Chapter 6: Tangible Non-Current Assets

Question 1

What is a Tangible Non-Current Asset?

Answer 1

Definition - a non-current asset is a resource controlled by the entity as a result of past events, and future economic benefits are expected to flow into the entity over more than 12 months

Non-current assets are purchased for use within a business that will be used to generate profits for more than 12 months.

A tangible asset has a PHYSICAL FORM that can be touched and seen. Examples of tangible assets include business premises and equipment, while intangible assets include items such as licences and brand names.

Question 2

Characteristics of tangible non-current assets include:

Answer 2

• They are used to drive future economic benefits for the company in increased revenue or decreased costs
• Incorporating the asset into a business may lead to capitalisation of directly attributable costs
• They may depreciate over time as the asset starts to age and deteriorate
• They may hold residual or scrap value at the end of the asset’s useful life

Question 3

Examples of tangible non-current assets (Property, Plant and Equipment) include:

Answer 3

• Land and Buildings such as building premises
• Fixtures and Fittings such as shelving in a shop and shop display unit
• Office Equipment such as computers, printers and cash registers
• Motor Vehicles such as delivery vans and company cars

Assets held for resale, such as light fittings and lamps in Sunrise Lighting, are not tangible non-current assets. These are tangible current assets expected to be monetised within 12 months.

Exam Advice - *In an exam question, determine the TYPE OF BUSINESS before deciding whether an asset is a tangible non-current asset or inventory.

A business selling cars will classify motor vehicles as inventories, not tangible non-current assets. Similarly, an IT business selling office equipment may classify computers as inventory instead of non-current assets.

Question 4

Asset Expenditure vs Expenses
- Asset expenditure is the cost associated with the purchase of non-current assets

Answer 4

These are assets bought by a business to be used for more than 12 months. Asset expenditure is classified as a non-current asset in the Statement of Financial Position.

The cost incurred for improving a non-current asset (one-off expenditure) is also categorised as an asset expenditure, such as office renovation and overhaul of a vehicle.

Assets (asset expenditure) are a business’s resources that give it some form of economic benefit in the future. For example, a delivery van is an asset of a business as it provides economic benefits in the form of cost reduction (no longer needing the services of external courier suppliers).

Question 5

EXPENSES are the day-to-day costs of running a business.

Answer 5

Expenses are debited in the Statement of Profit and Loss. Examples of expenses include:

• Rental payment for premises
• Gas and electricity payments
• Wages to employees
• Stationery expenses
• Costs of repairing and maintaining a non-current asset

Expenses are costs a business spends in its operations to generate revenue. The business immediately consumes the cost during the accounting year. For example, paying employees is an expense related to a financial period and is needed to run the business’s daily operations.

Question 6

Impact of Misclassification of Asset Expenditure and Expenses

Answer 6

Asset expenditure (non-current asset) appears in the Statement of Financial Position as it relates to the assets of a business.

Expenses appear in a business’s Statement of Profit or Loss as a deduction from income to calculate profit.

If misclassification between these expenditures occurs, there will be an impact on the profit and asset balance in the accounting period.

[See table]
Asset expenditure incorrectly treated as an expense -> expenses are overstated. therefore, profit is understated -> assets understated

Expenses incorrectly treated as asset expenditure -> expenses are understated. Therefore, profit is overstated. Assets overstated

Question 7

IAS 16 Property, Plant and Equipment

Answer 7

IAS 16 Property, Plant and Equipment prescribe the accounting treatment for tangible non-current assets. The principal issues specified in the standard are:

• The initial recognition of assets at acquisition
• The determination of an asset’s carrying amount
• The depreciation charges of assets

Question 8

Calculating Cost of Non-Current Assets

Answer 8

The total cost to be recognised as non-current assets is the following:

Purchase Price (incl. trade discounts)
+ Directly Attributable Cost (see below)
+ Cost of Dismantling and Site Restoration
= Cost to be Capitalised

Question 9

Directly Attributable Costs
Directly attributable costs are costs of bringing the asset to the location and condition necessary for operation. These costs must be classified as asset expenditure (assets) in the Statement of Financial Position.

Answer 9

Examples of directly attributable costs are:

• Cost of employee benefits that arise directly from the construction or acquisition of the non-current asset, such as wages and salaries
• Cost of site preparation
• Initial delivery and handling cost
• Installation and assembly cost
• Testing cost on whether the asset is functioning properly
• Professional fees such as consultancy, legal and architect fees, stamp duties
• Cost of extension to buildings
• Interest on the loan used to finance the acquisition of the asset

Question 10

Non-Current Asset Acquisition Double Entry.
Once the cost to be capitalised has been calculated, the amount is posted to the general ledger using journals.

