Chapter 8: Non-current assets

Chapter learning objectives

Upon completion of this chapter you will be able to:

• define non-current assets
• distinguish between capital and revenue expenditure
• explain the function and purpose of an asset register
• explain and illustrate the ledger entries to record the acquisition of non-current assets
• define and explain the purpose of depreciation
• explain the straight-line and reducing balance methods of depreciation and make necessary calculations
• explain and illustrate how depreciation expense and accumulated depreciation are recorded in ledger accounts
• explain and illustrate how depreciation is presented in the income statement and statement of financial position
• explain the relevance of consistency and subjectivity in accounting for depreciation
• make the necessary adjustments if changes are made in the estimated useful life/residual value of a non-current asset
• explain and illustrate the ledger entries to record the disposal of non-current assets for cash
• explain and illustrate the ledger entries to record the disposal of non-current assets through part exchange
• explain and illustrate the inclusion of profits or losses on disposal in the income statement
• explain and record the revaluation of a non-current asset in ledger accounts and in the statement of financial position
• explain the impact of a revaluation on accounting for depreciation and disposal of a non-current asset
• explain and illustrate how non-current asset balances and movements are disclosed in company financial statements.

1 Non-current assets

Non-current assets are distinguished from current assets by the following characteristics: they:

• are long-term in nature
• are not normally acquired for resale
• are could be tangible or intangible
• are used to generate income directly or indirectly for a business
• are not normally liquid assets (i.e. not easily and quickly converted into cash without a significant loss in value).

2 Capital and revenue expenditure

It follows that a business' expenditure may be classified as one of two types:

3 Non-current asset registers

Non-current asset registers are, as the name suggests, a record of the non-current assets held by a business. These form part of the internal control system of an organisation.

Non-current asset register

Details held on such a register may include:

• cost
• date of purchase
• description of asset
• serial/reference number
• location of asset
• depreciation method
• expected useful life
• net book value.

4 Acquisition of a non-current asset

A non-current asset register is maintained in order to control non-current assets and keep track of what is owned and where it is kept.

It is periodically reconciled to the non-current asset accounts maintained in the general ledger.

• The cost of a non-current asset is any amount incurred to acquire the asset and bring it into working condition

• The correct double entry to record the purchase is:

  Dr Non-current asset X

  Cr Bank/Cash/Payables X

• A separate cost account should be kept for each category of non-current asset, e.g. motor vehicles, fixtures and fittings.

Subsequent expenditure

Subsequent expenditure on the non-current asset can only be recorded as part of the cost (or capitalised), if it enhances the benefits of the asset, i.e. increases the revenues capable of being generated by the asset.

An example of subsequent expenditure which meets this criterion, and so can be capitalised, is an extension to a shop building which provides extra selling space.

An example of subsequent expenditure which does not meet this criterion is repair work. Any repair costs must be debited to the income statement, i.e. expensed.

Test your understanding 1

Acquisition of a non-current asset

Bilbo Baggins started a business providing limousine taxi services on 1 January 20X5. In the year to 31 December he incurred the following costs:

What amounts should be capitalised as 'Land and buildings' and 'Motor vehicles'?

5 Depreciation

• IAS 16 defines depreciation as 'the measure of the cost or revalued amount of the economic benefits of the tangible non-current asset that has been consumed during the period'.
• In simple terms, depreciation is a mechanism to reflect the cost of using a non-current asset.
• Depreciation matches the cost of using a non-current asset to the revenues generated by that asset over its useful life.
• Depreciation must also be matched to the pattern of use of the asset. This must be regularly reviewed and may be changed if the method no longer matches the usage of the asset.
• This is achieved by recording a depreciation charge each year, the effect of which is twofold ('the dual effect'):
  • Reduce the statement of financial position value of the non-current asset by cumulative depreciation to reflect the wearing out.
  • Record the depreciation charge as an expense in the income statement to match to the revenue generated by the non-current asset.

Depreciation

Depreciation may arise from:

• use
• physical wear and tear
• passing of time, e.g. a ten-year lease on a property
• obsolescence through technology and market changes, e.g. plant and machinery of a specialised nature
• depletion, e.g. the extraction of a mineral from a quarry.

The purpose of depreciation is not to show the asset at its current value in the statement of financial position, nor is it intended to provide a fund for the replacement of the asset. It is simply a method of allocating the cost of the asset over the periods estimated to benefit from its use (the useful life).

