Slide 8.1 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 8 Non-current (fixed) assets

Slide 8.2 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Definitions Asset Resource… from which future economic benefits are expected to flow. Non-current (fixed) assets Held for use in profit generating process. On a continuing basis. Not for sale in ordinary course of business.

Slide 8.3 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Classification Property, plant and equipment, also called tangible non-current (fixed) assets. Intangible non-current (fixed) assets. Investments held long term. Intangible: No physical substance Patents Trade marks Development costs Goodwill

Slide 8.4 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Valuation Normally at Cost less accumulated depreciation equals NET BOOK VALUE (NBV) or depreciated cost. Revaluation of non-current (fixed) assets Asset is given a valuation above cost. Usually applied to land and buildings. Revaluation is a choice for the company. If used, revaluations must be updated regularly.

Slide 8.5 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Cost of non-current (fixed) assets At acquisition Purchase price of an asset plus the cost of preparing it for use. –Legal costs of acquisition and installation and commissioning costs.

Slide 8.6 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Improvements after purchase Improvement expenditure may extend the asset’s annual output capacity increasing its economic life. reducing associated running costs. improving the quality of its output. Costs incurred to improve on the asset’s original condition: for example extension to a building. rebuilding shop fittings to attract new type of customer. These costs should be added to the original cost of the asset and depreciated over the remainder of its useful life.

Slide 8.7 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Repairs, restoration Costs incurred to maintain, repair or restore the asset to its original condition– treated as an expense and charged to the profit and loss account: for example, replacing roof damaged in storm. replacing engine in bus.

Slide 8.8 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Depreciation Non-current (fixed) assets are gradually used up in providing goods and services over time. Purpose of accounting depreciation is to spread the cost of a non-current (fixed) asset over its expected useful life. Depreciation is a method of allocating cost. Achieves a matching of costs against the related revenues.

Slide 8.9 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Depreciation (Continued) In historical cost (traditional) accounting: the Net Book Value (NBV) is the result of a calculation. (Original cost – Accumulated depreciation) it is not intended to represent the asset’s market value.

Slide 8.10 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Non-current (fixed) Assets and Depreciation YearAssets –Liabilities=Ownership interest 1 ↓↓ 2 ↓↓ 3 ↓↓ etc.

Slide 8.11 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Yearly depreciation, Accumulated depreciation Each year that a non-current (fixed) asset is in use, a portion of its cost is deducted from the balance sheet value. That portion of cost is ‘matched’ against the revenues of that year. This gives the depreciation charge of the year. (Income statement profit and loss account). The depreciation of the non-current (fixed) asset in each year is added to the depreciation of earlier years to arrive at the Accumulated depreciation. (Balance sheet).

Slide 8.12 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Calculation of depreciation Requires three items of information: the cost of the non-current (fixed) asset. the estimated useful life. the estimated residual value (the value remaining at the end of the useful life).

Slide 8.13 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Total depreciation Total depreciation of the non-current (fixed) asset is equal to the cost of the non-current (fixed) asset minus the estimated residual value.

Slide 8.14 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Purpose and methods The purpose of the depreciation calculation is to spread the total depreciation over the estimated useful life. Methods of depreciation (a) Straight-line method (b) Reducing value

Slide 8.15 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Straight-line depreciation Those who believe that a non-current (fixed) asset is used evenly over time apply a method of calculation called straight-line depreciation. The formula is :

Slide 8.16 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Non-current (fixed) asset, which has a cost of £1,000 and an expected life of 5 years. The expected residual value is nil. The calculation of the annual depreciation charge is: = £200 per annum Accounting policy: Depreciation is charged on a straight-line basis at a rate of 20% of cost per annum. Straight-line depreciation (Continued)

Slide 8.17 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 ‘Straight line’ – a graph of the net book value of the asset at the end of each year produces a straight line. Straight-line depreciation (Continued)

Slide 8.18 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 End of year Depn of the yearTotal depnNet book value of the asset (b)(c)(£1,000 – c) £££ ,000nil Pattern of depreciation and net book value Table 8.1 Pattern of depreciation and net book value over the life of an asset

Slide 8.19 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Straight-line depreciation – graph of net book value Figure 8.1 Graph of net book value over Years 1 to 5, for the straight-line method of depreciation Year 0Year 1Year 2Year 3Year 4Year 5 net book value

Slide 8.20 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Reducing-balance depreciation Those who believe that the non-current (fixed) asset depreciates faster in the earlier years of its life would calculate the depreciation. Formula: Fixed percentage × the net book value at the start of the year

Slide 8.21 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 rate = × 100% The rate of depreciation to be applied under the reducing balance method of depreciation is calculated by the formula: where n = the number of years of useful life R = the estimated residual value C = the cost of the asset Reducing balance depreciation (Continued)

Slide 8.22 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 n = 5 years C = £1,000 R = £30 (The residual value must be of reasonable magnitude. To use an amount of nil for the residual value would result in a rate of 100%). × 100% = approx 50%Rate = Example calculation Reducing balance depreciation (Continued) )( 1  1,000 30

Slide 8.23 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 YearNet book value at start of year Annual depreciationNet book value at end of year (a)(b) = 50% of (a)(a–b) £££ 11, Reducing balance calculation Table 8.2 Calculation of reducing-balance depreciation

Slide 8.24 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Reducing balance depreciation – graph of net book value Figure 8.2 Graph of net book value over Years 1 to 5, for the reducing-balance method of depreciation Year 0Year 1Year 2Year 3Year 4Year 5 net book value

Slide 8.25 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Retaining cash in the business Fee income £120,000. Pay wages and other costs £58,000. Depreciation calculated as £10,000. How much may the owner take in drawings? Cash available is £62,000. But if that is taken for personal use there is nothing left in the bank to put towards asset replacement. Take cash of £52,000 leaves £10,000 towards asset replacement. Problem – business may spend the £10,000 on other aspects of business, such as buying current assets or repaying loans.