Non-Current Asset Acquisition (by Cash)

Answer 10

Non-current assets purchased using cash will affect two ledger accounts:

• Individual Non-Current Asset (Dr, NCA Asset increased)
• Cash (Cr, Cash asset decreased)

The amount to be entered into these accounts is the capitalisation cost.

Question 11

Non-Current Asset Acquisition (on Credit)

Answer 11

Non-current assets purchased from credit suppliers will affect two ledger accounts:

• Individual Non-Current Asset (Dr, NCA (asset) increased)
• Trade Payables (Cr, Payables (liability) increased)

When the business pays the credit supplier the amount owed, the double-entry is:
Dr, Trade Payables, Payables (liability) decreased
Cr, Cash/Bank, Cash (asset) decreased

Question 12

Non-Current Asset Acquisition (by Loan)
A business may take out a bank loan to pay for the acquisition of a non-current asset.

Answer 12

This will affect two ledger accounts:

• Individual Non-Current Asset (Dr, NCA (Asset) increased)
• Bank Loan (Cr, Loan Payable (liability) increased)

As the business pays back the outstanding bank loan sum, the double-entry is:
Dr, Bank loan, loan payable (liability) increased
Cr, Bank account, cash (asset) decreased

Question 13

Introduction to Depreciation

An asset is a resource used by a business to generate profits.

For example, a delivery van is an asset that allows a business to deliver goods to customers, and this helps the business generate profit. Usage or consumption of the asset leads to depreciation.

Answer 13

As non-current assets are used (consumed), they wear out and devalue over time, and this consumption needs to be reflected as a cost to the business on an annual basis. This cost is depreciation.

DEPRECIATION is the expense charged to the Statement of Profit or Loss in each accounting period to reflect HOW MUCH OF THE ECONOMIC BENEFIT associated with a tangible non-current asset has BEEN USED UP in the accounting period.

Question 14

Depreciation Terminology

Answer 14

DEPRECIATION = is the expense charged to the Statement of Profit or Loss in each accounting period to reflect how much of the economic benefit associated with a tangible non-current asset has been used up in the accounting period.

The USEFUL LIFE of a non-current asset is the estimated period over which the asset will be consumed until it is worn out or until the business no longer wishes to use it.

The RESIDUAL VALUE of a non-current asset is what the asset is worth at the end of its useful life (sometimes referred to as scrap value).

The DEPRECIABLE AMOUNT of a non-current asset is the cost of the non-current asset less any expected residual value. For example, if a machine purchased for $50,000 has a scrap value of $1,000 at the end of its useful life, the depreciable amount is $49,000. Depreciation spreads the depreciable amount of the non-current asset over its useful life.

The purpose of depreciation is to match the revenue and expense in the same accounting period in line with the ACCRUALS PRINCIPLE OF ACCOUNTING.

Non-current assets generate profits for a business. Depreciation is the cost of the business using the non-current asset. Therefore, the depreciation cost is included as an expense in the Statement of Profit or Loss so that the consumption of the asset matches the profits generated from it. This is an application of the accruals principle.

> Market values are not relevant
- Land owned by a business is never depreciated. This is because the land is not consumed (unless it is a mine/quarry where its resource may be depleted)

EXAM - Land has an indefinite life because it cannot be consumed by business. This is why depreciation is not charged on land.

Question 15

Depreciation Methods
Depreciation spreads the depreciable amount of the non-current asset over its useful life. The depreciation cost is recorded as an expense in the Statement of Profit or Loss.

Answer 15

There are two methods of calculating the depreciation cost for an accounting period:

• The straight-line method
• The diminishing (reducing) balance method

Question 16

Straight-Line Method

Answer 16

The straight-line method of charging depreciation is where the total depreciable amount is charged in equal instalments over the asset’s expected useful life. The straight line method will result in the depreciation charge being the same each year

In a straight-line method, the depreciation charge is calculated as follows:
Depreciation charge per year = Depreciation Rate (%) × Cost of Asset

or

Depreciation charge per year = (cost of asset - residual value of asset) / estimated useful life of asset

At the end of the year, the asset value will decrease by the depreciation charge. The value after the depreciation charge is known as the CARRYING AMOUNT. (The carrying amount is sometimes referred to as the net book value, but carrying amount is the term that is preferred).

