FA3 p. 81-98

Question 1

Which four factors have to be considered to calculate a depreciation charge for a period?

Answer 1

To calculate a depreciation charge for a period, four factors have to be considered:

• the cost (or fair value) of the asset
• the useful life of the asset
• the residual value of the asset
• the depreciation method

Question 2

What, apart from the product itself, is included in the cost of an asset?

Answer 2

The cost of an asset will include all costs incurred by the business to bring the asset to its required location and to make it ready for use.

Question 3

A tangible non-current asset has both a physical life and an economic life. Describe these two.

Answer 3

The physical life will be exhausted through the effects of wear and tear and/or the passage of time.

The economic life is decided by the effects of technological progress and by changes in demand.

Question 4

What is residual value (or disposable value)?

Answer 4

When a business disposes of a tangible non current asset that may still be of value to others, some payment may be received. This payment will represent the residual value, or disposal value,

Question 5

Which are the two depreciation methods?

Answer 5

1. The straight-line method, which simply allocates the amount to be depreciated evenly over the useful life of the asset.
2. The reducing-balance method, which applies a fixed percentage rate of depreciation to the carrying amount of the asset each year. The effect of this will be high annual depreciation charges in the early years and lower charges in the later years.

Question 6

How does a business choose which depreciation method to use for a particular asset?

Answer 6

You choose the method that best matches the depreciation expense to the pattern of economic benefits that the asset provides.

Question 7

Which word is typically used for depreciation of intangible assets?

Answer 7

Amortisation

Question 8

What approach is taken for depreciation of an intangible asset?

Answer 8

The approach taken for the depreciation (or amortisation as it is usually called with intangibles) is broadly the same as that for property, plant and equipment (tangible non-current assets)

Question 9

Can intangible assets be revalued to fair value?

Answer 9

Yes, but this rarely occurs as there is usually no active market from which to establish fair values. For similar reasons, the residual value of an intangible asset is normally assumed to be zero.

Question 10

Why is the way in which we measure the cost of inventories (or stock) important?

Answer 10

Because the cost of inventories sold during a period will affect the calculation of profit and the remaining inventories held at the end of the period will affect the portrayal of wealth in the statement of financial position.

Question 11

Which three assumptions (regarding the way inventories are physically handled) are used to determine the cost of the inventories sold during the period, and the cost of the inventories remaining at the end of the period?

Answer 11

Three assumptions used are:

1 first in, first out (FIFO) – the earliest inventories held are the first to be used

2 last in, first out (LIFO) – the latest inventories held are the first to be used

3 weighted average cost (AVCO) – inventories entering the business lose their separate
identity and go into a ‘pool’, and any issues of inventories then reflect the average cost of the inventories that are held

Question 12

What does the prudence convention require, regarding estimates of inventory value?

Answer 12

The convention of prudence requires that inventories be valued at the lower of cost and net realisable value

Question 13

With which method is inventory value usually determined, and why?

Answer 13

Inventories are valued at the lower of cost and net realisable value. Since the cost of the inventories held is usually below the current net realisable value, the COST figure that will normally appear in the statement of financial position

Question 14

Of the three inventory value estimation methods, which two should be used for external financial reporting?

Answer 14

When preparing financial statements for external reporting, the cost of inventories should normally be determined using either FIFO or AVCO. The LIFO approach is not an acceptable method to use for external reporting.

Question 15

What does the consistency convention imply?

Answer 15

This convention holds that once a particular method of accounting is selected, it should be applied consistently over time.

Question 16

What does the matching convention imply?

Answer 16

The matching convention requires that the bad debt is written off in the same period as the sale that gave rise to the debt is recognized

Question 17

How is “allowance for trade receivables” handled in final accounts?

Answer 17

“Allowance for trade receivables” will be shown as an expense in the income statement and deducted from the total trade receivables figure in the statement of financial position.