Adjustments to financial statements 1 Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 IAS 16 PPE “The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment. The principal issues are the recognition of assets, the determination of their carrying amounts, and the depreciation charges and impairment losses to be recognised in relation to them.” Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 What is depreciation? Depreciation is the means by which the loss in value of a non-current asset is spread out over the useful life of the asset Depreciation is an expense Depreciation is the loss in value of a non-current asset over its useful economic life that is apportioned to financial periods It’s a non-cash expense Mr. Barry A-level Accounting Year 12

Accounting for Depreciation Fixed assets other than land lose their ability over time to provide services Costs of equipment, buildings, and land improvements should be transferred to expense accounts in a systematic manner during their expected useful lives. DEPRECIATION Adjusting entry to record depreciation is usually made at the end of each month or at the end of the year Fixed assets other than land lose their ability over time to provide services Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Adjusting Entry Account Debit Credit Depreciation expense £7,000 Accumulated depreciation - truck £7,000 Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Depreciation Accumulated depreciation Shows the amount that the asset has lost in value since its purchase Depreciation expense Shows the amount that the asset has lost in value this period. Factors that cause a decline the ability of a fixed asset to provide services may be identified as Physical depreciation Occurs from the wear and tear while in use and from the action of the weather Functional depreciation Occurs when a fixed asset is no longer able to provide services at the level for which it was intended. Mr. Barry A-level Accounting Year 12

Factors in accounting for depreciation expense The fixed asset’s initial cost Its expected useful life (UEL) Its estimated value at the end of its useful life (residual value) Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Depreciation Methods Straight line Reducing balance Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 1. Straight line Method Provides for the same amount of depreciation expense for each year of the asset’s useful life Annual depreciation expense = Cost – residual value UEL Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Example 1 A machine had a cost of £24,000, residual value of £2,000 and useful economic life of 5 years Annual depreciation expense = Cost – Residual value Life = £24,000 - £2,000 5 years = £4,400 annual depreciation Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Adjusting entry Account Debit Credit Depreciation expense £4,400 Accumulated depreciation - Machinery £4,400 Mr. Barry A-level Accounting Year 12

Income Statement Entry Less Expenses Depreciation charge Rent 4,400 3,000 Mr. Barry A-level Accounting Year 12

Statement of financial position (balance sheet) Entry NON CURRENT ASSETS £ Machinery at Cost 24,000 Accumulated depreciation 4,400 Net Book Value 19,500 Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Example 2 A machine had a cost of £30,000, residual value of £5,000 and useful life of 6 years. Calculate depreciation under the straight line method? What is depreciation expense in year 3? ANSWER= = £30,000 - £5,000 6 years = £4,167 annual depreciation Mr. Barry A-level Accounting Year 12

Reducing Balance Method Provides for a declining periodic expense over the estimated useful life of the asset. Book value = Cost – Accumulated depreciation Mr. Barry A-level Accounting Year 12

2. Reducing Balance Method Using this method the depreciation charge is a fixed percentage of the cost of the asset in the first year. In the second and later years the same percentage is taken of the reduced balance or net book value (cost less depreciation already charged) Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Example If a machine is bought for £10,000 on 1/1/11 and depreciation is to be charged at 20% per annum using the reducing balance method The depreciation calculations for the first three years would be as follows: Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Answer Year 1 Year 2 Year 3 Cost= £10,000 X .20 2, 000 depreciation Cost- Acc Dep= £10, 000- £2,000= £8,000 (NBV) X .20 1,600 depreciation £8,000- £1,600= £6,400 (NBV) X .20 1,280 depreciation Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Choice of Methods A business can choose whichever method it prefers Straight Line Method – same depreciation charge is charged each year – suit assets where benefits are to be gained evenly over the years Reducing Balance Method – more depreciation is charged in the early years – suit assets where main value is to be obtained from the asset in the early years Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Financial Accounting Depreciation of Non current Assets II: Disposals, Impairments and Revaluations Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Summary Non current assets fall in value Through consumption and use (wear & tear; obsolescence; depletion etc.) Financial accounts need to take account of this factor This is done through an annual charge for depreciation (effectively reduces the original cost of an asset each year to reflect wear & tear/usage) Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Summary Annual depreciation charge calculated using either the: Straight Line Method (based on cost) Reducing Balance (based on NBV at end of each period) Annual depreciation charge is charged as an expense through the Income Statement Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Summary In Balance Sheet must show for each class of fixed asset Cost Accumulated Depreciation (depreciation charged to date i.e. from date of acquisition) Net Book Value (NBV) Cost - Accumulated Depreciation = NBV (reduced value of the asset at the end of each accounting period) Mr. Barry A-level Accounting Year 12

Recording Depreciation Non current Asset Accounts are always kept for showing the assets at cost price (or revalued amount) Depreciation is shown accumulating in a separate “Accumulated Depreciation account or Provision for Depreciation Account” Mr. Barry A-level Accounting Year 12

Recording the Disposal of a non current Asset Remove Asset @ Cost Calculate depreciation on disposed asset Remove disposed asset depreciation from accumulated depreciation Calculate gain(profit) or loss on disposal Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Double Entry Depreciation Charge Dr.: Depreciation (I/S) (Expense) Cr.: Accumulated Depreciation being charge for the year Disposal Dr. : Disposal Account Cr. : Non current Account being cost of non current asset disposed of Mr. Barry A-level Accounting Year 12

Double Entry - Disposal Dr.: Accumulated Depreciation Cr.: G/L on Disposal account being accumulated depreciation on asset disposed of. Dr. : Bank Account Cr. : G/L on Disposal Account being remittance received on disposal Mr. Barry A-level Accounting Year 12

Double Entry - Disposal Transfer the balance on the disposal account to the Income Statement account If a profit is made on disposal the credit side will be greater than the debit side If a loss is made on disposal the debit side will be greater than the credit side NBV of Disposal (Cost - accumulated Depreciation) > Proceeds = Loss (< Proceeds = Profit) Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 IAS 36 Impairment 1 Impairment exists where the carrying value of the asset in the BS is greater than the recoverable amount. If an asset’s value in the accounts is greater than its realistic value (recoverable amount), then it can be said that the asset suffered an impairment loss. Treatment If asset had been revalued then write off impairment loss against revaluation surplus Otherwise should write off that impairment loss to the IS immediately (an expense). Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Revaluation IAS 16 allows entities to show non current assets at : Cost or Revalued to their Fair value (only if fair value can be reliably measured) Normally use market value for land, buildings, plant, equipment as the fair value Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Revaluation If a company decides to revalue one of its Non Current Assets it must apply that policy to all of the assets in that Class. (IAS 16) Revalue all assets in that class at the same time If a non current asset is revalued – must use a Revaluation Reserve Dr Asset Cr Revaluation Reserve Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 REVALUATION Depreciation should always be on the revalued amount. Will also result in entries to the following BS Accounts: Non Current asset (cost) Accumulated Depreciation Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 Revaluation If Company adopts the policy, must have a full revaluation every 5 years Interim revaluation in Year 3 Revalue to Market value Details disclosed in Note to the accounts, Original cost, revalued amount, dates, valuers & qualifications etc Examples Mr. Barry A-level Accounting Year 12

A-level Accounting Year 12 IAS 16 NB Example of depreciation on revalued asset Fixed asset cost €3m in Year 2000 Useful economic life = 10 years Revalued at end of Year 2002 to €3.3m How is this treated in the accounts ? Also show entries for Year 2003. Mr. Barry A-level Accounting Year 12