PRINCIPLES OF ACCOUNTING
Lecture 11
Reporting non-current assets
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Lecture Outline
Classification of Long lived assets
– Tangible assets
– Intangible assets
Property, Plant and Equipment (PPE)
– Acquisition cost
– Depreciation
– Disposal
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Classification of long lived assets
Tangible assets: have physical substance.
– Land
– Buildings, fixtures, and equipment
– Natural Resources
Intangible assets are long lived assets without
physical substance that confer specific rights on
their owner
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Acquisition of PPE
Plant assets are initially recorded at acquisition cost.
Acquisition cost should include all of the costs that are
normal and necessary to acquire the asset and prepare it
for its intended use.
– Items included in acquisition cost would generally include
purchase price, taxes paid at time of purchase, incidental costs,
renovation and repairs costs incurred prior to the asset’s use,
transportation charges, installation costs.
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Which costs to be included?
A firm purchased a photocopier for $5,000 and incurred
the following additional costs:
–
–
–
–
Freight on photocopier
Insurance in transit
Cost of installation & testing
Cost of carpet shampoo in
photocopier room prior to install
$100
$20
$100
$50
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Acquisition cost
Eg., Delta purchased a new 737 aircraft from
Boeing for list price of $63m; was offered a
discount of $4m, paid $0.2m delivery cost and
$0.8m preparation costs.
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Recording acquisition for cash
Assuming Delta paid cash for the aircraft and
related cost. The transaction is recorded as
follows:
Dr. Flight Equipment $60m
Cr. Cash
$60m
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Recording acquisition for debt
Assuming Delta signed a note payable for the
new aircraft and paid cash for the transportation
and preparation cost. The transaction is
recorded as follows:
Dr. Flight Equipment $60m
Cr. Cash
$1m
Cr. Note payable
$59m
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Recording acquisition for Equity
Assuming Delta gave Boeing 400,000 shares of
its $3 par value common stock with market value
of $85 per share and paid the balance in cash.
Dr. Flight Equipment
$60m
Cr. Common stock
$1.2m
Cr. Additional paid in capital $32.8m
Cr. Cash
$26m
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Recording acquisition by
construction
A company may construct an asset for its own use
instead of buying from a producer
The acquisition cost of that asset includes all the
necessary costs associated with construction such
as labor cost, materials and “ capitalised interest”.
Capitalised interest represents interest
expenditures included in the cost of a selfconstructed asset
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A lump-sum purchase of asset
A lump-sum purchase: the purchase price should
be allocated to different items on the basis of the
proportion of the fair market value.
1 Jan, Payton purchased building and land for $100,000
– Estimated market value for land is $30,000 and for building is
$90,000. Total is $120,000
– Allocation of purchase price :
– Land: $100,000 * (30,000/120,000) = $25,000
– Building: $100,000 * (90,000/120,000) = $75,000
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Capital versus revenue expenditure
A capital expenditure is a cost that improves the asset and
is added to the cost of the asset.
A revenue expenditure is a cost that keeps an asset in its
normal operating condition and is treated as an expense.
If an expenditure increases the life of the asset or its
productivity, it should be treated as a capital expenditure
and added to the asset account.
If an expenditure simply maintains the productive capacity
of the asset during the current accounting period only, it
should be treated as an expense.
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Depreciation
Depreciation
The allocation of the cost of the asset over its
useful life
Expense
Non-cash item
Process of allocation not valuation
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Depreciation
Factors contributing to decline in value of a noncurrent asset
– Wear and tear through physical use of asset
– Technical obsolescence
– Commercial obsolescence
Depreciation is made to ensure matching
principle.
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Depreciation
3 factors in calculating depreciation
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Accumulated depreciation
The amount of depreciation that has
accumulated since the purchase of the asset.
Contra asset account
Increase by a credit
Decrease by a debit
Normal balance is credit balance
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Net book value or carrying value
This is the value of the asset after subtracting
depreciation from the original cost of the asset.