Slide 8.26 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Presentation in financial statements Example: On 1 January Year 2 Electrical Instruments purchased a three-year lease of a shop for £60,000. The accounts over the next three years would include the following items related to the lease.

Slide 8.27 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Income statement (profit and loss account) Year ended 31 DecYr 2Yr 3Yr 4 £000’s Depreciation expense20 Balance sheet at 31 Dec Lease at cost 60 Less: Accumulated depreciation Net book value40200

Slide 8.28 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Straight-line with residual value The Removals Company was set up on 1 January Year 2, purchased van for £60,000, and started to trade. The manager estimates that: 1.The van will be used for 3 years; and 2.Estimated residual value of £6,000 (second hand or scrap value).

Slide 8.29 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Calculation Net cost of the van = (£60,000 – £6,000) = £54,000. Net cost has to be depreciated over 3 years. i.e. (54,000/3) = £18,000 per year. Assume: During the year cash receipts from sales were £120,000 and cash expenses were £58,000 for wages, petrol and running costs.

Slide 8.30 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 £000’s Van at cost 60 Less: Accumulated depreciation(18) Net book value 42 Cash Ownership interest at start 60 Profit for the year Balance sheet – end Year 2 Table 8.4 The Removals Company: Statement of financial position (balance sheet) at end of Year 2 and Income statement (profit and loss account) for Year 2

Slide 8.31 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 £000’s Fees for removal work120 Cash expenses(58) Depreciation(18) (76) Profit for the year 44 Income statement (profit and loss account) Year 2 Table 8.4 The Removals Company: Statement of financial position (balance sheet) at end of Year 2 and Income statement (profit and loss account) for Year 2 (Continued)

Slide 8.32 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Year 2Year 3 £000’s Van at cost60 Less: Accumulated depreciation1836 Net book value4224 Cash Ownership interest OI at start60104 Profit and loss account Balance sheet Table 8.6 The Removals Company statement of financial position (balance sheet) at end of Year 3 and Income statement (profit and loss account) for Year 3

Slide 8.33 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Year 2Year 3 £000’s Turnover120 Cash expenses(58) Depreciation(18) 76 Profit for the year44 Income statement (profit and loss account) Table 8.6 The Removals Company statement of financial position (balance sheet) at end of Year 3 and Income statement (profit and loss account) for Year 3 (Continued)

Slide 8.34 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Presentation See text book for more detail on Spreadsheets Presentation

Slide 8.35 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Chapter 8 Bookkeeping supplement

Slide 8.36 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Capital contributedCapital withdrawn RevenueExpenseOwnership interest IncreaseDecreaseLiability Right-hand side of the equation DecreaseIncreaseAsset Left-hand side of the equation CREDIT ENTRIESDEBIT ENTRIES Debit and credit entries in ledger accounts Table 8.12 Rules for debit and credit entries in ledger accounts

Slide 8.37 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 DateTransaction or eventAmountDrCr Year 2£ 1 JanOwner contributes cash60,000CashOwnership interest 1 JanPurchase furniture van60,000Van at costCash All yearCollected cash from customers 120,000CashSales All yearPaid for running costs58,000Running costs Cash 31 DecCalculate annual depreciation 18,000Depreciation expense Accumulated depreciation Analysis of transactions for the Removals company, Year 2 Table 8.13 Analysis of transactions for The Removals Company, Year 2

Slide 8.38 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 L1 Ownership interestL4 Accumulated depreciation of van L2 CashL5 Sales L3 Van at costL6 Running costs L7 Depreciation of the year Ledger accounts required to record transactions

Slide 8.39 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 L1 OWNERSHIP INTEREST DATEPARTICULARSPAGEDEBITCREDITBALANCE Year 2£££ Jan 1CashL260,000(60,000) L2 CASH DATEPARTICULARSPAGEDEBITCREDITBALANCE Year 2£££ Jan 1Owner’s capitalL160,000 Jan 1VanL360,000nil Jan– Dec SalesL5120,000 Jan– Dec Running costsL658,00062,000 Ledger accounts required to record transactions (Continued)

Slide 8.40 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 L3 VAN AT COST DATEPARTICULARSPAGEDEBITCREDITBALANCE Year 2£££ Jan 1CashL260,000(60,000) L4 ACCUMULATED DEPRECIATION OF VAN DATEPARTICULARSPAGEDEBITCREDITBALANCE Year 2£££ Dec 31 Depreciation for the year L718,000(18,000) Ledger accounts required to record transactions (Continued)

Slide 8.41 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 L5 SALES DATEPARTICULARSPAGEDEBITCREDITBALANCE Year 2£££ Jan– Dec CashL2120,000(120,000) L6 RUNNING COSTS DATEPARTICULARSPAGEDEBITCREDITBALANCE £££ Jan– Dec CashL258,000 Ledger accounts required to record transactions (Continued)

Slide 8.42 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 L7 DEPRECIATION OF THE YEAR DATEPARTICULARSPAGEDEBITCREDITBALANCE £££ Dec 31 Accumulated depreciation L418,000 Ledger accounts required to record transactions (Continued)

Slide 8.43 Pauline Weetman, Financial and Management Accounting, 5 th edition © Pearson Education 2011 Ledger account title££ L1 Ownership interest60,000 L2 Cash62,000 L3 Van at cost60,000 L4 Accumulated depreciation of van18,000 L5 Sales120,000 L6 Running costs58,000 L7 Depreciation18,000_______ Totals198,000 Trial balance at the end of Year 2 for the Removals company Table 8.14 Trial balance at the end of Year 2 for The Removals Company