Unit 5

Learning objectives
Non-current assets Capital and revenue expenditure Depreciation- nature and calculation Change in accounting date of depreciation Revaluation of non-current assets

Non-current assets
Non-current assets are distinguished from current assets by the following characteristics:Are long-term in nature Are not normally acquired for resale Could be tangible or intangible Are used to generate income directly or indirectly for a business Are not normally liquid assets

Non-current asset registers

Are records of the non-current assets held by a business. They form part of the internal control system of an organization Details held on such a register may include:Cost and date of purchase Description, serial, reference number Location of the asset Depreciation method and expected useful life Net book value
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Capital vs. revenue expenditure

Capital expenditure
Capital expenditure is long term in nature as the business intends to receive the benefits of the expenditure over a long period of time It includes expenditure on the acquisition of noncurrent assets required for use in the business, not for resale It also includes expenditure on existing non-current assets aimed at increasing their earning capacity

Examples
Expenditure in connection with or incidental to the purchase or installation of an asset (Carriage inwards on machinery bought) ii. Acquisition of new assets. iii. Expenditure incurred for putting the old asset purchased, into working condition. iv. Additions and extensions to existing assets. v. Legal costs of buying building vi. Betterment of non-current assets or improvement of an asset to produce more, to improve its earning capacity or to reduce its operating expenses or to increase the life of asset.
i.

Revenue Expenditure
Revenue expenditure consists of expenditure incurred in one period of the accounting, the full benefit of which is enjoyed in that period only. This does not increase the earning capacity of the business but it is incurred in order to maintain the existing earning capacity of the business. It includes all expenses which arise in normal course of business. The benefit of such expenditure is for a short period, say, one year only and it is not to be carried forward to the next year. The expenditure is of a recurring nature i.e. incurred every year.

Examples
Purchase of raw materials for conversion into finished goods. ii. Selling and distribution expenses incurred for sale of finished goods e.g. sales office expenses, delivery expenses, advertisement charges, etc iii. Establishment expenses like salaries, wages, rent, rates, taxes, insurance, depreciation on office equipment. iv. Depreciation of plant, machinery and equipment. v. Expenses incurred in order to maintain the existing non-current assets in an efficient and workable state such' as repairs to building, repairs to plant, whitewashing and painting of building.
i.

Activity 1- Classify the following into capital or revenue expenditure

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Purchase of extra van Cost of rebuilding warehouse which had fallen down Building extension to the warehouse Painting extension to warehouse when it was first built Repainting extension to warehouse three years later Carriage costs on bricks for new warehouse extension Carriage cost on purchases Carriage cost on sales Legal cost on collecting debts Legal charges on acquiring new premises for office Fire insurance premium Costs of erecting new machine

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Capital expenditure, revenue expenditure and final accounts

Accounts treat capital expenditure and revenue expenditure in different ways in the final accounts of the business Capital expenditure- Statement of financial position Revenue expenditure- Income statement
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Activity 2
Calculate cost of acquisition of microcomputer

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What is depreciation
IAS 16 defines depreciation as the measure of the cost or revalued amount of the economic benefits of the tangible non-current asset that has been consumed during the period
Depreciation is part of the cost of the non-current asset consumed during its period of use by the firm, therefore depreciation is the allocation of the cost of the non-current assets over its period of use

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Causes of Depreciation
Physical deterioration Wear and tear Erosion, rust and decay Economic factors Obsolescence Inadequacy The time factor (e.g. assets of a fixed legal life) Depletion

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Methods of calculating depreciation charges:Straight line method

Reducing balance method

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 Dr Income statement Cr Provision for depreciation account

Accounting treatment for depreciation

Note
The non-current asset account continues to show the asset at cost each year A separate provision for depreciation account must be opened for each class of non-current asset The balance on the Provision for depreciation account is deducted from the cost of the fixed asset in the statement of financial position

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Straight line method

The total amount of depreciation that an asset will suffer is estimated as the difference between what it cost and the estimated amount that will be received when it is sold or scrapped at the end of its useful life. The total depreciation is then spread evenly over the number of years of its expected life Calculation: (Cost estimated proceeds on disposal) estimated useful life in years