Since the assets are acquired part-way through 20X2, the depreciation charge in the accounting period 20X2 needs to be pro-rated.
Pro-Rata Depreciation = Annual Depreciation x (Depreciation months/12 months)

Question 17

Diminishing (Reducing) Balance Method

In the straight-line method, depreciation is expressed as a fixed percentage of the asset’s cost.
In contrast, the reducing balance method calculates depreciation as a fixed percentage of the ASSET’S CARRYING AMOUNT.

Answer 17

** An asset’s Carrying Amount (NBV) is the value after deducting the accumulated depreciation from the asset’s initial cost

Carrying amount (NBV) = Cost - Accumulated Depreciation

Question 18

The reducing balance method uses a percentage applied to the carrying amount of an asset rather than its cost.

Answer 18

Depreciation charge per year = Depreciation Rate (%) × Asset’s Carrying amount

In the reducing balance method, the depreciation percentage is applied to a reduced figure each year, resulting in a lower depreciation charge each year.

the reducing balance method assumes that less of the benefits of the delivery van is consumed in the later years.
~~
At the end of the delivery van’s useful life, its carrying amount is similar under both methods. Regardless of which method is used, the business starts and ends at the same position with the same depreciable amount being charged over the 4 years.

Question 19

Which Depreciation Method to use?

Answer 19

A business selects the depreciation method based on how they expect to use the asset’s economic benefits.
- If the business EXPECTS EQUAL BENEFITS EACH YEAR, the straight-line method is used.
For example, a business owns a furniture piece. Since the furniture is not expected to vary its benefit contributions to the business throughout its useful life, the straight-line depreciation method should be applied.

Question 20

If the business expects MORE SIGNIFICANT BENEFITS IN EARLIER YEARS, they use the reducing balance method.

Answer 20

This is when an asset becomes increasingly less productive for each year of use.
For example, a business owns a manufacturing machine. It is expected that the machine will produce more output in the early years of its useful life, which decrease as the years progress. Since more significant benefits are expected in its earlier years, the machine should apply the reducing balance depreciation method.

Question 21

Non-Current Asset Depreciation Double Entry

Answer 21

Once the depreciation charge for the year is calculated, it is posted to the general ledgers using Journals. The depreciation charge is reported as an expense in the Statement of Profit or Loss.

The depreciation charge entry for non-current assets will affect two ledger accounts:

• Depreciation Expense (SPL) (Dr, depreciation (expense) increased
• Accumulated Depreciation (SFP) (Cr, Accumulated depreciation reduces the value of NCA (asset)

Question 22

Introduction to Disposal of Non-Current Assets

Answer 22

A business purchases tangible non-current assets to generate profits over several years. These assets will remain with the business until they can no longer be used and have been fully depreciated.

A business may also decide to sell or dispose of an asset before it has reached the end of its useful life. Examples of such situations include:

• A newer and more efficient model of an asset (such as a computer) is available
• An asset has become redundant. the asset no longer undertakes the activity that it was used for
  = The asset is broken but can be sold for its scrap value.

Question 23

Considerations for Disposal of Non-Current Assets
- Cost of the asset
- accumulated depreciation of the asset
- sales proceeds/exchanges
- gains or loss on disposal

Answer 23

Cost of the asset - When an asset is sold, the business no longer has the asset to use in the business. This means the asset’s original cost needs to be removed from the relevant Non-Current Asset – Cost account.

Accumulated depreciation of the asset - When disposing of a non-current asset, all aspects of the asset’s balances are removed from the general ledgers. This would mean the asset’s accumulated depreciation is removed from the relevant Non-Current Asset – Accumulated Depreciation account.

Hence, The NBV of the asset is removed from the Statement of Financial Position altogether.

Question 24

Sale proceeds / exchanges

Answer 24

For non-current assets with residual values, the sales proceeds received from the business by disposing of such assets will affect the Cash/Bank ledger account.

In whole or part exchanges, the disposed asset’s value is part of the amount paid for a new asset, so no cash is received on disposal. Note that the agreed value of the disposed asset for the exchange may not be its carrying amount.

Question 25

Gains or Loss on Disposal

Answer 25

The difference between the sales proceeds and the carrying amount of an asset (Cost – Accumulated Depreciation) determines whether the sale generates a gain or loss on disposal.

