PowerPoint to accompany Chapter 11 Non-Current Assets: Property, Plant and Equipment, and Intangibles Learning Objectives 1. Measure the cost of a non-current asset 2. Account for depreciation 3. Select the best depreciation method for income tax purposes 4. Account for the disposal of a non-current asset 5. Account for the revaluation of a non-current asset 6. Account for intangible assets Non-current Assets
Objective 1 Measure the cost of a non-current asset. Cost Principle An asset must be carried on the balance sheet at the amount paid for it. The cost of an asset equals the sum of all of the costs incurred to bring the asset to its intended purpose. Land and Land Improvements
Land Improvements All improvements located on the land but subject to depreciation: Fencing Paving Sprinkler systems Lighting etc. Buildings Construction Architectural fees Building permits Contractor charges Payments for materials, labour Interest during construction? (AASB 123 prefers expensing) Buildings Purchasing Purchase price Agents commissions Stamp duty Repairing or renovating building for its intended purpose
Machinery and Equipment Purchase price (less any discounts) Transportation charges Insurance in transit Customs duties Installation costs Expenditures to test asset before it is placed in service Capitalising The Cost of Interest Suppose on January 1, 20X1, In Motion T-Shirts borrows $50,000 on a twoyear, 10% loan, to build a warehouse. Total interest for the financial year ended 30/6/X1 is 6/12 x $10,000 = $2,500. AASB 123 (Borrowing Costs) allows capitalisation (record as asset) but prefers expensing (more conservative). Capitalising The Cost of Interest Jan-June 20X1 Building 50,000 Cash at Bank 50,000 Building the warehouse June 30 20X1 Building 2,500 Cash at Bank 2,500 Capitalising the interest
Lump-sum Purchases Business may purchase a group of assets (e.g. land and buildings) For accounting purposes we need to indentify each separately Using the relative-fair-value method (AASB3) we divide the cost according to their fair (market) values. Lump-sum Purchases Example In Motion T-shirts paid $100,000 for a combined purchase of land and a building. The land is appraised at $30,000 and the building at $60,000. How much of the purchase price is allocated to land and how much to the building? Lump-sum Purchases Example Land: $30,000 $120,000 = 25% $100,000 25% = $25,000 Building: $90,000 $120,000 = 75% $100,000 75% = $75,000
Distinction Between Capital Expenditures and Expenses Does the expenditure increase capacity or efficiency or extend useful life? YES NO Capital Expenditure Debit Non-current Assets accounts Expense Debit Repairs and Maintenance account Distinction Between Capital Expenditures and expenses Does the expenditure increase capacity or efficiency or extend useful life? This is easy in theory but allows choice in practice. There are cases where it is clearly an expense or clearly an asset. But in cases where doubt exists this allows earnings management (legally produce higher or lower profit figures). Measuring The Depreciation of Property, Plant and Equipment Depreciation is NOT a process of valuation Depreciation does NOT provide cash for the replacement of the asset
Measuring The Depreciation of Property, Plant and Equipment Cost Estimated useful life Estimated residual value Objective 2 Account for depreciation. Depreciation Methods Straight-Line (SL) Units-of-Production (UOP) Reducing-Balance (RB)
Depreciation Methods Example Qantas purchased a baggage-handling truck for $41,000. It is expected to have a trade-in value of $1,000 at the end of its useful life. The van has an estimated service life of 100,000 km or 5 years. Straight-line Method example (Cost Residual value) years of useful life ($41,000 1,000) = $40,000 5 = $8,000 Year 1 Depreciation: $ 8,000 Year 2 Depreciation: 8,000 Year 3 Depreciation: 8,000 Year 4 Depreciation: 8,000 Year 5 Depreciation: 8,000 Total Depreciation: $40,000 Units-of-Production Method Example ($41,000 1,000) 100,000km = $.40/km Year 1: 20,000000 km =$ 8,000 Year 2: 30,000 km = 12,000 Year 3: 25,000 km = 10,000 Year 4: 15,000 km = 6,000 Year 5: 10,000 km = 4,000 Total: 100,000 km =$40,000
