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Introductory Financial Accounting

Accounting for Non-current (Fixed) Assets

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Learning Outcomes• Discuss the principles used to decide whether expenditures should

be capitalised or expensed• Identify the general rules for valuing tangible non-current (fixed)

assets and explain the effects of asset revaluations on the final accounts and distinguish between realised and unrealised profits

• Explain the concept of depreciation and discuss a variety of definitions of it

• Outline the factors affecting a depreciation charge and calculate a depreciation charge using the straight line, declining balance and production usage methods

• Calculate the profit or (loss) on the disposal of an asset• Construct more complex financial statements making adjustments

for depreciation• Define intangible fixed assets, give examples of them and outline

briefly the rules for their recognition and valuation

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A review of what we already know

• Asset definition:• A resource controlled by an entity as a result of past events and which future

economic benefits are expected to flow to the entity

• Asset recognition in the accounts when:• it is probable that the economic benefits will flow to the enterprise, and• the cost of the asset can be measured at a monetary amount with sufficient

reliability

• Non-current (fixed) asset:• An asset that is held for use on a continuing basis

• Types of non-current (fixed) assets:• Tangible – having physical substance e.g. land, buildings, fixtures and

fittings, plant, machinery, vehicles

• Intangible – not having physical substance e.g. research and development, goodwill

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Accounting for tangible non-current (fixed) assets

• At what amount should we measure the asset?

• Initial measurement – purchase price or production cost

• Includes all capital expenditure• Initial expenditure on new non-current assets,

also• Subsequent expenditure on existing non-current

assets that enhances their earning capacity

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At what amount should we measure the asset?

• Subsequent measurement requires consideration of

• maintaining initial measurement (historical cost) or revaluing (fair value)– depreciation– impairment

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Revaluing & Impairing• Revaluation• Non-current (fixed) assets may be revalued to their fair

(market) value• The unrealised gain is taken to capital not income, and is

recorded separately from other gains under a ‘revaluation’ heading

• Impairment• A reduction in the recoverable amount (net realisable value or

value in use) of a fixed asset to below its accounting carrying amount

• If identified, the carrying amount of the asset must be reduced with a ‘double entry’ reduction firstly to any revaluations in the capital account and secondly by a reduction in the income statement/profit and loss account

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Revaluation

• A company has several buildings valued in the accounts at £6.5 million

• The buildings are valued by a qualified valuer who states their value now to be £10 million

• Increase Buildings in BS to £10m (+3.5m)

• Create Revaluation Reserve in Capital & Reserves section of BS for £3.5m

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An Impaired asset

• If we believe the value of an asset may have fallen we need to carry out an impairment review.

• We compare the carrying amount with the recoverable amount

• Recoverable amount is the higher of• Net realisable value or• Value in use• If the asset is impaired:• Write down asset value to “impaired” value• Charge to Revaluation Reserve (if any/until used up)

after that• Charge as expense in P&L account

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Example

• Toad Ltd has this information on its asset register of machines

• Machine NBV NRV Value in use• £ £ £• A 5,000 3,500 6,200• B 8,200 10,000 12,000• C 2,100 1,000 2,000• D 4,800 4,500 4,000• E 5,300 5,500 4,700• Should any of these assets be “impaired” and if so by

how much?

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Example - Answer

• Machine Carrying Recoverable Impair

• A 5,000 6,200 No

• B 8,200 12,000 No

• C 2,100 2,000 Yes 100

• D 4,800 4,500 Yes 300

• E 5,300 5,500 No

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What should happen in the accounts?

• A company has 3 assets which undergo an impairment review.

• All assets were acquired in 2003• Asset C Asset D Asset E• NBV @2005 £900,000 £600,000 £550,000• Reval in 2004 £200,000 - £100,000• Results of impairment review• Value in Use £680,000 £630,000 £470,000• Net Real. Val £650,000 £570,000 £500,000

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What would happen in the accounts

• Asset C• Cr Asset C £220,000• Dr Revaluation Reserve £200,000• Dr P&L £20,000

• Asset D• Not impaired – may revalue upward

• Asset E• Cr Asset E £50,000• Dr Revaluation Reserve £50,000

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Depreciation• The application of the matching principle to non-current (fixed)

assets requires us to calculate the amount of depreciation in any period and match this, as an expense, with the revenues of the period.

• What is depreciation?• The systematic allocation of the depreciable amount of a non-

current (fixed) asset over its useful life

• Depreciable amount means the ‘book’ (i.e. the account) value of the asset less its residual value

• Residual value is the amount that would currently be obtained from disposal of the asset if the asset were at the end of its useful life

• Useful life is the period over which an asset is expected to be of use to the entity

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How do we calculate the depreciation charge for the period?

• The measure of depreciation is an estimate, and is affected by decisions relating to the asset’s:– cost (or value)– useful economic life – residual value, and– the depreciation method chosen e.g. straight-

line, reducing balance/ (accelerated method)

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How is depreciation reflected in the accounts?

• The period depreciation charge is• expensed to the income statement/profit and

loss account, and• deducted from the cost of the asset in the

balance sheet to disclose the asset’s net book value at the balance sheet date

• Note: this depreciation charge is a bookkeeping entry – it does not represent any movement of cash.

• Depreciation Example.doc

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What happens on the sale of an asset?

• The gain or loss on the sale of the asset is calculated:

• sale proceeds – net book value of the asset (from balance sheet)

• and recorded in the income statement/profit and loss account as it is a realised gain or loss

• The asset is eliminated from the balance sheet• The consideration received is recorded in the

balance sheet

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Example

• What would be the gain/loss on sale of the above asset in the following scenarios?

• (A) using straight line deprecation asset sold at the end of year two for £5,500

• (B) using the reducing balance method the asset is sold at the end of year two for £5,500

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Answer

• (A)• Book Value 7,000• Proceeds 5,500• Loss 1,500 in P&L (expense)• (B)• Book Value 5,135• Proceeds 5,500• Profit 365 in P&L (income)

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Intangible Assets

• Research and development costs:• no intangible asset arising from research

expenditure should be recognised • an intangible asst arising from

development expenditure may be recognised on meeting certain criteria and should be amortised once commercial exploitation begins (normal maximum 20 years)

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Conditions for capitalisation

• There is a clearly defined project• Related expenditure is separately identifiable• The outcome of the project can be assessed with

reasonable certainty as to – Its technical feasibility and– Its ultimate commercial viability

• Cost of project reasonably expected to be exceeded by sales revenue

• Adequate resources exist to enable the project to be completed

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Goodwill

• Definition: • future economic benefits arising from assets that are not

capable of being individually identified and separately recognised

• Measurement: • the difference between the fair values of the individual

net assets of the entity and the entity as a whole• Accounting: • only purchased goodwill should be recognised as an

asset (purchased goodwill arises as a result of one entity acquiring another)– it may not be revalued but– should be tested annually for impairment

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Example

• Ash Again.doc

• IS.doc

• BS.doc