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Example 1- Straight line method

A machine cost Rs 20,000. It is expected to have a useful life of five years at the end of which time it is expected to be sold for Rs 5,000. (i) What would be the annual depreciation on the machine (ii) Prepare the provision for depreciation of the machine for each year (iii) Prepare a statement of financial position extract to show the non-current asset of machine at the end of each year
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Activity 3
A motor vehicle cost Rs 18,000. It is expected to have a useful life of seven years and to be sold for Rs 4,000 at the end of that time. The business uses the straight line method of depreciation Prepare the Provision for depreciation of Motor vehicles account for each year. Prepare a statement of financial position (statement of financial position) extract to show the non-current asset of Motor vehicles at the end of each year
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Assets bought/sold in a period

If an asset is bought or sold in a period, there are two ways in which the depreciation could be accounted for:Provide a full years depreciation in the year of acquisition and none in the year of disposal Monthly or pro rata depreciation, based on the exact number of months that the asset has been owned

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Compute the depreciation charge based on the following information, given that depreciation is charged using the straight line method at the rate of 10 % and that the year end is 31/12.
NON CURRENT ASSET ACCOUNT

Activity 4

01/01

Balance b/d

10,000

01/06

Disposal

3,000

01/10

Additions

5,000
15,000

31/12

Balance c/d

12,000
15,000

01/01

Balance b/d

12,000

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Reducing balance method

Also known as the diminishing balance method A fixed percentage for depreciation is deducted from the cost in the first year. In the second or later years the same percentage is taken from the reduced balance.

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Example 2
A machine cost Rs 20,000. It is expected to have a life of five years. Depreciation is to be calculated at the rate of 25 % per annum on the reducing balance method.

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Activity 5
A machine costing Rs 40,000 and with an expected life of five years is to be depreciated by the reducing balance method. The annual rate of depreciation is 30 %. (i) Prepare the provision for depreciation of Machinery account for the years 1 to 5 (ii) Prepare a statement of financial position extract at the end of each of the five years

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Choice of depreciation method

Providing for depreciation is an application of the matching principle, and the method chosen for any particular type of asset should depend upon the contribution the asset makes towards earning revenue. Straight line method should be used for assets that are expected to earn revenue evenly over their useful working lives It is also used where the pattern of an assets earning power is uncertain. The reducing balance method should be used when it is considered that an assets earning power will diminish as the asset gets older
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How to account for the disposal of non-current assets

When a non-current asset is sold, the difference between its net book value and the proceeds of sale represents a profit or loss on disposal This profit or loss is transferred to the P&L account (Income statement) The profit or loss is calculated in a disposal account

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Double entry bookkeeping for disposal of non-current assets

Transfer the cost price of the asset sold to an asset disposal account Dr Disposal account Cr noncurrent asset account Cr Disposal account

Transfer the depreciation provided to date on the asset to the asset disposal account

Dr Provision for depreciation

For the amount received on disposal:- Dr Bank/Cash Cr Disposal account A debit balance remaining on disposal Dr Income account is a loss statement A Credit balance remaining on disposal account is a Profit Dr Disposal Account Cr Disposal A/c Cr Income statement
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Example 3- Disposal of noncurrent assets

At 01 December 2003, a machine which had cost Rs 20,000 was sold for Rs 500. A total of Rs 18,000 had been provided for depreciation on the machine Show the accounting entries to record the above

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Double entry for Disposal through part exchange agreement

Transfer the cost price of the asset sold to an asset disposal account Transfer the depreciation provided to date on the asset to the asset disposal account Dr Disposal account Dr Provision for depreciation Dr noncurrent asset account (part of cost of new asset) Dr noncurrent asset account Cr noncurrent asset account Cr Disposal account