Reducing-Balance Method Example (approx) Straight-line rate is 100% 5 = 20% Reducing-balance is approximately 1.5 times the straight-line rate = 30% What is the book value of the van at the end of the first year? $ 41,000 30% = $ 12,300 depreciation $ 41,000 $12,300 = $ 28,700 Reducing-Balance Method Example End of year 1 Depreciation Expense $ 12,300 Accumulated Depreciation $12,300 To record depreciation expense for a one-year period Reducing-Balance Method Example Remember the book value of the truck at the end of the first year? $ 41,000 $12,300 = $ 28,700 Depreciation for the second year is $ 28,700 30% = $ 8,610 Giving a book value of $ 28.700 - $ 8,610 = $ 20,090
Reducing-balance method example (precise method) The method used in the last few slides is a approximate method commonly used for its simplicity Your textbook (pages 441-442) 442) shows the more precise method. Comparing depreciation methods See Exhibit 11-10 on page 444 of your textbook Comparing depreciation methods The large amount in year 5 using the reducing balance is due to the inaccuracy of using 1.5 times the straight line method. This is amount is used to totally depreciate the asset Using the formula on page 442 of your textbook the rate is.524%
Objective 3 Select the best depreciation method for income tax purposes. Relationship between depreciation and taxes Most businesses use straight-line depreciation for financial reporting. For tax purposes businesses can use; Prime Cost which is straight-line. Diminishing Value which is reducing-balance at 1.5 times the straight-line rate. Depreciation for partial years Assume In Motion T-Shirts buys a building on 1 July for $100,000 with a RV of $40,000 and a useful life of 20 years. How much is the building's depreciation on 31 st of December? Prime cost method: 3,000 6/12 = $1,500 Reducing-balance method: $2,250 1.5 = $2,250
Changing the useful life Revised SL depreciation = Cost Accumulated depreciation New residual value Estimated remaining useful life Objective 4 Account for the disposal of a non-current asset. Disposing of non-current assets Sell, exchange, scrap. First bring depreciation up to date, then: Dr Accumulated Depreciation, Cr Asset. Gain/loss is reported on the Income Statement... and closed to Profit and Loss Summary.
Disposing by scrapping an asset Suppose you disposed of a piece of equipment that cost $6,000 and has no residual value. Accumulated depreciation is $6,000 The entry to record the disposal is Acc Dep n Equipment 6,000 Equipment 6,000 Disposing by scrapping an asset Assume we scrap the same piece of equipment a year earlier when accumulated depreciation was $5,000 The entry to record the disposal is Acc Dep n Equipment 5,000 Loss on disposal of equip 1,000 Equipment 6,000 Preferred disclosure instead of gains and losses show disposal proceeds as revenue and carrying amount as an expense Dr Acc. Depn 5,000 Cr Equipment 6,000 Dr Carrying Amount of Asset 1,000
Disposing by selling example You sell on old piece of furniture Cost: $ 10,000 Residual value: $ 0 Purchased 1 January 20X6 Estimated useful life at acquisition: 10 yrs Disposing by selling example Assume the equipment is sold on 30/6/X9. What is the accumulated depreciation on June 30? $10,000 10 = $1,000 $1,000 * 6/12 = $500 $1000*3 + $500 = $3,500 Disposing by selling example Assume the furniture is sold for $5,000. June 30, 20X9 Cash 5,000 Accumulated Depreciation 3 500 Loss on Sale of Furniture 1,500 Furniture 10,000
Dr Accumulated Depreciation 3,500 Cr Furniture 10,000 Dr Cash 5,000 Cr Disposal proceeds - revenue 5,000 Dr Carrying amount expense 6,500 Exchanging non-current assets (e.g. trade-in) Domino s Pizza trade in a delivery van Old van cost $10,000 and accumulated depreciation of $8,000 A trade-in of $2,500 is allowed. The new van costs $13,000 Thus the cash payment is $10,500. Gain on sale is $500 (2,500 2,000). Exchanging non-current assets (e.g. trade-in) The journal entry is Delivery van (new) 13 000 Acc Dep n (old) 8 000 Delivery van (old) 10 000 Cash at Bank 10 500 Gain on Sale of Vehicle 500
Dr Delivery van (new) 13,000 Dr Accumulated depreciation (old) 8,000 Cr Delivery van (old) 10,000 Cr Cash at bank 10,500 Cr Trade-in allowance revenue 2,500 Dr Carrying amount (old)- expense 2,000 Internal control of non-current assets Cornerstone of internal control is separating custody of assets from accounting for the asset. Also need physical controls to prevent theft and maintain physical condition of the asset. Impairment of non-current assets AASB 136 Impairment of Assets requires, if carrying amount is greater than its recoverable amount then the carrying amount must be reduced ( written down ). Recoverable amount = greater of selling price or value in use (present value of future cash flows).
