UNIT 5. Chapter 31. Contents of published accounts

Question 1

Further amendments to the published accounts

Answer 1

• Goodwill
• Valuing intangible assets
• Capital expenditure and revenue expenditure
• Depreciation of assets
• Valuation of inventories

Question 2

Def. Goodwill

Answer 2

Arises when a business is valued at or sold for more than the balance sheet value of its assets due to their good reputation and trading links.

Question 3

Accounting problems regarding goodwill (2)

Answer 3

• It should not appear as an asset of an existing business because it is difficult to value and easy to lose
• It will appear on the balance sheet of a business that has bought another firm and has paid for the goodwill. However, it should be written off as soon as possible to reasons above.

Question 4

Def. Intellectual property

Answer 4

An intangible asset that has been developed from human ideas and knowledge e.g. patents, copyrights, brands.

Question 5

Def. Market value

Answer 5

The estimated total value of a company is it were taken over. This is usually greater than the balance sheet value.

Question 6

Def. Capital expenditure

Answer 6

Any item bought by a business and retained for more than one year, that is the purchase of fixed or non current assets.

Question 7

Def. Revenue expenditure

Answer 7

Any expenditure on costs other than non current asset expenditure.

Question 8

Why capital expenditure should not be recorded as an expense and recorded in the profit and loss account? (2)

Answer 8

• The assets would not appear as fixed assets on the balance sheet - lowers the value of the business below its true worth.
• The year’s profits will be low as a result of high costs, while profits later years would be higher.

Question 9

Def. Depreciation

Answer 9

The decline in the estimated value of a non current asset over time.

Question 10

How does using depreciation helps avoid problems with balance sheets and profit and loss accounts? (2)

Answer 10

• The assets will retain some value on the balance sheet each year until fully depreciated or sold off.
• The profits will be reduced by the amount of that year’s depreciation as overheads

Question 11

Reasons for decline in asset’s value? (2)

Answer 11

• Wear and tear through usage

* Technological change, making the asset more out of date

Question 12

Def. Straight line depreciation

Answer 12

A constant amount of depreciation is subtracted from the value of the asset each year.
Depreciation = (Original cost of asset - expected residual value)/ expected useful life of assets (years)

Question 13

Def. Net book value

Answer 13

The current balance sheet value of a non current asset

= Original cost - accumulated depreciation

Question 14

Benefits and limitations of straight line depreciation

Answer 14

Benefits:
• Easy to calculate and understand
Limitations:
• Made with estimates of life expectancy and residual value -> hence can be inaccurate
• Some assets, like cars, depreciate more in the first 2 years than the following years which is not shown.

Question 15

What is the link between depreciation and cash flows?

Answer 15

• Depreciation is not recorded in the cash flows - it is a non cash expense in the profit and loss account
• The full price of the non current asset is recorded as cash outflow the moment the payment is made.

Question 16

How to value inventories in the balance sheet?

Answer 16

Inventories are unsold goods that can be in the form of raw materials, work in progress, or finished goods.
Inventories should be recorded as their purchase price (historical cost) or their net realisable value (NRV), whichever is lower.
E.g. A couch has been bought for 60$ and stored for 6 months. It now needs $20 of repair to be sold for $70. It’s NRV is now 70 - 20 = $50. The lost $10 should be recorded as soon as noticed.

Question 17

Def. Net realisable value

Answer 17

The amount for which an asset (usually an inventory) can be sold minus the cost of selling it. IT is only used on balance sheets when NRV is estimated to be below historical cost.