean that too much depreciation would have been allocated over the life of the asset. As a result, the carrying va ue of the asset would be /ess than its resale value.

Question 26

What to remember about a disposal of NCA account

Answer 26

It must always balance with either a bank or sundry creditor entry.

Question 27

How often do you update the carrying value for reducing balance depreciation

Answer 27

Every balance day

Question 28

Select and justify the most appropriate depreciation method for a vehicle

Answer 28

As a vehicle would generally be more efficient in its earlier years of use, it would be expected to generate more revenue in its earlier years and less revenue in its later years. As the reducing balance method allocates more depreciation in an asset’s earlier years of use and less depreciation when the asset is older, it is the most appropriate method for depreciating the vehicle.

Question 29

Consider the effect of reducing balance depreciation on the budgeted income statement for the year ending 30 June 2018 and rue budget balance sheet as at 30 June 2018. Use the graph in favourites to help answer this question.

Answer 29

In relation to the Budgeted Income Statement for the year ended 30 June 2018, the graphs provided show that depreciation expense would be higher under the reducing balance method compared to the straight-line method, and therefore the net profit would be lower.

In relation to the Budgeted Balance Sheet as at 30 June 2018, the carrying value of the asset under the reducing balance method is significantly lower than under the straight-line method. The owner’s equity would also be lower at this time because of the greater depreciation expense being allocated under the reducing balance method up to this time.

Question 30

5 different types of General journal entries used when trading in vehicle plus one extra entry that is not always necessary

Answer 30

Unallocated depreciation (extra entry)

Disposal of historical cost

Disposal of accumulated depreciation

Sundry creditor/Bank (the entry will be in crj not gj)

Profit or loss

New asset

Question 31

Justify use of reducing balance for a computer

Answer 31

A computer is likely to be more efficient in its earlier years of use and therefore can be expected to generate more revenue in its earlier years. The reducing balance should be used as it allocates more of an asset’s cost as a depreciation expense in its earliest years, and less in the later years of an asset’s life. By doing this, a more accurate profit will be determined over the life of the asset.

Question 32

Explain how an income statement would differ for the final year of an assets useful life if straight line was used rathe than reducing balance

Answer 32

Depreciation expense would be higher in Year 5 under the straight-line method as it allocates the same amount of depreciation every year. This amount would therefore be higher than the reducing balance method in Year 5, which means that net profit would be lower using the straight-line method.

Question 33

Explain how an accountant should determine the appropriate method of depreciation

Answer 33

The method chosen should allocate the cost of the asset according to the expected revenue-earning pattern of the asset.

If the asset is expected to generate the same amount of revenue each reporting period, the straight line method should be adopted as it allocates the same amount of cost each reporting period.

However, if the asset is expected to be more productive in its earlier years and therefore generate more revenue in those periods, the reducing balance method should be adopted as it allocates more cost in the earlier years and less in the asset’s later years, when it is less productive.

Question 34

Carrying value

Answer 34

The carrying value represents the amount yet to be allocated as depreciation, plus any estimated residual value expected to be realised at the end of the asset’s useful life.

Question 35

A profit or loss on disposal of a non current asset is really just a depreciation adjustment

Answer 35

I agree.

A profit on disposal occurs when the proceeds from the disposal exceeds the carrying value of the asset. This means that the depreciation over the asset’s life had written the asset down too much, possibly due to understating the useful life of the asset or its estimated residual value.

A loss on disposal is the result of under-depreciation and is usually caused by overstating either the estimated residual value or the estimated useful life of the asset.

Question 36

Melissa Smith, the owner of MS Electronics, received the following email from her new accountant.

Hi Melissa,
When reviewing your financial statements from last year, I noticed that you depreciated the photocopier system using the reducing balance method of depreciation. I recommend that you use the straight-line method from now on. Using this method will provide a more appropriate depreciation expense each year for the photocopier.
Regards, Ben

c. With reference to appropriate accounting principles and qualitative characteristics, discuss the factors that the accountant would have considered when making this recommendation.

