2. Financial Accounting 1 Lecture – 20 Recap What are fixed assets How to record purchase and disposal of fixed assets Classification of fixed assets What is depreciation Methods of depreciation Policies of Depreciation Capital Work In Progress Revaluation

3. Financial Accounting 2 Lecture – 20 Areas Covered In this Lecture In this Lecture We Will Cover Following Areas A reminder of Journal Entries For Capital Work In Progress, and Its Presentation in Balance Sheet How to Treat Disposal of Asset in Case we are charging depreciation on the Basis of Use Revaluation of fixed Assets

4. Financial Accounting 3 Lecture – 20 Capital Work In Progress The issue of capital work in progress arises when construction of a Fixed Asset asset is not complete at the time of preparing the balance sheet. Since the asset is not complete therefore it can not be classified in fixed assets Also no depreciation is charged as the asset is not in use and we had said that Depreciation is a Charge for the Use of the asset. Therefore the Costs Incurred to the date of the Balance Sheet Date on the construction of that incomplete asset are accumulated in an account called Capital Work In Progress. The Journal Entries are as follows:

5. Financial Accounting 4 Lecture – 20 Capital Work In Progress Journal Entries At the time of Payment for the construction: DebitCapital Work In Progress Account CreditCash / Bank / Payable At the time when the asset is completed and put in use DebitFixed Assets (relevant account) CreditCapital Work in Progress Account Balance in the Capital Work in Progress Account therefore becomes ZERO when the asset is completed and its use is started. REMEMBER no depreciation is charged on capital work in progress. Capital Work in Progress is presented after Fixed Assets and before other long term assets in Balance Sheet. Its presentation in balance sheet is shown in the following slide

6. Financial Accounting 5 Lecture – 20 Capital Work In Progress Presentation Name of the Entity Balance Sheet As At ParticularsAmount Rs. Assets Fixed Assets Capital Work in Progress Other Long Term Assets Current Assets xxx Totalxxx Liabilities Capital Profit xxx Long Term Liabilities Current Liabilities xxx Totalxxx

7. Financial Accounting 6 Lecture – 20 Dep. and Disposal in Case Depreciation on the Basis of Use We discussed two policies for charging depreciation: One was to charge depreciation on the basis of use, And the other was to charge full depreciation on the year of purchase and charging no depreciation in the year of sale. In the second case it is easier to charge depreciation and calculate WDV at disposal. But in the first case the calculations are a little bit difficult we will therefore revise them for you. Just to remind you the data of the example was:

8. Financial Accounting 7 Lecture – 20 Example ABC Co. prepares it’s accounts on December 31, every year. On Dec 31 Year 4 the machinery included: One machine purchased on July 1, Yr 1 for Rs. 50,000 One machine purchased on Jan 1, Yr 2 for Rs. 75,000 One machine purchased on April 1, Yr 3 for Rs. 100,000 Machine 1 is disposed off on Sep 30, Yr 4. Depreciation is charged at 25% reducing balance method. Show the calculations of depreciation on machinery for the four years, applying following policies: (1) Dep. is charged on the basis of use (2) Full Dep. on the year of purchase and no Dep. in the year of disposal.

9. Financial Accounting 8 Lecture – 20 Yr 1: One machine purchased on July 1, Yr 1 for Rs. 50,000 Policy 1 WDV Opening Balance 0 Purchase50,000 50,000 Dep. (50,000 x 25%) x 6/12(6,250) WDV Closing Balance43,750 The purpose of revising the same problem is mainly to explain the working of disposal in case this policy is adopted, but we have shown the first three years as well here for your convenience. Students should remember on thing that two different accounts namely Cost and Accumulated Depreciation are used but for the purpose of explaining the working we are deducting the depreciation figure from cost in first year and WDV in subsequent years.