Land normally 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.

6 Methods of calculating depreciation

Straight-line method

Depreciation charge = (Cost – Residual value)/Useful life

Or X% x cost

Residual value: the estimated disposal value of the asset at the end of its useful life.

Useful life: the estimated number of years during which the business will use the asset.

Residual value

The residual value may be a second-hand value or scrap value. It is unlikely to be a significant amount and is often zero.

The useful life does not necessarily equal the physical life of the asset. For example many businesses use a three-year useful life for computers. This does not mean that a computer can no longer be used after three years; it means that the business is likely to replace the computer after three years due to technological advancement.

Straight-line depreciation is often expressed as a percentage of original cost, so that straight-line depreciation over four years would alternatively be described as straight-line depreciation at 25% pa.

Reducing balance method

Depreciation charge = X % x carrying value (CV)

CV: original cost of the non-current asset less accumulated depreciation on the asset to date.

Assets bought/sold in the period

If a non-current asset is bought or sold in the period, there are two ways in which the depreciation could be accounted for:

• provide a full year's depreciation in the year of acquisition and none in the year of disposal
• monthly or pro-rata depreciation, based on the exact number of months that the asset has been owned.

Illustration 1 – Reducing balance method

Dev, a trader, purchased an item of plant for $1,000 on 1 August 20X1 which he depreciates on the reducing balance at 20% pa. What is the depreciation charge for each of the first five years if the accounting year end is 31 July?

Solution

Solution

Test your understanding 2

Karen has been running a successful nursery school 'Little Monkeys' since 20X1. She bought the following assets as the nursery grew:

• a new oven for the nursery kitchen at a cost of $2,000 (purchased 1 December 20X4).
• a minibus to take the children on trips for $18,000 (purchased 1 June 20X4).

She depreciates the oven at 10% straight line and the minibus at 25% reducing balance. A full year's depreciation is charged in the year of purchase and none in the year of disposal.

What is the total depreciation charge for the year ended 31 October 20X6?

A $2,531

B $2,700

C $4,231

D $2,731

Test your understanding 3

The following information relates to Bangers & Smash, a car repair business:

What is the total depreciation charge for the years ended 31 December 20X5 and 20X6?

7 Accounting for depreciation

Whichever method is used to calculate depreciation, the accounting remains the same:

• The depreciation expense account is an income statement account and therefore is not cumulative.
• The accumulated depreciation account is a statement of financial position account and as the name suggests is cumulative, i.e. reflects all depreciation to date.
• On the statement of financial position it is shown as a reduction against the cost of non-current assets:

Illustration 2 – Accounting for depreciation

Santa runs a large toy shop in Windsor. In the year ended 31 August 20X5, she bought the following fixed assets:

• A new cash register for $5,000. This was purchased on 1 December 20X4, in time for the Christmas rush, and was to be depreciated at 10% straight line.
• A new delivery van, purchased on 31 March 20X5, at a cost of $22,000. The van is to be depreciated 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.

Solution

Solution

Cash register Depreciation charge: 10% x $5,000 x 9/12

= $375

Delivery van Depreciation charge: 15% x $22,000 x 5/12

= $1,375

Test your understanding 4

Coco acquired two fixed assets for cash on 1 August 20X5 for use in her party organising business:

• a 25-year lease on a shop for $200,000
• a chocolate fountain for $4,000.

The fountain is to be depreciated at 25% pa using the reducing balance method.

A full year of depreciation is charged in the year of acquisition and none in the year of disposal.

Show the ledger account entries for these assets for the years ending 31 October 20X5, 20X6 and 20X7.

8 Consistency and subjectivity when accounting for depreciation

The following are all based on estimates made by the management of a business:

• depreciation method
• residual value
• useful life.

Different estimates would result in varying levels of depreciation and, consequently, profits.

It can be argued that these subjective areas could therefore result in manipulation of the accounts by management.

In order to reduce the scope for such manipulation and increase consistency of treatment, IAS 16 Property, Plant and Equipment requires the following:

• Depreciation method should be reviewed at each year end and changed if the method used no longer reflects the pattern of use of the asset.
• Residual value and useful life should be reviewed at each year end and changed if expectations differ from previous estimates.

Illustration 3 – Changes to estimates

Alfie purchased a non-current asset for $100,000 on 1 January 20X2 and started depreciating it over five years. Residual value was taken as $10,000.