Question 26

Calculating Gains or Losses on Disposal

Answer 26

The gain or loss on disposal of a tangible non-current asset is calculated as:

Sales proceeds - carrying amount = gain/loss on disposal

If the sales proceeds are greater than the carrying amount = Gain on disposal

If the Sales proceeds are less than the carrying amount = loss on disposal

Question 27

Non-Current Asset Disposal Double Entry

There are FOUR steps to follow in recording the disposal of non-current assets. The double-entry steps revolve around the Disposal Account.

Answer 27

The steps to record the non-current asset disposal are:

• Remove asset from the Cost account
• Remove asset from the Accumulated Depreciation account
• Record sale proceeds
• Record gain or loss on disposal

Question 28

1. Remove asset from the Cost Account

Answer 28

First, the business removes the asset’s cost in the Non-Current Asset–Cost account by transferring the asset’s cost to the disposal account.

The double entry for this is:
Dr Disposal [category=control], offset to disposal account
Cr Non-current asset - cost [category = asset], the asset is being removed

Question 29

2. Remove Asset from the accumulated depreciation account

Answer 29

Next, the accumulated depreciation is removed from the Asset – Accumulated Depreciation account by transferring the amount to the Disposal account.

The double entry for this is:
Dr Non-current asset - accumulated depreciation [category = asset], the accumulated depreciation of the asset is being removed
Cr Disposal [category = control], offset to disposal account

Question 30

3. Record Sales Proceeds

Answer 30

The sales proceeds received are recorded in the Disposal and Cash/Bank accounts. If the disposal of the asset generates no sales proceeds, the below entry is omitted.

The double entry for this is:
Dr Bank [category=asset], bank asset has increased
Cr Disposal [category=control], offset to disposal account

Question 31

4. Record Gains or Loss on Disposal

Finally, the Disposal account is closed off. The balance c/d is the gain or loss on disposal and is recorded as an income or expense in the Statement of Profit or Loss.

If the sales proceeds are greater than the carrying amount (gain on disposal,) the double entry is:
Dr, Disposal, [cat=control], offset to disposal account
Cr, Gain on Disposal [cat=income (SPL)

Answer 31

If the sales proceeds are less than the carrying amount (loss on disposal), the double entry is:
Dr, Loss on Disposal [cat=expense(SPL)], loss (expense) has increased
Cr, Disposal [cat=control], offset to disposal account

The Disposal account is created for each non-current asset disposal.

Question 32

What is the Non-Current Asset Register?
Definition - The non-current asset register is a memorandum document where each asset is listed, including information on all the activities relating to the asset.

Answer 32

The acquisition, depreciation and disposal of tangible non-current assets recorded in the general ledger accounts show the transaction balance of the asset category. It does not retain any detail about individual assets once it is closed off at the end of the year.

A business keeps track of individual assets’ cost, carrying amount, depreciation and disposal using a separate record known as the NON-CURRENT ASSET REGISTER.

Question 33

The non-current asset register has the following information on each asset:

Answer 33

• Date of Purchase
• Description
• Location
• Useful life
• Depreciation Method
• Depreciation Amount
• Carrying amount
• Ultimate Disposal proceeds

The non-current asset register is useful for a business as it is used to verify the existence of assets within a business. The business can perform an asset count at each location according to the non-current asset register.

Question 34

Since the same information concerning the non-current asset is recorded in the general ledger and the asset register, the two balances should agree. Therefore, the asset register also acts as a source of supporting documentation to verify the accuracy of balances in the ledger accounts.

Answer 34

Differences between the two reports should not occur in a computerised system, as the same information automatically updates the ledgers and the asset register simultaneously with the input of non-current assets transactions.

However, businesses with manual systems may encounter differences between these balances due to entry omissions of purchase costs or depreciation charges from one of the reports.

Discrepancies found involving omissions or errors should be corrected by making posting entries into the omitted or erroneous report.

Question 35

Authorisation of Asset Expenditure

Answer 35

In larger companies where the owner is not directly in charge of the business’s operations, the authority to purchase business assets and resources may be delegated to MANAGERS. However, there should be RULES regarding the level of asset expenditure that the managers can make.

The rules prevent mismanagement and misuse of power, such as managers using business resources to purchase personal items instead of assets needed in a business.

In such cases, many businesses set authorisation limits for asset expenditure. For example, purchases over $5,000 need to be approved by a senior manager, while expenditure over $10,000 needs to be approved by a committee of managers.