That is, cost less accumulated depreciation
Represents the value of the asset in the
accounting records.
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Depreciation methods
Straight-line method
Reducing-balance
Units of production
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Lecture example
Truck Purchase(cost):
Estimated Useful Life:
Residual Value:
Useful life in kilometres
Year 1
Year 2
Year 3
Year 4
Year 5
$100,000
5 years
$ 10,000
90,000
20,000 kilometres
30,000 kilometres
10,000 kilometres
20,000 kilometres
10,000 kilometres
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Straight line method
Depreciation expense the same amount every
year over the useful life of the asset.
Formula
Depreciation =
Cost – Residual Value
exp p.a
Estimated Useful Life
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Straight line method
Year
Depreciation
Accumulated
depreciation
Book value
1
2
3
4
5
10,000
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Reducing balance method
Applied at a particular rate
– Double declining method: applied at double of the
straight line rate.
Calculated on last periods book value
Accelerated method
– Why?
• Because more of the depreciation cost is allocated to the
earlier years of an asset’s life and less depreciation to the
latter years.
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Reducing balance method
Reducing balance rate = double the straight-line
rate.
– What is the depreciation rate?
What is the depreciation expense in each of the
five years?
What is the book value at the end of the fifth
year?
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Reducing balance method
Year
Depreciation
Accumulated
depreciation
Book value
1
2
3
4
5
10,000
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Units of production
This method assumes that depreciation is solely
through the usage of the asset
Allocates depreciation based on the units of
output or use during each period of an assets
useful life
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Units of production
Year
Depreciation
Accumulated
depreciation
Book value
1
2
3
4
5
10,000
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Comparison of depreciation method
The choice of depreciation method can have a significant
impact on firms’ financial statements.
The method to be selected should be chosen on the basis
of best satisfying the matching principle.
The choice of depreciation method should be linked to the
nature of asset being considered.
A business may use both methods for different assets that
have different revenue-earning patterns.
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Choice of depreciation method
Factor
Likely choice
Simplicity
Straight line method
Reporting to stockholders
Straight line method
Comparability
Same method with others in the
same industry or line of business
Straight line method
Management bonus plan
Technological
competitiveness
Accelerated method
Reporting for tax purpose
Accelerated method
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Disposal of PPE
When an asset is disposed, all accounts related
to it must be removed.
The asset account and accumulated
depreciation should be eliminated from the
balance sheet.
The gain or loss on sale of asset is recorded as
Other income/ expense in the income statement.
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Disposal of PPE
Example: 1 Jan 20X7, a machine is purchased for
$20,000
Estimated residual value: $2,000, estimated useful
life:5 years
Assume it is sold on 1 Jul 20X9.
Accumulated depreciation up to 1 Jul 20X9 (2.5
years) = {(20,000 – 2,000)/5} * 2.5 = 9,000
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Disposal of PPE
Proceeds from sale of the machine is $12,400
Book value = Cost – Accumulated depreciation
= 20,000 – 9,000 = 11,000
Gain on sale = 12,400 – 11,000 = 1,400
1 Jul 20X9
Dr Accumulated depreciation
9,000
Dr Cash
12,400
Cr Machine
20,000
Cr Gain on sale of asset
1,400
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Disposal of PPE
Proceeds from sale of the machine is $10,000
Book value = Cost – Accumulated depreciation
= 20,000 – 9,000 = 11,000
Loss on sale = 11,000 – 10,000 = 1,000
1 Jul 20X9
Dr Accumulated depreciation
9,000
Dr Cash
10,000
Dr Loss on sale of asset
1,000
Cr Machine
20,000
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Intangibles
Patents
Copyrights
Trademarks, brand names
Franchises, licenses
Goodwill
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Tutorial
S9-2
S9-3
E9-13
E9-14
E9-15
E9-19
E9-21
E9-22
P9-27A
P9-28A
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