1. 1 Introductory Financial Accounting Accounting for Non-current (Fixed) Assets

2. 2 Learning Outcomes Discuss the principles used to decide whether expenditures should be capitalised or expensed Identify the general rules for valuing tangible non-current (fixed) assets and explain the effects of asset revaluations on the final accounts and distinguish between realised and unrealised profits Explain the concept of depreciation and discuss a variety of definitions of it Outline the factors affecting a depreciation charge and calculate a depreciation charge using the straight line, declining balance and production usage methods Calculate the profit or (loss) on the disposal of an asset Construct more complex financial statements making adjustments for depreciation Define intangible fixed assets, give examples of them and outline briefly the rules for their recognition and valuation

3. 3 A review of what we already know Asset definition: A resource controlled by an entity as a result of past events and which future economic benefits are expected to flow to the entity Asset recognition in the accounts when: it is probable that the economic benefits will flow to the enterprise, and the cost of the asset can be measured at a monetary amount with sufficient reliability Non-current (fixed) asset: An asset that is held for use on a continuing basis Types of non-current (fixed) assets: Tangible – having physical substance e.g. land, buildings, fixtures and fittings, plant, machinery, vehicles Intangible – not having physical substance e.g. research and development, goodwill

4. 4 Accounting for tangible non-current (fixed) assets At what amount should we measure the asset? Initial measurement – purchase price or production cost Includes all capital expenditure Initial expenditure on new non-current assets, also Subsequent expenditure on existing non-current assets that enhances their earning capacity

5. 5 At what amount should we measure the asset? Subsequent measurement requires consideration of maintaining initial measurement (historical cost) or revaluing (fair value) –depreciation –impairment

6. 6 Revaluing & Impairing Revaluation Non-current (fixed) assets may be revalued to their fair (market) value The unrealised gain is taken to capital not income, and is recorded separately from other gains under a revaluation heading Impairment A reduction in the recoverable amount (net realisable value or value in use) of a fixed asset to below its accounting carrying amount If identified, the carrying amount of the asset must be reduced with a double entry reduction firstly to any revaluations in the capital account and secondly by a reduction in the income statement/profit and loss account

7. 7 Revaluation A company has several buildings valued in the accounts at £6.5 million The buildings are valued by a qualified valuer who states their value now to be £10 million Increase Buildings in BS to £10m (+3.5m) Create Revaluation Reserve in Capital & Reserves section of BS for £3.5m

8. 8 An Impaired asset If we believe the value of an asset may have fallen we need to carry out an impairment review. We compare the carrying amount with the recoverable amount Recoverable amount is the higher of Net realisable value or Value in use If the asset is impaired: Write down asset value to impaired value Charge to Revaluation Reserve (if any/until used up) after that Charge as expense in P&L account

9. 9 Example Toad Ltd has this information on its asset register of machines MachineNBVNRV Value in use £ £ £ A5,0003,5006,200 B8,20010,00012,000 C2,1001,0002,000 D4,8004,5004,000 E5,3005,5004,700 Should any of these assets be impaired and if so by how much?

10. 10 Example - Answer Machine Carrying Recoverable Impair A 5,000 6,200No B 8,200 12,000No C 2,100 2,000Yes 100 D 4,800 4,500Yes 300 E 5,300 5,500No

11. 11 What should happen in the accounts? A company has 3 assets which undergo an impairment review. All assets were acquired in 2003 Asset CAsset DAsset E NBV @2005£900,000£600,000£550,000 Reval in 2004£200,000-£100,000 Results of impairment review Value in Use£680,000£630,000£470,000 Net Real. Val£650,000£570,000£500,000

12. 12 What would happen in the accounts Asset C Cr Asset C£220,000 Dr Revaluation Reserve£200,000 Dr P&L£20,000 Asset D Not impaired – may revalue upward Asset E Cr Asset E£50,000 Dr Revaluation Reserve£50,000

13. 13 Depreciation The application of the matching principle to non-current (fixed) assets requires us to calculate the amount of depreciation in any period and match this, as an expense, with the revenues of the period. What is depreciation? The systematic allocation of the depreciable amount of a non- current (fixed) asset over its useful life Depreciable amount means the book (i.e. the account) value of the asset less its residual value Residual value is the amount that would currently be obtained from disposal of the asset if the asset were at the end of its useful life Useful life is the period over which an asset is expected to be of use to the entity

14. 14 How do we calculate the depreciation charge for the period? The measure of depreciation is an estimate, and is affected by decisions relating to the assets: –cost (or value) –useful economic life –residual value, and –the depreciation method chosen e.g. straight- line, reducing balance/ (accelerated method)

15. 15 How is depreciation reflected in the accounts? The period depreciation charge is expensed to the income statement/profit and loss account, and deducted from the cost of the asset in the balance sheet to disclose the assets net book value at the balance sheet date Note: this depreciation charge is a bookkeeping entry – it does not represent any movement of cash. Depreciation Example.doc

16. 16 What happens on the sale of an asset? The gain or loss on the sale of the asset is calculated: sale proceeds – net book value of the asset (from balance sheet) and recorded in the income statement/profit and loss account as it is a realised gain or loss The asset is eliminated from the balance sheet The consideration received is recorded in the balance sheet

17. 17 Example What would be the gain/loss on sale of the above asset in the following scenarios? (A) using straight line deprecation asset sold at the end of year two for £5,500 (B)using the reducing balance method the asset is sold at the end of year two for £5,500

18. 18 Answer (A) Book Value7,000 Proceeds5,500 Loss 1,500 in P&L (expense) (B) Book Value5,135 Proceeds5,500 Profit 365 in P&L (income)

19. 19 Intangible Assets Research and development costs: no intangible asset arising from research expenditure should be recognised an intangible asst arising from development expenditure may be recognised on meeting certain criteria and should be amortised once commercial exploitation begins (normal maximum 20 years)

20. 20 Conditions for capitalisation There is a clearly defined project Related expenditure is separately identifiable The outcome of the project can be assessed with reasonable certainty as to –Its technical feasibility and –Its ultimate commercial viability Cost of project reasonably expected to be exceeded by sales revenue Adequate resources exist to enable the project to be completed

21. 21 Goodwill Definition: future economic benefits arising from assets that are not capable of being individually identified and separately recognised Measurement: the difference between the fair values of the individual net assets of the entity and the entity as a whole Accounting: only purchased goodwill should be recognised as an asset (purchased goodwill arises as a result of one entity acquiring another) –it may not be revalued but –should be tested annually for impairment

22. 22 Example Ash Again.doc IS.doc BS.doc