Property, Plant and Equipment Flashcards
What is Capital Expenditure?
- It is the costs to acquire assets that will benefit the business in the current and future years.
- When incurred, it is charged to an assest account and subsequently allocated as an expense to the years it benefits
What is Revenue Expenditure?
- It is the costs to acquire assests and services that will be used up in a particular year.
- E.g rent, repairs, salaries etc.
- When incurred, it is charged to an expense account and matched against the revenue earned for the year it benefits.
Journal Entry to record Acquisition of PPE
Debit- Plant, Property and Equipment (PPE)
Credit - Cash at Bank / Other Payables
What is Depreciation?
- It is the systematic allocation of the cost of PPE over its useful life.
- As the PPE are used in the business operations to help generate revenue, a portion of the cost of PPE must be allocated as depreciation expense to every year it benefits to ensure accurate atching of expenses against revenue generated by the use of PPE.
Factors to Consider in the Management of Depreciation
- Cost of its asset: Care must be taken to include in the original cost all expenses necessary to bring the asset into a location and condition ready for its intended use. Cost is the only factor that is objective and verifiable n determining the amount of depreciation.
- Expected Residual Value: Residual value is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. The total amount of depreciation to be charged over an asset’s useful life is the cost of the asset less its residual value.
- Useful Life of The Asset: This is the estimated period of time that the asset is expected to be used in carrying out the business activities. It depends on the type of asset being considered and is usually expressed in number of years. Useful life is not necessarily the same as physical or economic life of an asset.
Causes of Depreciation
Wear and Tear
Physical Deterioration
Obsolescence due to Technological Advancement and Market Changes
Legal or similar limits on the use of the assets
Journal Entry to Record Depreciation
Debit - Depreciation Expense
Credit - Accumulated Depreciation
What is Straight Line Method?
With the Straight Line Method, each accounting period is allocated a uniform amount of the depreciable value.
This method assumes that depreciation is a uniformed function of time.
This method is suitable when the PPE provides equal benefits over its useful life.
Depreciation (SL) Equation
(Cost - Estimated Residual Value) / Estimated Useful Life
OR
Depreciable Value X Rate of Depreciation
What is Reducing Balance Method?
With Reducing Balance Method, each accounting period is allocated a uniformed rate of NBV. As the rate remains constant while the book value declines, annual depreciation is less each year.
This method is suitable when the PPE provides greater benefits in the entry years of its useful life than in the later years.
This accelerated depreciation method is also appropriate when benefits derived from the asset are approximately equal over the asset’s life but repair and maintenance costs increase significantly in later years. This will allow the total cost of using the asset to be constant over its useful life
Depreciation (RB) Equation
NBV x Rate of Depreciation
Choice of Depreciation Method
Depreciation method chosen should reflect the pattern of consumption of the economic benefits.
More expense should be recognised in periods when the asset is used more, and less in periods when the asset is used less. As assets are used to produce revenue, matching expense recognition with asset usage also matches expense recognition with revenue recognition.
For PPE with a reasonably constant pattern of consumption, the allocation basis should be done using the straight-line method.
Reducing Balance Method is best for assets that generate more revenue earlier in their useful lives and less in later years.
The method once selected should be applied consistently throughout its useful life unless changes in circumstances make it no longer applicable. This is to comply with the consistency concept
What is Impairment Loss on PPE?
An asset is impaired when its carrying amount [NBV - (Cost - AD)] is greater than its recoverable amount.
Adjustment for Impairment Loss
Debit - Impairment Loss
Credit - Accumulated Depreciation
Revaluation Equation
Valuation - Carrying Amount (NBV)
