Lecturer: Chara Charalambous1 Financial & Managerial Accounting Lecture 5

Lecturer: Chara Charalambous 1

Financial & Managerial Accounting

Lecture 5


Aims of today’s lecture

• Prepare the Accounting for Depreciation

• Record the Accounting for disposal of Fixed Assets

• What are the Intangible fixed assets


Non Current Assets / Fixed Assets

• Non-Current Assets are distinguished from current assets by the following characteristics:

• -They are long-term in nature• -They are not normally acquired for resale • -They could be tangible or intangible• -They are used to generate income directly or

indirectly for a business• They are not normally liquid assets: they will not

easily converted into cash without a significant loss in value.


Fixed Assets registers



Depreciation

• According to IAS 16 ‘Depreciation is the measure of the cost of the tangible non-current asset that has been consumed during the period’ In other words is the cost of using a fixed asset.


Depreciation may arise from:

a)Use

b)Physical wear and tear

c)Passing of time

d)The fact that a fixed asset is old-fashion and imperfect because of the technology and market changes for e.g. the creation of a new machinery which is more specialized in a sector

• The purpose of the depreciation is to allocate the cost of an asset over the periods estimated to benefit from its use (the useful life)

• Land has an unlimited life and so does not require depreciation, but buildings should be depreciated.

• Depreciation of an asset begins when it is available for use.

Depreciation is recorded each year and has a dual effect:

1.Reduce the value of the fixed asset by cumulative depreciation (the act of gathering/increasing by addition) in the balance sheet to reflect the wear and tear (damage, tiring, exhausting).

In accounting we use the definition ‘accumulated depreciation’ and we mean by this the total amount of the loss of the fixed asset.

2.Record the depreciation charge as an expense in the income statement .



Methods of calculating depreciation

STRAIGHT LINE

Depreciation charge is the same each year and so assumes that the benefit is consumed equally

Useful for assets which provide equal benefit each year e.g. machinery

REDUCING BALANCE

A reducing amount of depreciation is charged each year and so assumes that more benefit is consumed in earlier years

Useful for assets which provide more benefit in earlier years e.g. cars, IT equipment


• Straight line methodDepreciation Charged = Cost - Residual Value Useful lifeOr Depen = Cost* X% Straight line depreciation is often expressed as a percentage of original cost.

Residual Value: the estimated disposal (clearance/removal) value of the asset at the end of its useful life. The residual value may be a second hand value or a scrap value ( not a significant amount and is often zero).

Useful Life: the estimated number of years during which the business will use the asset. The useful life does not necessarily equal the physical life of an asset.For e.g. Many business use a three year useful life for computers. This does not mean that the computer can no longer be used after three years, it means that the business is possible to replace the computer after three years due to a technological advancement.


• Reducing balance methodDepreciation Charged =Carrying value* X% Carrying value (CV) is the original cost of the fixed asset less the accumulated depreciation on the asset to date.

Example 1: (reducing balance method)Chris, a trader, purchased a computer for € 1000 on August Y12 which he depreciates on the reducing balance method at 20% per annum. What is the depreciation charged for each of the first five years if the accounting year end is 31 July?

Solution: Depreciation Charge Cumulative Depen1.1000*20% 200 2002.(1000-200)*20% 160 3603.(1000-360)*20% 128 4884.(1000-488)*20% 102 5905. (1000-590)*20% 82 672


• Fixed Assets bought or sold during the period

If a fixed asset is bought or sold during the period there are two ways in which the depreciation can be calculated:

a) provide a full years depreciation in the year of acquisition and none in the year of disposal (means when selling a second hand fixed asset).

b) Monthly or pro-rata depreciation based on the exact number of months that the asset has been owned.


Example 2: Karen has been running a successful nursery school ‘Little

Monkeys’ since Y1. She bought the following assets as the nursery grew:• a new oven for the nursery kitchen at a cost of €2000 – purchased 1ST Dec

Y4• A minibus to take the children on trips for €18000 – purchased 1ST June Y4

She depreciates the oven at 10% straight line and the minibus at 25% reducing balance. A full year depreciation is charged in the year of purchase and none in the year of disposal. Required:What is the total depreciation charged and the accumulated depreciation for the year ended 31st Oct Y6?