10. Financial Accounting 9 Lecture – 20 Yr 3: One machine purchased on April 1, Yr 3 for Rs. 100,000 Policy 1 WDV Opening Balance89,062 Purchase 100,000 189,062 Dep. (89,062 x 25%) (22,265) Dep. (100,000 x 25%) x 9 / 12 (18,750) WDV Closing Balance 148,047 Yr 2: One machine purchased on Jan 1, Yr 2 for Rs. 75,000 Policy 1 WDV Opening Balance43,750 Purchase75,000 118,750 Dep. (118,750 x 25%) (29,688) WDV Closing Balance89,062

11. Financial Accounting 10 Lecture – 20 If we had been been presenting this example properly then the figures would have been as follows: Cost Machinery Account Year 1Rs. 50,000 Year 2Rs. 75,000 Year 3Rs.100,000 225,000 Accumulated Depreciation Year 1Rs. 6,250 Year 2Rs. 29,688 Year 3Rs. 22,265 + 18,750 = 41,015 76,953 WDV = 225,000 – 76,953 = 148,047, Which is the same as shown in the previous working.

12. Financial Accounting 11 Lecture – 20 In the year 4 we have to dispose off the Machine 1 on Sep 30, Yr 4. Therefore we have to calculate it’s Accumulated Depreciation / WDV at the time of disposal: WDV of machine sold this year Cost YR 150,000 Dep Yr 1 (50000 x 25 %) 6/12 6,250 WDV YR143,750 Dep Yr 2 (43750 x25%)10,938 WDV YR2 32,812 Dep Yr 3 (32,812 x 25%) 8,203 WDV YR3 24,609 Dep Yr 4 (24,609 x 25%) x 9 / 12 4,614 WDV YR4 19,995

13. Financial Accounting 12 Lecture – 20 Yr 4: Machine 1 is disposed off on Sep 30, Yr 4. Policy 1 WDV Opening Balance 148,047 Dep. Machine 1 (4,614) Dep. Others (148,047 – 24,609) x 25% (30,860) 112,573 WDV of Asset Disposed (19,995) WDV Closing Balance 92,578 WDV of machine sold this year Cost yr 150,000 Dep Yr 1 (50000 x 25 %) 6/12 6,250 WDV YR143,750 Dep Yr 2 (43750 x25%)10,938 WDV YR2 32,812 Dep Yr 3 (32,812 x 25%) 8,203 WDV YR3 24,609 Dep Yr 4 (24,609 x 25%) x 9 / 12 4,614 WDV YR4 19,995

14. Financial Accounting 13 Lecture – 20 Revaluation of Fixed Assets We briefly discussed Revaluation of Fixed Assets in the last lecture. Since this is an advanced area in accounting of fixed assets, therefore we will not go into details but still you should have a fair understanding of the area. OR We will discuss the details when we cover RESERVES, a component of LIABILITIES, but it is important to understand the basics and effect on fixed assets account at this point.

15. Financial Accounting 14 Lecture – 20 The Need For Revaluation Revaluing means “Valuing Again”. This means that the Revaluation of something is required when we think that the value shown in Balance Sheet is does not represent its real worth. The theory behind revaluation is as follows: We have said that the balance sheet shows the financial position of an entity at a specific date. And we record fixed assets at their purchase cost in the books of accounts. Now the fixed assets are assets that have physical existence and are used by the business for a long time. Therefore unlike Debtors, Creditors, Cash, Bank and other balance sheet items they may have a value different than the one appearing in the accounts. It may be less or more than the WDV / book value.

16. Financial Accounting 15 Lecture – 20 The Need For Revaluation Take the example of Land. A company may use a piece of land on which its factory or office is built for many years. This period can extend to ten, fifteen, twenty years or even more. You know that the value of land is almost always on the rise. So at some time the company may think that the land is not being shown at its real worth in the accounts. Same can be the case with other assets like Building, Machinery etc. Therefore the need of revaluation arises to show the fixed assets of the company at their fair value. FAIR VALUE – is the value that an asset would fetch in a transaction between two knowledgeable parties in an arms length deal (market value where seller and buyer both have a fair idea of market).