At 1 January 20X3 a review of asset lives was undertaken and the remaining useful life was estimated at eight years. Residual value was estimated as nil.

Calculate the depreciation charge for the year ended 31 December 20X3 and subsequent years.

Solution to changes in estimates

Test your understanding 5

Alberto bought a wood-burning oven for his pizza restaurant for $30,000 on 1 January 20X0. At that time he believed that the oven's useful life would be 20 years after which it would have no value.

On 1 January 20X3, Alberto revises his estimations: he now believes that he will use the oven in the business for another 12 years after which he will be able to sell it second-hand for $1,500.

What is the depreciation charge for the year ended 31 December 20X3?

A $2,000

B $2,125

C $1,875

D $2,375

9 Disposal of non-current assets

Profit/loss on disposal

Note: A disposals T account is required when recording the disposal of a non-current asset. This is an income statement account which reflects any profit or loss on disposal.

Disposal for cash consideration

This is a three-step process:

(1) Remove the original cost of the non-current asset from the 'non-current asset' account.

(2) Remove accumulated depreciation on the non-current asset from the 'accumulated depreciation' account.

(3) Record the cash proceeds.

The balance on the disposals T account is the profit or loss on disposal:

The profit or loss on disposal can also be calculated as proceeds less NBV of asset at disposal.

Test your understanding 6

Percy Throwerp runs a landscape gardening business. On 1 February 20X2, he purchased a sit-on lawnmower costing $3,000. He depreciates it at 10% straight line on a monthly basis. A few years later he decides to replace it with one which has an enclosed cabin for when it rains. He sells the lawnmower to an old friend, Alan Titchmuck, for $2,000 on 31 July 20X5.

How much is charged to Percy's income statement in respect of the asset for the year ended 31 December 20X5?

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.

The procedure to record the transaction is very similar to the three-step process seen for a cash disposal. The first two steps are identical, however steps 3 and 4 are as follows:

(3) Record the part exchange allowance (PEA) as proceeds.

(4) Record the cash paid for the new asset.

Again, the balance on the disposals T account is the profit or loss on disposal:

Disposals

There are two debits to the non-current asset account in respect of the new asset:

• PEA
• cash balance.

Together these are the cost of the new asset. If preferred you can show the total as one debit (however do not forget to record both credits).

Test your understanding 7

Bindi Bobbin runs a business altering and repairing clothes. When she started business on 1 January 20X2, she bought a Soopastitch II sewing machine for $2,500. She depreciates sewing machines using the straight-line method at a rate of 20% pa, and she charges a full year of depreciation in the year of acquisition and none in the year of disposal.

The business has now grown such that she needs a faster machine, and she will upgrade to the Soopastitch V during December 20X5. The Soopastitch salesman has offered her a part exchange deal as follows:

Part exchange allowance for Soopastitch II $750

Balance to be paid in cash for Soopastitch V $4,850

Show the ledger entries for the year ended 31 December 20X5 to reflect this transaction.

10 Revaluation of non-current assets

• Some non-current assets, such as land and buildings may rise in value over time. Businesses may choose to reflect the current value of the asset in their statement of financial position. This is known as revaluing the asset.
• The difference between the CV of the asset and the revalued amount (normally a gain) is recorded in a revaluation reserve in the capital section of the statement of financial position.
• This gain is not recorded in the income statement because it is unrealised, i.e. it is not realised in the form of cash.
• IAS 1 requires that a revaluation gain is disclosed in "other comprehensive income" on the statement of comprehensive income. (this is later covered within chapter 15)

Fair values

If the fair value of a non-current asset can be measured reliably, it can be carried at its fair value at the date of revaluation, less any subsequent depreciation and impairment losses. The revaluation should be repeated regularly to ensure that the fair value of the asset does not differ materially from the carrying amount.

An upward revaluation should be credited to revaluation surplus, unless it reverses a previous downward revaluation which was charged as an expense.

A downward revaluation should be charged as an expense, unless it reverses a previous upward revaluation, when it may be charged against the revaluation surplus for that same asset.

If one asset in a class is revalued, all assets of that class must be revalued. This is to prevent selective revaluation of only those assets that have increased in value.