Record part exchange allowance (PEA) as proceeds

Cr Disposal account(sale proceeds of old asset) Cr Cash

Record the cash paid for the new asset

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Activity 6
Robin started business in January 2002 and bought a machine CAT for Rs 2500. He depreciates his machine using the straight line method at a rate of 20 %. He charges full year depreciation in acquisition years and none in disposal years His business has grown in 2005 and he requires a better machine CATII. CATII salesman offered him the following deal:Part exchange allowance for Cat for Rs 750 Balance to be paid in cash for CATII Rs 4850. Show the ledger entries for the year ended 31 December 2005
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Zaza has prepared his financial statement up to 30 April each year until 30 April 2007, when Zaza changed the accounting date by making up the next financial statements for 16 months to 31st August 2008. Zazas policy is the charge proportionate depreciation in periods of purchase and sale and as from the first day of the month in which assets are acquired, and up to the last day of the month before the month of disposal. Annual depreciation on motor vehicles is on 10 % straight line basis.
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Change in accounting date- Example 4

Change in accounting date (Cont)

Additional information are as follows: Motor vehicles at cost: 192,000 Accumulated depreciation 64,000 During the 16 months ended 31st August 2008 the following transaction took place:On 15 June 2007, a new motor vehicle was purchased for 12,000. An existing vehicle which had cost 16, 000, and which had a book value of 8,000 on 15 May 2007, was given in part exchange at an agreed price of 5,000. The remaining balance of 7,000 was paid in cash.
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Change in accounting date (Cont)

Prepare the following accounts:1. Motor vehicle 2. Accumulated depreciation 3. Disposal account

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Revaluation of non-current assets

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Non-current assets revaluation

Some non-current assets such as land and buildings may rise in value over time. Businesses may choose to reflect the current value of the assets in the statement of financial position. This is known as revaluing the asset The difference between the NBV of the asset and the revalued amount is recorded in a revaluation reserve in the capital section of the statement of financial position This gain is now shown in the income statement under comprehensive On revaluation, the accumulated depreciation account is cleared off.

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Example 5
A company owns land which originally costs Rs 250,000. No depreciation has been charged on the land. The company wants to revalue the land to reflect its current marker value. A valuer advises that it is Rs 600,000. What is the double entry to record this revaluation?
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Example 6
A company runs a business for many years from a building which originally cost Rs 300,000 and on which Rs 100,000 total depreciation has been charged to date. The company wishes to revalue the building to Rs 750,000. What is the double entry to record the revaluation?

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Activity 7
Jones owns a factory. The premises were purchased on 1 January 20X1 for Rs 450,000 and depreciation charged at 2 % pa straight line. Jones now wishes to revalue the premises to Rs 800,000 on 1 January 20X7 to reflect the market value. What is the balance on the revaluation reserve after the transaction?
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Depreciation of a revalued asset

When a non-current asset has been revalued, the charge for the depreciation should be based on the revalued amount and the remaining useful life of the asset. This charge will be higher than depreciation prior to revaluation. The excess of the new depreciation charge over the old depreciation charge should be transferred from the revaluation reserve to accumulated profits (within the capital section of the statement of financial position):
Dr Revaluation reserve Cr Accumulated profits
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Activity 8
Alpha owns a retail unit. He bought it 25 years ago for Rs 100,000, depreciating it over 50 years. At the start of 20X6 he decides to revalue the unit to Rs 800,000. The unit has a remaining useful life of 25 years. What accounting entries should be made in 20X6?
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Activity 9
The statement of financial position of a football club at 31 December 20X7 includes the following information:Depreciation has been provided at 2 % on the straight line basis. The stadium is revalued on 30 June 20X8 to Rs 1,380,000. There is no change in the estimated useful life. What is the depreciation charge for the year ended 31 December 20X8.
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Stadium cost Depreciation

Rs 1,500,000 Rs 450,000

Activity 10-Disposal of a revalued asset

A company runs a club. Some years ago, the company purchased land next to the existing club, with the intention of making another club for its foreign staffs. The cost of the land was Rs 260,000. The company has not yet built the new club but has revalued the land for Rs 600,000. The company has now decided that building the new club will be uneconomical and has found a buyer who is willing to pay Rs 695,000 for the land. What are the ledger entries on disposal?
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