Week 5 - inventory Costing and PPE Flashcards
How would you record a change in inventory?
Using the conservatism principle you would choose the lower of
1. Cost Carrying amount - initial cost
2. Net realisable value (NRV) - the estimated selling price less and costs involved in selling and distributing the goods.
What is PPE?
Tangible assets that:
-Are held for use in the production or supply of goods or services, for rental to others or for administrative purposes.
- Are expected to be used during more than one period.
How is PPE initially measured?
PPE is initially measured at cost. This includes:
1. The purchase price
2. All costs incurred to bring the asset into a location and conditions ready for use. e.g. cost of site preparation, installation costs etc.
What classifies as capital expenditure?
▪ Cash spent to purchases assets
▪ The asset is expected to provide
future benefits, items last for more
than a year
▪ Another term is ‘capitalized costs’
▪ Examples:
– Plant and machinery
– Factory buildings
– IT systems
What classifies as revenue expenditure?
▪ Cash spent on day-to day
operations
▪ Is consumed within an accounting
year
▪ Entire amount is charged to
income statement
▪ Examples:
– Wages and salaries
– COS
– Marketing costs
When can subsequent expenditure on PPE be capitalised (added to the cost of the asset on the SOFP)?
Only if it enhances the economic benefit of the asset.
- Routine repairs and maintenance costs do not add economic benefit –
they simply restore the asset to its previous condition before it was broken. These are therefore not capitalised and treated as an expense in the
Income Statement - Adding an extension to a shop adds economic benefit since capacity is increased leading to higher future sales
- Expenditure extending the useful life of PPE is added to the cost of the asset (SOFP) = capitalised costs
In subsequent measurement what are the two models used?
Cost model and revaluation model.
What is the cost model?
The asset is included on the SOFP at cost less accumulated depreciation and impairment losses. This net amount is referred to as a Carrying amount, or Net Book Value (NBV).
What is the revaluation model?
The asset is included on the SOFP at revalued amount (fair value) less subsequent depreciation and impairment losses. Arising revaluation gains are credited to an account Revaluation Reserve. The Revaluation reserve is part of company’s Equity
How would you double entry land which costs £30,000 which is valued at £70,000?
Dr Land £40,000
Cr Revaluation reserve £40,000
What are the two PPE depreciation methods?
Straight line method where there is a constant charge over the life of the asset
Reducing Balance Method - decreasing charge over the life of the asset.
What are the four factors that need to be considered to calculate depreciation?
- cost (or fair value) of an asset
- useful life of an asset
- residual value of an asset
- depreciation method
What is residual value?
-AKA disposal value, scrap value
-Selling value of an asset at the end of its useful life
Depreciable amount = Initial cost - residual value
What is useful economic life?
Period of which an asset generates economic benefit. Assets are depreciated based on their economic life.
How is the straight line method used?
Depreciable expense = (initial cost- residual value)/useful economic life
How is the reducing balance method used?
The reducing-balance method of depreciation is an accelerated
method that results in more depreciation expense in the early years of an asset’s life and less depreciation expense in the later years of an asset’s life
Depr. expense = Depreciation rate (would be given in exam) x NBV at the start of the year
How would you do the double entry for depreciation?
Dr Depreciation expense = EXPENSE, IS
Cr Accumulated depreciation = CONTRA ACCOUNT to PPE @ Cost
What determines which depreciation method you use?
▪ The depreciation method used should reflect the pattern in which the asset’s economic benefits are consumed by the entity
▪ The method chosen should be applied consistently unless there is a change in the expected pattern of economic benefits
▪ Entities usually select the method used by industry peers to enhance
comparability
▪ The depreciation method, the residual value and the useful life of an asset should be reviewed at least at each financial year-end
How would you recognise an impairment loss if its NBV decreases to below recoverable amount?
prudence principle states that you should reduce the asset on the balance sheet to its recoverable amount and recognise an impairment loss.
How would you recognise an impairment loss on the double entry?
Dr Impairment loss (expense)
Cr Equipment (asset)
Where are impairment losses recorded?
In the income statement regardless of which method the company uses: historic cost or fair value.
What is a disposal?
The sale of an asset.
How would you calculate gains on disposal?
Gain/loss on disposal = Disposal proceeds(i.e. cash received) - NBV
How would you account for the disposal of PPE?
Create a temporary T-account for the disposal – the ‘Disposal’ T account.
1. Remove cost of the asset from the PPE cost account
Dr Disposal
Cr PPE
2. Remove the accumulated depreciation
Dr Accumulated Depreciated
Cr Disposal
3. Record the cash proceeds
Dr Cash
Cr Disposal
4. The balancing figure in the disposal account is the gain / loss on disposal