Illustration 4 – Revaluation of non-current assets

Vittorio owns land which originally cost $250,000. No depreciation has been charged on the land in accordance with IAS 16. Vittorio wishes to revalue the land to reflect its current market value, which he has been advised is $600,000.

What is the double entry to record this revaluation?

Land revaluation

Solution

The land is currently held at cost of $250,000. This needs to be increased by $350,000 to reflect the new valuation of $600,000. Therefore the double entry required is:

Illustration 5 – Revaluation of non-current assets

Hamish runs a kilt-making business in Scotland. He has run the business for many years from a building which originally cost $300,000 and on which $100,000 total depreciation has been charged to date. Hamish wishes to revalue the building to $750,000.

What is the double entry required to record the revaluation?

Solution to revaluation of NCA's

Solution

The current balances in the accounts are:

Building cost $300,000

Accumulated depreciation $100,000

• The building cost account needs to be raised by $450,000 to $750,000.
• On revaluation, the accumulated depreciation account is cleared out.

Therefore the double entry required is:

Dr Building cost $450,000

Dr Accumulated depreciation $100,000

Cr Revaluation reserve $550,000

The gain of $550,000 reflects the difference between the NBV pre-revaluation of $200,000 and the revalued amount of $750,000.

Extract from the Statement of comprehensive income: (covered in more detail within chapter 17)

Other comprehensive income:

Gain on property revaluation $450,000

In summary:

Revaluation surplus = Revalued amount – NBV

For a non-depreciated asset:

For a depreciated asset:

The revaluation gain is disclosed on the face of the statement of comprehensive income under "other comprehensive income" and in the statement of changes in equity (SOCIE).

Test your understanding 8

Max owns a fish-finger factory. The premises were purchased on 1 January 20X1 for $450,000 and depreciation charged at 2% pa straight line.

Max now wishes to revalue the factory premises to $800,000 on 1 January 20X7 to reflect the market value.

What is the balance on the revaluation reserve after this transaction?

A $350,000

B $395,000

C $404,000

D $413,000

11 Depreciation and disposal of a revalued asset

Depreciation of a revalued asset

• When a non-current asset has been revalued, the charge for depreciation should be based on the revalued amount and the remaining useful life of the asset.
• this charge will be higher than depreciation prior to the revaluation.
• the excess of the new depreciation charge over the old depreciation charge should be transferred from the revaluation reserve to accumulated profits (within the capital section of the statement of financial position):

Illustration 6 – Depreciation of a revalued asset

Eddie owns a retail unit in central Springfield. He bought it 25 years ago for $100,000, depreciating it over 50 years. At the start of 20X6 he decides to revalue the unit to $800,000. The unit has a remaining useful life of 25 years.

What accounting entries should be made in 20X6?

Solution

Solution

On revaluation at start of 20X6

Depreciation for 20X6

Reserves transfer for 20X6

Test your understanding 9

Spartacus United football club's statement of financial position at 31 December 20X7 includes the following information:

Depreciation has been provided at 2% on the straight-line basis.

The stadium is revalued on 30 June 20X8 to $1,380,000. There is no change in its remaining estimated future useful life.

What is the depreciation charge for the year ended 31 December 20X8?

Test your understanding 10

Tiger Trees owns and runs a golf club. Some years ago Tiger purchased land next to the existing course with the intention of creating a smaller nine-hole course. The cost of the land was $260,000. Tiger hasn't yet built the additional course but has revalued this land to $600,000. He has now decided that building the new course is uneconomical and has found a buyer who is willing to pay $695,000 for the land.

What are the ledger entries on disposal?

Disposal of a revalued asset

• The disposal of a revalued asset is recorded as already seen.

12 Disclosure of non-current asset balances in company financial statements

IAS 16 PPE Disclosure

IAS 16 Property Plant and Equipment contains a number of disclosure requirements relating to non-current assets. Here are the main ones:

(1) The measurement bases used for arriving at the carrying amount of the asset (e.g. cost or valuation). If more than one basis has been used, the amounts for each basis must be disclosed.

(2) Depreciation methods used, with details of useful lives or the depreciation rates used.

(3) The gross amount of each asset heading and its related accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period.

(4) A reconciliation of the carrying amount at the beginning and end of the period, showing:

• additions
• assets classified as held for sale
• disposals
• revaluations
• depreciation.

(5) Any commitments for future acquisition of property, plant and equipment.