Solution: Oven Accounting years Y4: 1 NovY4- 31 Oct Y5: 2000*10%=200

Y5: 1 NovY5- 31 Oct Y6: 2000*10%= 200 400


Minibus:

Accounting years

Y3: 1Nov Y3-31 Oct Y4: 18000*25%= 4500

Y4: 1Nov Y4- 31 Oct Y5: (18000-4500)*25%= 3375

Y5: 1Nov Y5- 31 Oct Y6: (18000-7875)*25%= 2531.25

10406.25

The depreciation charge for the year ended 31st Oct Y6 is:

200+2531.25=2731.25 will go to income statement

The Accumulated depreciation up to 31st Oct Y6 is:

400+10406.25=10806.25 will go to balance sheet

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Example 3: Santa runs a large toy shop in Windsor. During the year ended

31st August 20X5 she bought the following fixed assets:

• A new cash register for €5000 was purchased on 1 Dec 20X4 and was to be depreciate at 10% straight line

• A new delivery van purchased on 31st March 20X5 at a cost of €22000. The van is to be depreciate at 15% reducing balance.

Santa charges depreciation on a monthly basis.

Required:

1. What is the depreciation charge for the year ended 31st August 20X5 and 31st August 20X6?


Accounting for Deprecation• Which ever method is used to calculate depreciation

the accounting remains the same:Dr: Depreciation expense x Cr: Accumulated Depreciation x

• The depreciation expense account is an income statement account and therefore is not cumulative.

• The Accumulated Depreciation account is a balance sheet account and as the name suggests is cumulative: reflects all depreciation to date. On the b/ce sheet it is shown as a reduction against the cost of the fixed asset:

Cost x Accum/ed Depreciation (x) Carrying Value - NBV X

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Example 4: Santa runs a large toy shop in Windsor. During the year ended

31st August 20X5 she bought the following fixed assets:• A new cash register for €5000 was purchased on 1 Dec 20X4

and was to be depreciate at 10% straight line• A new delivery van purchased on 31st March 20X5 at a cost of

€22000. The van is to be depreciate at 15% reducing balance.

Santa charges depreciation on a monthly basis.

Required:

1. What is the depreciation charge for the year ended 31st August 20X5 and 31st August 20X6?

2. Show the relevant ledger accounts and statement of financial position extract as at that dates.


Cash Register Delivery Van1DecY4 5000 b/ce c/d 5000 31 MarY5 22000 b/ce c/d 22000

B/ce b/d 5000 B/ce b/d 22000

Depreciation expense Accumulated. Deprec31 AugY5 31 AugY5

Acc Dep C.R 375 Profit & Loss 1750 b/ce c/d 1750 Depr exp 1750

Acc Dep D.V 1375

1750 1750 1750 1750

B/ce b/d 1750


• Workings:

C.R 5000*10%*9/12= 375

D.V 22000*15%*5/12= 1375

Balance Sheet as at 31st August Y5

FIXED ASSETS Cost Accum. NBV

Depreciation

Cash Register 5000 (375) 4625

Delivery Van 22000 (1375) 20625

27000 1750 26250


Disposal of Fixed Assets• Disposal means clearance, removal or discarding. The

disposal value is important when selling an old fixed asset as a second hand asset.

In a case of sale of an old fixed asset if:• Proceeds>NBV/CV => PROFIT ON DISPOSAL• Proceeds<NBV/CV => LOSS ON DISPOSAL• Proceeds=NBV/CV => NEITHER PROFIT NOR LOSS

ON DISPOSAL A disposal T account is required when selling a fixed asset. This is an

income statement account which reflects any profit or loss on disposal.


1. Accounting for Disposal for cash3 steps must be followed:• 1.Transfer the original cost of the fixed asset to the disposal

account

Dr Disposal X

Cr Fixed Asset X • 2.Transfer accumulated depreciation of the fixed asset to

the disposal account

Dr. Accumulated Depreciation X

Cr Disposal Account X• 3. Record the Cash proceeds (income, earnings)

Dr Bank account X

Cr Disposal Account X

The balance on the disposal T account is the profit

or loss on disposal.

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2. Accounting for Disposal through a part exchange agreement (PEA)

A part exchange agreement arises where an old asset is provided in part payment for a new one, the balance of the new asset being paid in cash.

4 steps must be followed:• 1.Transfer the original cost of the fixed asset to the

disposal account

Dr Disposal X

Cr Fixed Asset X

• 2.Transfer accumulated depreciation of the fixed asset to the disposal account

Dr. Accumulated Depreciation X

Cr Disposal Account X

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• 3.Record the part exchange allowance (PEA) as proceeds

Dr New fixed asset (part of cost of new fixed asset) X Cr Disposal Account (sale proceeds of old asset) X• 4. Record the cash paid for the new asset Dr New fixed Asset account X Cr Bank account X• The balance on the disposal T account is the profit or loss on disposal. Disposal Account Original cost Accumulated Depreciation Profit on disposal Proceeds Loss on disposal


Example 5: Percy runs a landscape gardening business. On 1st Feb 20X2 he purchased a sit-on lawnmower costing

€3000. He depreciates it at 10% straight line

on a monthly basis. A few years later he

decides to buy a better one. He sells

the old to a friend for €2000 on 31st July 20x5

Required: How much is charged to Percy’s income statement in respect of the asset for the year ended 31 Dec 20X5? Prepare the ledger accounts for the year 20X5 only.