Example You own a block of land that cost you $100,000 and is recorded at cost You have it valued and find its worth $80,000000 The journal entry would be Impairment loss Land 20 000 Land 20 000 Example cont. If the land had a building with carrying amount of $150,000 (cost $200,000) with a recoverable amount of $120,000 The journal entries would be Accumulated Dep n 50 000 Building 50 000 Impairment Loss on Building 30 000 Building 30 000 Accumulated Dep n 50 000 Building 80 000 Impairment Loss on Building 30 000
Objective 5 Account for the revaluation of a non-current asset. Revaluation AASB 116 Property, Plant and Equipment allows assets to be recorded at cost or fair value (arm s length sale). Upward revaluations are credited to owners equity (Revaluation Reserve account). Downward revaluations are expenses. This is conservatism. Example Land which cost $100,00 is revalued to $200,000 The entry would be: Land 100 000 Revaluation Reserve 100 000
Examples Building with carrying amount of $150,000 (cost $200,000) is revalued to $120,000 The journal entries would be Accumulated Dep n 50 000 Building 50 000 Revaluation loss on Building 30 000 Building 30 000 Revaluation For depreciable assets the accumulated depreciation is first credited against the asset. No offsetting decreases against increases is allowed. Only when an asset was previously revalued upwards can a downwards revaluation be debited to Revaluation Reserve. Examples Assume the building before actually originally cost $130,000 and had been revalued to $200,000 Thus the entry would be Accumulated Dep n 50 000 Building 50 000 Revaluation Reserve 30 000 Building 30 000
Objective 6 Account for intangible assets. Intangible assets Not physical in nature Patents Copyrights Trademarks Franchises Specific Intangibles Goodwill Intangible assets: Patents Patents are government grants. They give the holder the right to produce and sell an invention for 20 years. Suppose a company pays $200,000 to acquire a patent on 1 January. The company believes that its expected useful life is 5 years. What are the entries?
Intangible assets: Patents Jan 1 (this year) Patents 200,000 Cash 200,000 To acquire a patent Dec 31 (next year) Amortisation Expense Patents 40,000 Accumulated Amort. Patents 40,000 To amortise the cost of a patent Intangible assets: Copyrights Literary compositions (novels) Musical compositions Films (movies) Software Other works of art Intangible Assets: Trademarks Trademarks, Trade Names, or Brand Names are assets that represent distinctive identifications of a product or service
Intangible assets: Franchises Franchises and licences are privileges granted by private business or government to sell a product or service. Intangible assets: Goodwill Goodwill Example Purchase price paid for Tasman Stores Assets at market value 9 million Less liabilities 1 million Market value of Tasman net assets: Goodwill $10 million 8 million $ 2 million Accounting for goodwill AASB 138 Intangible Assets does not allow the recognition of internally generated goodwill. AASB 3 Business Combinations states t that goodwill is not amortised. AASB 136 Impairment of Assets requires the regular measurement of the current value of purchased goodwill if it has decreased then a loss is recorded.
Special issues Research and development Ethical Issue: Capitalise or expense expenditure PowerPoint to accompany End of Chapter 11