Non Current Assets & Depreciation Accounting Non Current Assets & Depreciation

Clive Vlieland-Boddy FCA FCCA MBA PhD EU 2009

Non Current Assets (NCA’s) also known as Fixed Assets Are assets whose useful life is expected to last more than one year.

Tangible Intangible Investments

Valuation of NCA’s Historic Cost less depreciation. Possible to re-value if appropriate.( Permitted by IFRS)

Non Current Assets Most companies acquire assets in order to perform their activities and use them in the business. Ryanair and Air France buy planes. Renfe and SNCF buy trains. Coke and Pepsi buy bottling plants.

Non Current Assets These assets usually last for many years. The expenditure therefore cannot be written off in one year but under the “matching concept” must be taken over the economic useful life. Will return to this.

Non Current Assets -Tangibles They represent the investment that management make in the infrastructure of the company to enable it to function. Without these the company could not trade. They tend to be physical assets. E.g. Planes Vehicles Plant and Equipment Ships Buildings

Consumption of non Current Assets Clearly an asset such as an aeroplane lasts for many years. So when American Airlines buys a new plane, it would expect it to last for say 20 plus years and even then it would have a residual value. The loss in value over the period of ownership should therefore be written off over its economic life useful life. Here the matching concept requires us to match income with expenditure. Remember “prudence”

Depreciation This is a non cash item. It represents the reduction in the value of a Fixed Asset over an accounting period. The aim is to use an acceptable accounting method of depreciation so that the Fixed Asset is written off over its estimated useful life down to its scrap value.

AmortiZation This is the same as depreciation but normally used to reduce the value of Land & Buildings and Intangibles. It is more commonly seen in the USA. ( Then spelt with a “z”)

Useful Life Consider the following: Physical wear and tear. Obsolescence. Legal limits.

Lets Look At a 737-800 aircraft Plane Costs $50m Scrap Value after 20 years $10m Therefore loss over 20 years $40m How do we recognise this loss in value?

Over 20 years…. Depreciation!

Depreciation But how do we depreciate non current assets?

Methods of Depreciation Straight Line Reducing or declining balance. Cycle or unit method.

Straight Line Method Equal annual amounts. Taking the Bowing 737 Example, where $40m has to be depreciated over 20 years. = $2m per annum.

Reducing or Declining Balance A reducing percentage is taken each year. This is particularly relevant to assets whose “shine” will tarnish as years go by. So the Bowing 737 would be depreciated at 7.5% per annum. So: Year 1 = 7.5% of $50m = $3.7m Year 2 = 7.5% of $46.3m = $3.5m Year 3 = 7.5% of $42.8m = $3.2m Year 4 = 7.5% of $39.6m = $3.0m and so on……………….

Useful Economic Life The number of years that the NCA’s can be effectively used in the business.

Unit or Cycle Method Not often used but could be used with the Bowing 737 Example on hours flown. If say over 20 years, the plane is expected to fly for 40,000 hours then you could create an hourly charge of $1000.

Which Method? It is up to management to chose. However, industries tend to settle on the same methods and rate.

Depreciation in the Accounts It is an expense in the Income statement under overheads. It is a reduction from Non Current Assets in the Balance Sheet.

Disclosure Depreciation Methods Used and Rates Useful expected lives. Reconciliation of Additions/Disposals/Depreciation. Revaluations

Net Book Value The cost less the accumulated depreciation top date is called the Net Book Value. So Say Cost of $50m Accumulated Depreciation $20m Net Book Value is $30m

Which Method is best? Industry standards should be used. Usually Reducing balance to assets that lose value quickly and straight line for others.

Consistency, Matching &Prudence To be able to compare year against year, firms must apply the same method and rates. Clearly depreciation is a way to try to match the expenditure with the income it generates. Prudence should prevail so long as it does not totally distort the picture! In essence industry standards will be used.

Activity 14.3.1 Can you have a go at this before next session.

Exercise 24 Lets work together

Financial Accounting Investments - NCA’s

NCA’s - Investments

Investments Enterprises will often acquire other companies as part of their strategy. Either vertically to control the supply chain distribution. Or horizontally to monopolies their market places.

Examples: Wall Mart entered the UK market by acquiring ASDA a large supermarket group. Sky bought BSB to monopolize the UK satellite industry. EBay bought Pay Pal to assist settlement for payments to buyers and sellers.

Subsidiaries & Associated Companies Subsidiaries are investments where there is more than 50% ownership and control can be exercised over the company. An Associate is where there is no control and less than 50% shareholding.

Accounting Issues Now the only accepted method is the Purchase Method. This means that the Parent will show the book values (or if revalued then that value)of all assets and liabilities of its subsidiaries. The difference is Goodwill.

Goodwill The price paid for an investment over and above its net asset value.

Accounting Intangible NCA’s

Research & Development Many companies appreciate the need to make substantial investment into research and developing new products or processes. Take a pharmaceutical company. They would spend many millions, and several years, researching and testing a new drug. How then does the matching concept affect them?

The difference between Research and Development Research is to some extent speculative, while development is not. Research must be written off as an expense in the Income Statement when it is incurred. Development can be capitalized and shown as a Non Current Asset and taken forward to be matched with the expected income, so long as it meets the following criteria:

Compare Microsoft wants to spend $100m on developing Windows Millennium 10. SKB wants to spend $100m developing a potential cure for cancer.

Capitalisation of R & D Must be technically feasible. Company must intend to complete it. Economically viable based on reasonable projections.

Accounting Treatments Write it off as incurred. This takes no affect of the Matching Concept. Capitalise the investment and write it off over the expected period that will benefit from the investment. Remember prudence…. Essentially, general research should be written off immediately, but development costs can be capitalised and carried forward.

Goodwill This normally occurs in accounts where a company has acquired another and paid a price in excess of that companies net asset value. It can be capitalised and shown as an intangible in the Balance Sheet but should be quickly written off. Subject to an annual impairment test. “What is it now worth?”

Disposals of Fixed Assets The Sale proceeds are compared to the cost less the accumulated depreciation (The net Book Value). The balance is either a profit or loss on disposal.

Coffee Break 14.5.1

Coffee Break 14.7.1

The End