Note: The above exercise mentions that the depreciation is charged on a

monthly basis not fully the first year and none in disposal.(method b of

slide 11)


Solution:

Workings: Y2 3000*10%*11/12=275

Y3 3000*10%=300

Y4 3000*10%=300

Y5 3000*10%*7/12=175

Total depreciation 1050

Records in Year 5:

Lawnmower Depreciation

Y5 B/ce b/d 3000 Disposal 3000 Y5 Acc Depn 175 P&L 175

875 total for the first 3 years


Accumulated depreciation

Y5 Disposal 1050 Y5 B/ce b/d 875

Depen up to 31st July 175

1050 1050

Disposal Account

Y5 Lawnmower 3000 Accumulated Depen 1050

Profit on Disposal 50 Bank 2000

3050 3050

Profit and Loss account for the year ended 31st Dec Y5

Gross Profit X

Add: Profit on disposal 50

Less Depreciation (175)

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Example 6: Bindi runs a business altering and repairing clothes and when she started operation on 1st Jan Y2 she bought a machine for 2500. She depreciates the machine using the straight-line method at a rate of 20% per annum and she charges a full year depreciation in the year of acquisition and none in the year of disposal.

On 7th of December of Y5 she decides to replace the old machine with a faster machine costing 5600. The salesman has offered her a part exchange deal as follows:

• Part Exchange allowance for old machine 750• Balance to be paid in cash for new machine 4850

Required:Show the ledger entries for the year ended 31st Dec Y5.

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Solution:

Workings: Y2 2500*20%=500

Y3 2500*20%=500

Y4 2500*20%=500

Y5 0

Total depreciation 1500

Records in Year 5:

Old Machine Depreciation

Y5 B/ce b/d 2500 Disposal 2500 Y5 Acc Depreciation

for new machine1120 P&L1120

New machine

Y5 DisP-PEA 750

Bank 4850 B/ce c/d 5600

5600 5600

1500 total for the first 3 years

5600*20%


Accumulated depreciation

Y5 Disposal 1500 Y5 B/ce b/d 1500

B/ce c/d 1120 Depen for new machine 1120

2620 2620

B/ce b/d 1120

Disposal Account

Y5 old machine 2500 Accumulated Depen 1500

New Machine- PEA 750

Loss on Disposal 250

2500 2500

Profit and Loss account for the year ended 31st Dec Y5

Gross Profit X

less: Loss on disposal 250

Less Depreciation 1120


Intangible AssetsIntangible Assets Intangible assets do not have a physical form. Just like

any other assets, intangibles do have a value and are part of the owner’s equity of a company.

Examples of Intangible Assets• Patents• License• Copyright• Goodwill• Contracts• Trademark• Franchise Every one of the above examples plays a role in

generating income. Patents for example allow a company to generate revenue with restraints on the competition. A license to sell a product, like alcohol for example, allows a business to increase revenue with the sale of alcohol.


• Copyrights. A copyright gives its owner the exclusive right to publish and sell a musical, literary, or artistic work during the life of the creator plus 70 years, although the useful life of most copyrights is much shorter.

• Franchises and Licences. Franchises and Licences are rights that a company or government grants an entity to deliver a product or service under specific conditions.

• Trademarks and Trade Names is a symbol, name or phrase identified with a company, product or service.

• Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and favorable location. The evidence that goodwill exists is the proven ability to earn excess profits. .


Depreciation and Amortization of Intangible Assets

• Depreciation and amortization are synonymous, it’s basically just different terms depending on the asset being devaluated. Fixed assets are depreciated and intangible assets are amortized. Other than the terminology, methods for depreciation of fixed assets can normally be applied when amortizing intangible asset.

• Patents, licenses, copyright, contracts and other intangible assets generally have a useful life. Even though they may have a long life in legal terms, they generally have more value (generate more revenue) in the early part of the assets life. Methods of depreciation like straight-line and other depreciation can generally be applied to the amortization of intangible assets.


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Lecturer: Chara Charalambous1 Financial & Managerial Accounting Lecture 5