(6) If assets are stated at revalued amounts, the following should be disclosed:

• the effective date of the revaluation
• whether an independent valuer was involved
• the methods and assumptions applied in estimating the items' fair value
• the carrying amount that would have been recognised had the assets been carried at cost
• the revaluation surplus, indicating the change for the period.

IAS 38 Intangible assets treatment

Intangible assets

Many businesses invest significant amounts with the intention of obtaining future value on areas such as:

• scientific/technical knowledge
• design of new processes and systems
• licences and quotas
• intellectual property, e.g. patents and copyrights
• market knowledge, e.g. customer lists, relationships and loyalty
• trademarks

All these expenses may result in future benefits to the business, but not all can be recognised as assets.

Objective of IAS 38 Intangible assets

The objective of IAS 38 is to prescribe the specific criteria that must be met before an intangible asset can be recognised in the accounts.

Definition

An intangible asset is an identifiable non-monetary asset without physical substance.

To meet the definition the asset must be identifiable, i.e. separable from the rest of the business or arising from legal rights.

It must also meet the normal definition of an asset:

• controlled by the entity as a result of past events (normally by enforceable legal rights)
• a resource from which future economic benefits are expected to flow (either from revenue or cost saving)

Recognition

To be recognised in the financial statements, an intangible asset must:

• meet the definition of an intangible asset, and
• meet the recognition criteria of the framework:
  • it is probable that future economic benefits attributable to the asset will flow to the entity
  • the cost of the asset can be measured reliably.

If these criteria are met, the asset should be initially recognised at cost.

Disclosure

The notes to the accounts will detail the total intangible non-current assets in the statement of financial position at net book value.

Chapter summary

Test your understanding answers

Test your understanding 1

The correct answer is A

Land and buildings

Office premises: $250,000

Legal fees: $10,000

Total: $260,000

• The cost of the purple paint does not form part of the cost of the office and so should not be capitalised. Instead it should be taken to the income statement as a revenue expense.

Motor vehicles

3 Mercedes E series $116,000

Number plates $210

Delivery charges $180

Total $116,390

• The number plates are one-off charges which form part of the purchase price of any car.
• The road licence fee, drivers' wages and receipts are ongoing expenses, incurred every year. They cannot be capitalised, but should be taken to the income statement as expenses.

Test your understanding 2

The correct answer is D

Test your understanding 3

The correct answer is B

Machine 1 $ $

Machine 2

Total depreciation charge

Test your understanding 4

Annual depreciation workings:

Note, details of the depreciation method and rate for the lease are not given in the question. We are however told that the lease term is 25 years. This suggests that it would be appropriate to use the straight-line method with a useful life of 25 years.

20X5
Lease: $200,000/25 years = 8,000
Fountain: $4,000 x 25% = 1,000

Total: 9,000

20X6
Lease: $200,000/25 years = 8,000
Fountain: $3,000 x 25% = 750

Total: 8,750

20X7
Lease: $200,000/25 years = 8,000
Fountain: $2,250 x 25% = 563

Total: 8,563

Test your understanding 5

The correct answer is A

Initial depreciation charge = $30,000 /20 years = $1,500

CV at date of change = $30,000 – ($1,500 x 3yrs)

New depreciation charge = $25,500 – $1,500 / 12 years

Test your understanding 6

(1) Dr Disposals $3,000

(2) Dr Accumulated depreciation $1,050

(3) Dr Cash $2,000

The charge to the income statement for the year ended 31 December 20X5 is: $

Depreciation charge for the year 175

Profit/loss on disposal (50)

Note: As depreciation is charged monthly, it is necessary to charge an amount to the income statement for the period 1 January 20X5 to the disposal date 31 July 20X5.

Test your understanding 7

Depreciation b/f working:

$2,500 x 20% x 3 years = $1,500

Depreciation charge working:

$5,600 x 20% = $1,120

Test your understanding 8

The correct answer is C

Test your understanding 9

Depreciation must continue to be charged on the original cost until the date of revaluation. Thereafter it is charged on the revalued amount:

1 January to 30 June 20X8

2% x $1,500,000 x 6/12

15,000

Note that this is part of the depreciation cleared out on revaluation and so is not part of the accumulated depreciation balance at the year end.

1 July to 31 December 20X8

(1,380,000/34.5 years)x (6/12)

20,000

This amount will form the accumulated depreciation at the year end.

Total depreciation charge

Test your understanding 10

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