FINANCIAL ACCOUNTING
Lecture 4
Lecturer: Chara Charalambous
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Aims of today’s lecture
• Prepare the Accounting for
Depreciation
• Record the Accounting for disposal of
Fixed Assets
• What are the Intangible fixed assets
Lecturer: Chara Charalambous
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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.
Lecturer: Chara Charalambous
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Fixed Assets registers
Lecturer: Chara Charalambous
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Lecturer: Chara Charalambous
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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 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 .
Lecturer: Chara Charalambous
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Depreciation may arise from:
• Use
• Physical wear and tear
• Passing of time
• 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.
Lecturer: Chara Charalambous
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Methods of calculating depreciation
REDUCING BALANCE
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
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
Lecturer: Chara Charalambous
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• Straight line method
Depreciation Charged = Cost - Residual Value
Useful life
Or
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.
Lecturer: Chara Charalambous
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•
Reducing balance method
Depreciation 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:
1.1000*20%
2.(1000-200)*20%
3.(1000-360)*20%
4.(1000-488)*20%
5. (1000-590)*20%
Depreciation Charge
200
160
128
102
82
Lecturer: Chara Charalambous
Cumulative Depen
200
360
488
590
672
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• Fixed Assets bought or sold in the
period
If a fixed asset is bought or sold in 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.
b) Monthly or pro-rata depreciation based on the exact
number of months that the asset has been owned.
Lecturer: Chara Charalambous
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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.
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
Lecturer: Chara Charalambous
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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
Lecturer: Chara Charalambous
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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
x
Lecturer: Chara Charalambous
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Example 3:
Santa runs a large toy shop in Windsor. In 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
What is the depreciation charge for the year ended 31st August
20X5?
Show the relevant ledger accounts and statement of financial
position presentation at that date.
Lecturer: Chara Charalambous
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Cash Register
Delivery Van
1DecY4 5000 b/ce c/d 5000
B/ce b/d 5000
31 MarY5 22000 b/ce c/d
B/ce b/d 22000
Depreciation expense
Accumulated. Deprec
31 AugY5
Acc Dep C.R 375 Profit & Loss 1750
Acc Dep D.V 1375
1750
22000
31 AugY5
b/ce c/d 1750 Depr exp 1750
1750
1750
1750
B/ce b/d
Lecturer: Chara Charalambous
1750
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• 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
Lecturer: Chara Charalambous
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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.
Lecturer: Chara Charalambous
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1.Accounting for Disposal for cash
3 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
Lecturer: Chara Charalambous
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
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Example 4: 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
How much is charged to Percy’s income statement in respect
of the asset for the year ended 31 Dec 20X5?
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)
Lecturer: Chara Charalambous
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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
875 total for the
first 3 years
Depreciation
Y5 B/ce b/d 3000 Disposal 3000
Y5 Acc Depn 175 P&L 175
Lecturer: Chara Charalambous
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Accumulated depreciation
Y5 Disposal 1050 Y5 B/ce b/d
Depen up to 31st July
1050
875
175
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)
Lecturer: Chara Charalambous
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Example 5: 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% p.a. and
she charges a full year depreciation in the year of
acquisition and none in the year of disposal.
In December of Y5 she decides to replace the old machine
with a faster machine. 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
Show the ledger entries for the year ended 31st Dec Y5.
Lecturer: Chara Charalambous
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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
Y5 B/ce b/d 2500 Disposal 2500
New machine
Y5 DisP-PEA 750
Bank
4850 B/ce c/d 5600
5600
5600
1500 total for the
first 3 years
Depreciation
Y5 Acc Depreciation
for new machine1120 P&L1120
5600*20%
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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)
Lecturer: Chara Charalambous
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Intangible 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.
Lecturer: Chara Charalambous
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• 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.
.
Lecturer: Chara Charalambous
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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.
Lecturer: Chara Charalambous
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Lecturer: Chara Charalambous
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