Answer 36

Depreciation is allocated so that an accurate profit can be determined for a given reporting period. This is achieved by matching the revenue earned by an asset with the expense allocated as depreciation. The method that is selected should consider the revenue-earning pattern of the photocopier. ACCURATE PROFIT

If it is thought that the machine would earn revenue consistently over its lifespan, the straight-line method should be used. If the asset is expected to be more productive in its earlier years, the reducing balance method should be used. By selecting the most appropriate method, the accountant would ensure that the most relevant amount of expense would be written off each reporting period. RELEVANCE

However, as the reducing balance method has already been used, the consistency principle would suggest that the same method should be used again in the future. This is done so that valid comparisons of performance can be made from period to period, thus satisfying the qualitative characteristic of comparability. CONSISTENCY/QC

The conservatism principle would support the reducing balance method as it writes off more of the asset’s cost in its earliest years, thus reducing the likelihood of overstating the value of the asset. CONSERVATISM

Question 37

If a question asks you to justify your treatment of an item and you have included that item as part of the cost of a NCA WHAT DO YOU SAY

Answer 37

The ITEM is included in the cost of the ASSET as it is a cost incurred in getting the ASSET into a condition ready for use to start earning revenue and it is expected to provide future
economic benefits over the life of the ASSET.

Question 38

Refer to a characteristic to explain why you should not switch depreciation methods

Answer 38

The accounting characteristic of comparability demands that reports should be able to be compared from one reporting period to the next. By changing depreciation methods, subsequent accounting reports will not be able to be compared accurately from one year to the next if the method of depreciation and/or method of measurement are changed.

Question 39

Photo in favourites

Explain how the Income Statement would be different for the year ended 30 June 2015 if the
Van was traded in and if the Van was originally depreciated using Option 1.

Answer 39

If the Van was traded-in on 30 June 2015, Ed’s Envelopes would have reported a profit on disposal of $2 600. Yet, if the Van was depreciated using Option 1, there would have been a loss on disposal of $2 000.

Question 40

Explain why a profit on disposal occurred on the trade in

Answer 40

A Profit on Disposal occurred as the trade-in allowance was greater than the carrying value of the Van. This may have been due to over depreciating the Van due to underestimating the Van’s useful and/or residual value as the Van was in better condition than expected when it was traded in.

Question 41

Explain the treatment of GST incurred on the purchase of NCA’S

Answer 41

Even though the GST is an amount incurred ($1050) and paid ($49) in getting the Computer System into a condition ready for use to start earning revenue (1 mark), it is not included in the cost of the Computer System as it will not provide economic benefits over the life of the Computer System.

Question 42

On 1 January 2016, Humphrey’s Hats purchased Shelving costing $8 700 plus GST.

The Shelving is expected to have an estimated useful life of 8 years and an estimated residual value of $1 500.

The accountant was unsure about which method of depreciation should be used. It was decided to depreciate the Shelving using the straight-line method.

Humphrey stated: ‘It doesn’t matter which method we choose as we can change to the reducing-balance method of depreciation next year if we want to’.

Referring to one accounting principle and one qualitative characteristic, explain whether
Humphrey is correct.

Answer 42

Humphrey is incorrect in assuming that depreciation methods can be changed, as the accounting principle of consistency demands that once a depreciation method has been chosen, that method should be used from one period to the next. CONSISTENCY

Also, the qualitative characteristic of comparability demands that reports should be able to be compared from one reporting period to the next. COMPARABILITY

By changing depreciation methods, subsequent accounting reports will not be able to be compared accurately from one year to the next if the method of depreciation and/or method of
measurement are changed. EXPLAIN QC

An inconsistent approach to depreciating assets may see a significant change in profit from one reporting period to the next, a change that may not be a reflection of a change in trading performance but rather just an accounting adjustment. MISLEADING

Question 43

Explain treatment of VicRoads registration

Answer 43

Even though the registration is required to get the Van into a condition ready to start earning revenue, it is not included in the cost of the Van as it is not expected to provide future economic benefit to the life of the Van. Rather, the VicRoads registration is treated as a Prepaid Expense, as it is expected to provide future economic benefits over the next 12 months.