17. Financial Accounting 16 Lecture – 20 Rules For Revaluation But when we stop using one policy that is stating Fixed Assets at their original cost the way we have been doing before then we have to follow some rules. The major rules and regulations governing revaluation are as follows: Once the fixed assets are stated at revalued amount then the exercise of revaluation has to carried out at regular intervals. The frequency of revaluation depends intervals depend on the movement in the fair market values. This means that you cannot use this to get results of your choice i.e. getting the assets revalued when the market values are high but not doing it again when the market values drop or vice versa. Again once you state the balances at revalued amount the revaluation has to be carried out at regular intervals.

18. Financial Accounting 17 Lecture – 20 Rules For Revaluation The work of revaluation has to be carried out by an expert authorized in this respect by regulatory authorities. You can not just say it yourself that as of today we have revalued our assets to such and such value. If we decide to revalue an asset say a piece of land or machinery then we have to revalue the whole class to which that asset belongs i.e. Land and Plant and Machinery respectively. It is not possible to revalue selected assets within one classification. For example if an organization owns four different pieces of land and it decides to revalue Land, then all the land will have to be revalued. Again this rule has been framed to prevent malpractice of obtaining desired results by selected revaluation.

19. Financial Accounting 18 Lecture – 20 Accounting for Revaluation Lets assume that a whole class of assets say Plant and Machinery or Land and Building was purchased in Year 1 for Rs. 200,000. Depreciation is charged at 20% on straight line. After the end of Year 3, Cost of the asset is still Rs. 200,000 and its accumulated depreciation is Rs. 120,000 (40,000 x 3). This means that book value or WDV of the asset is Rs. 80,000. At the time of revaluation it is discovered that the Fair Value of the asset is Rs. 140,000. Now there are two methods of recording this revaluation:

20. Financial Accounting 19 Lecture – 20 Accounting for Revaluation (1) Step 1 The accumulated depreciation is charged off against the cost of the asset DebitAccumulated Dep. Account120,000 Credit Plant and Machinery120,000 This will reduce cost to Rs. 80,000 Step 2 Cost of the asset is increased to Rs. 140,000. The credit is given to a new account Revaluation Reserve Account. This account will have a credit balance and will be shown as a liability in balance sheet. DebitPlant and Machinery Account60,000 Credit Revaluation Reserve Account60,000 This will increase the cost to the desired level of Rs. 140,000 (80 + 60)

21. Financial Accounting 20 Lecture – 20 Accounting for Revaluation (2) In this method both Cost and Accumulated Depreciation are increased in a proportionate manner so that the resulting Book Value is equal to the revalued amount. In this case WDV is Rs. 80,000 and the desired Book Value is Rs. 140,000. This is an increase of Rs. 60,000 or 75% of 80,000. So we have to increase both cost and Acc. Dep. by 75% to get the desired WDV. 75 of cost 200,000 is 150,000 DebitPlant and Machinery Account150,000 Credit Revaluation Reserve Account150,000 75 of Acc. Dep. 120,000 is 90,000 Debit Revaluation Reserve Account90,000 Credit Accumulated Dep. Account90,000 The net result is an increase in WDV by Rs. 60,000 (150 – 90) and an increase in revaluation reserve by Rs 60,000 (150 – 90)

22. Financial Accounting 21 Lecture – 20 Treatment of Revaluation Reserve One might think what is the purpose of the whole exercise. At on side we have increased an asset and on the other a liability has increased. It would have made more sense if the Credit was given to P&L Account. Then we would have said that the business gained from Appreciation in the value of a fixed asset. Ultimately this reserve also becomes part of the P&L but we will cover that at a later stage.

23. Financial Accounting 22 Lecture – 20 Treatment of Revaluation Loss It is not necessary that revaluation produces a gain. It can also result in a loss. In this case the calculation is made the same way but instead of Revaluation Reserves Account a Loss on Revaluation of Fixed Assets account is used which is charged to P&L straightaway.