/ AAT Level 3 Accounts Preparation This Unit will be divided into 5 lessons: Lesson 1: Double Entry Bookkeeping, Accounting for Tax and Capital & Revenue Expenditure Lesson 2: Depreciation, Disposal of Capital Assets and Financial Statements & Accounting Concepts Lesson 3: Accounting for Inventory, Irrecoverable & Doubtful Debts and Control Account Reconciliations Lesson 4: Bank Reconciliations, Accruals & Prepayments, Suspense Accounts & Errors and Extended Trial Balance Lesson 5: Exam Practice

Lesson 2 DEPRECIATION Depreciation is the measurement of the cost (wear and tear) of the non-current asset used in an accounting period. In accordance with the accruals concept which states that costs incurred in a period should be matched with the income produced in the same period, the cost of the asset should also be matched to income produced in the period.

Calculating Depreciation: You need to establish the following: 1. cost of the asset 2. the asset’s useful economic life = period over which economic benefits can be expected 3. residual value = how much the asset can be expected to be sold for at the end of its useful economic life

Depreciation Methods: There are two methods of calculating depreciation: Straight line = this method assumes that the asset will be used consistently throughout its useful economic life so the depreciation charge will be the same each year. Depreciation is calculated as cost of the asset less the residual value divided by its economic useful life. Reducing balance = this method assumes that the asset is used less as it gets older and the depreciation charge will therefore reduce each year. The business will establish the depreciation rate which will be expressed as a percentage. Depreciation is calculated as carrying value of the asset x depreciation %.

When calculating depreciation of an asset that has been purchased or disposed of in the year, the depreciation charge will need to be pro-rated. For example, if the financial year ends on 31 March X2 and an asset was purchased on 31 December X1, depreciation using the straight line method, would be calculated as follows: Cost of the Asset - Residual Value / 12 months X 3 months Useful Economic Life Accounting for Depreciation DebitDepreciation expense account (on the statement of income and expenditure) CreditAccumulated depreciation (on the statement of financial position)

DISPOSAL OF CAPITAL ASSETS When a non-current asset is disposed of through sale or being scrapped, you will need to remove the balances in the ledger accounts relating to that asset. The balances will be the original cost of the non-current asset and the accumulated depreciated charged in relation to the non- current asset. When disposing of a non-current asset, you will need to create a new ledger account known as the disposal account. This account will be used to remove the existing balances and to calculate the profit or loss on disposal of the non-current asset.

Calculating Profit or Loss on Disposal: In order to calculate the profit or loss, you will need to subtract the carrying value of the non-current asset from the sale proceeds. The difference is the profit or loss. A profit will arise where the sale proceeds exceeds the carrying value and a loss will occur where the sale proceeds are lower than the carrying value.

Accounting for a disposal of a non-current asset: 1. Remove the original cost of the non-current asset DebitDisposal Account CreditNon-current asset cost 2. Remove the accumulated depreciation of the non-current asset DebitAccumulated depreciation of the non-current asset CreditDisposal Account

3. Enter the sale proceeds DebitBank/Receivable account CreditDisposal Account 4. The last step is to balance off the ledger accounts to establish whether a profit or loss has been made. 9

Part Exchange of a Non-Current Asset: Where an asset is part exchanged for a new asset, the value of the old asset will be deducted from the new asset. The balance is the amount to be paid for the new asset. However, for accounting purposes, the new non-current asset will be valued at its full cost and you will need to dispose of the old asset as follows: 1. Remove the original cost of the non-current asset DebitDisposal Account CreditNon-current asset cost 2. Remove the accumulated depreciation of the non-current asset DebitAccumulated depreciation of the non-current asset CreditDisposal Account 10

Enter the part exchange value received DebitNon-current asset cost CreditDisposal Account 4. Enter the balance paid for the new asset DebitNon-current asset cost CreditBank Account 5. The last step is to balance off the ledger accounts to establish whether a profit or loss has been made.

When a non-current asset has been disposed of, it will no longer feature as part of the statement of financial position and the statement of income and expenditure will include the profit or loss on disposal. A profit will be treated as income and a loss will be treated as an expense. 12

FINANCIAL STATEMENTS AND ACCOUNTING CONCEPTS Financial statements comprise of the following: Statement of Income and Expenditure (profit and loss account) Statement of Financial Position (balance sheet) Statement of Cash Flows Financial statements are produced to show how the business has performed over the period to which they relate and to show the financial position of the business (what the assets and liabilities are). 13

Financial statements are prepared with the following concepts in mind: Going concern = financial statements must be prepared on the basis that the business will continue into the future. Accruals = transactions are accounted for in the period to which they relate or ‘incurred’. This is regardless of whether or not the transaction has been paid in the period. Prudence = assets and liabilities should not be overstated and liabilities and expenses should not be understated. Consistency = accounting methods adopted should be applied consistently to transactions and in future accounting periods. It is therefore crucial that accounting policies remain unchanged unless any change is required. Should an accounting policy change, the nature of the change, the reason for the change and the effect of the change will need to be disclosed in the financial statements. This concept allows users to easily compare data from one accounting period to another, which assists in establishing how well the business has performed for example. 14