Chapter 8: Non-current assets and depreciation

Question 1

1.1 Capital and revenue expenditure

Answer 1

Capital expenditure is expenditure on the purchase of long term assets or expenditure leading to an improvement in their earning capacity. Long term assets = non-current assets = assets used to be used in the business for more than a year.
Revenue expenditure is all expenditure other than capital expenditure and relates to the day to day running costs of the business.

Question 2

2.1 Cost of non-current assets

Answer 2

The cost of a non-current asset is any amount incurred to acquire the asset and bring into working condition. It includes the purchase price, delivery costs, legal fees and subsequent expenditure which enhances the asset. It excludes repairs, renewals, and repainting.
Non-current assets are capitalised, included on the statement of financial position. The correct double entry to record the purchase is: Dr Non-current asset Cr bank/cash/payables
For a sole trader, a separate cost account should be kept for each category of non-current assets. For a company all purchases are grouped together under property, plant, and equipment.
Subsequent expenditure on a non-current asset can only be recorded as part of the cost if it enhances the benefits of the asset (increases the revenues generated by the asset). An example is an extension to a shop building. Repairs costs are not capitalised.

Question 3

3.1 Depreciation of non-current assets

Answer 3

IAS 16 defines depreciation as the systematic allocation of the depreciable amount of an asset over its useful life. It also defines depreciable amount as the cost of an asset, or other amount substituted for cost, less its residual value.
Depreciation recognises the depreciable amount (cost less residual value) over the useful life of the asset. The residual value is the estimated amount an entity would get from disposing the asset at the end of its useful life. The useful life is the period when an asset is expected to be available for use by an entity.
Depreciation is a mechanism to reflect the wearing out of a non-current asset. Depreciation is not meant to show the asset at its current value in the statement of financial position and provide a fund for the replacement of an asset.
The dual effect of depreciation is to reduce the statement of financial position value of the non-current asset by deprecation to reflect the wearing out and to record the depreciation charge as an expense in the statement of profit or loss to match the revenue generated by the non-current asset.
Land has an infinite life so does not require depreciation, but buildings should be depreciated.

Question 4

3.2 Methods of depreciation

Answer 4

Straight line method: depreciation charge = (cost – residual value) / useful life or % x cost (can be used when there is no residual value)
Straight line depreciation is assumed to be charged monthly in this exam.
Reducing balance method: depreciation charge = % x carrying amount.
The carrying amount is the original cost of the non-current asset less accumulated depreciation on the asset to date.

Question 5

3.3 Accounting for depreciation

Answer 5

• Dr Depreciation expense (statement of profit or loss)
• Cr Accumulated depreciation (statement of financial position)
  The depreciation expense account is a statement of profit or loss account and is closed off at the year end and taken to the statement of profit or loss. The accumulated depreciation account is a statement of financial position account. On the statement of financial position, it is shown as a reduction against the cost of non-current assets.
  Depreciation method, residual value and economic life are all estimates made by management. Different estimate would result in different levels of depreciation, these subjective areas could result in manipulation of the accounts by management, in order to reduce this risk, IAS 16 requires the following:
• Depreciation method reviewed each year end and changed if method no longer reflects the pattern of use of the asset
• The residual value and useful life also reviewed and year end and changed if expectations differ
• The carrying amount of the asset is then depreciated using the new estimates
  When the estimates change the subsequent deprecation = carrying amount at the date of the estimate change less residual value divided by the remaining useful economic life. Or if we change the reducing balance the depreciation is the percentage times the carrying amount at date estimate changed.

Question 6

4.1 Disposal of non-current assets

Answer 6

An accounting profit or loss arises on the disposal of a non-current asset. Profit is proceeds less carrying amount. A disposals T account is required when recording the disposal, this is a statement of profit or loss account and it reflects any profit or loss on disposal.
Disposals for cash consideration:
- Remove the original cost of the non-current asset from the non-current asset account
- Remove accumulated depreciation on the non-current asset from the accumulated depreciation account
- Record the cash proceeds
- Balance off the disposals account to identify the profit or loss
Disposals through a part exchange agreement:
- Remove the original cost of the non-current asset from the non-current asset account. Dr Disposals (original cost) Cr NC assets (original cost)
- Remove accumulated depreciation on the non-current asset from the accumulated depreciation account. Dr Accumulated depreciation Cr Disposals
- Record the part exchange allowance as proceeds and as part of the cost of the new asset. Dr NC assets Cr Disposals
- Record the cash balance for the new asset Dr NC assets Cr Cash
- Balance off the disposals account to find the profit or loss

Question 7

4.2 Impairment of non-current assets

Answer 7

An impairment means that the recoverable amount of an asset is less than its carrying amount. The recoverable amount is the greater of the fair value less costs to sell or the value in use (present value of future cash flows expected to be generated by the asset). The difference between the carrying amount and the recoverable amount is charged to the statement of profit or loss.
- Dr Impairment expense
- Cr Accumulated depreciation

Question 8

5.1 Non-current asset register

Answer 8

A non-current asset register is a list of all the non-current assets of the business, broken down normally by location and asset type and is maintained in order to control non-current assets and keep track of what is owned and where it is kept.

Question 9

6.1 Intangible non-current assets

Answer 9

assets held for the long term which have no physical form (patents and goodwill). Intangibles are held on the statement of financial position at their carrying amount. They have a useful life which is amortised, and the amortisation is an expense in the statement of profit or loss. Internally generated intangibles do not appear on the statement of financial position.
Goodwill: the excess value of a business above the carrying amount of its assets less its liabilities in its accounting records. This is reputations, skills and experience of staff or customer relationships. Goodwill is generally not recorded in the financial statements. The exception is where goodwill is purchased in the acquisition of another business, recognised goodwill is reviewed annually for impairment rather than being depreciated or amortised.
Research and development expenditure: research costs are charged to the statement of profit or loss. In some cases, development expenditure must be shown as a non-current asset on the statement of financial position, in this case amortisation is recorded to reflect the use of the asset.