Lecture 4

PART 1:
HI6025: Accounting Theory

and Current Issues
Depreciation of
non-current assets
(Chapter 5)
Lecture 4
Accounting for Non-current
Assets
Holmes Institute 2015
Depreciation of assets
Depreciation of assets (cont.)
Depreciation:
allocating the cost of an asset or revalued amount
over periods in which benefits are expected to be
derived
recognising such allocation as an expense
Depreciable assets
non-current assets having limited useful lives
depreciable assets may comprise a significant
proportion of total assets
In determining how to allocate the cost of an

asset three issues must be addressed
1. Which depreciable base should be used for the
asset?
2. What is the assets useful life?
3. Which method of cost apportionment is most
appropriate for the asset?
Determination of useful life
Method of cost apportionment
Factors to consider (AASB 116)
Should best reflect the economic
reality of the assets use
wear and tear through physical use
Available methods:
technical obsolescence
commercial obsolescence
straight-line method
legal life
sum-of-digits method
declining-balance method
production basis
Refer to Worked Example 5.2 (p. 178)

Straight-line method
Example of Prime Cost (SL) method

Example of straight line depreciation
Cost
$33 000 Residual $ 3 000
Estimated useful life of 4 years
Annual depreciation = $33 000 - $3000
4 years
= $7500
Depreciation expense is calculated as
Cost Residual (salvage) value

Useful life
This method is appropriate when benefits to
Entry to record depreciation expense at end of each

year
be derived from the asset are expected to be

uniform throughout the assets useful life
Jun 30 Depreciation Expense Machinery
7 500
Accumulated Depreciation Machinery

(Depreciation expense for the year)
Sum-of-digits method
Example of SoD method
(Cost less residual value) is multiplied by successively
smaller fractions to calculate depreciation expense

Numerator in fraction
changes each year, and is the years remaining of
the assets useful life at the beginning of the period
Denominator in fraction
calculated by adding the years in the assets useful
life; or
n(n +1)/2 where n is the useful life
This method is appropriate when economic benefits
expected to be derived are greater in the early years
than later years
Example Sum-of-years digits depreciation

Cost
$33 000
Residual $ 3 000
1 + 2 + 3 + 4 = 10
Year
Depreciabl
e amount
1
2
3
4
$30 000
30 000
30 000
30 000
Depreciation Total accum Carryin

for the year
depn
g amt
Fraction
x
x
x
x
4/10
3/10
2/10
1/10
=
=
=
=
$12 000
9 000
6 000
3 000
$12 000
21 000
27 000
30 000
$21 000
12 000
6 000
3 000
Example RB (DV) depreciation method
Declining-balance method
Depreciation expense is calculated on the assets
opening written-down value
Written-down value
cost (or revalued amount) less accumulated
depreciation
Percentage used for depreciation expense is
calculated as 1 nth root of (residual value/cost)
This method is appropriate when economic
benefits expected to be derived are greater in the
early years than in later years
7 500
11
Cost
$33 000
Residual $ 3 000
Depreciation rate
= 1 (3000/33,000)yx 0.25
= 45% (approx)
Year
1
2
3
4
Carrying amt at
beg of yr
$33 000
18 150
9 982
5 490
x
x
x
Rate
45%
45%
45%
Annual
depreciation exp
$14 850
8 168
4 482
2 490
Carrying amt at
end of yr
$18 150
9 982
5 490
3 000
When to start depreciating an asset
Production basis
Depreciation expense is calculated as:
From the time an asset is first put into use, or
Units produced in current period x (cost residual
is held ready for use
value)
Total expected production
If constructing an asset, it is not depreciated
This method is appropriate where useful life

might be related more to production output than
time
until ready for use

If an asset is able to be used but is not
200,000 units x ($1,000,000-100,000)
2,000,000 (total ex. Prod.) = $90,000
actually used for a number of periods, the

asset is still depreciated from the time it was
able to be used
13
14
Land and buildings
Revision of depreciation rate and method
Residual value and useful life must be

reviewed at least annually (AASB 116)
Where acquired together, cost must be
apportioned between land and buildings
If expected useful life or residual value are

different from that previously expected:
entity must revise depreciation rate
buildings to be systematically depreciated

over time
land not usually depreciated owing to
unlimited useful life
Depreciation method must also be reviewed

annually
15
Derecognition of assets
16
Sale of a depreciable asset (cont.)

The profit or loss on sale is generally referred to as
a gain or loss on derecognition
Recognised on a net basis in the income statement
Gain or loss from de-recognition of
asset (disposal)
difference between net disposal
proceeds (measured at fair value) and
assets carrying amount
Journal entries to record sale (if for cash)

Dr
Cash at bank
Dr
Accum. depreciation - asset
Cr
Cr
Gain on derecognition of asset

Asset

17
18
Modifying existing non-current assets

Expenditure on modifications or improvements should
be capitalised where
expenditure is material; and
expenditure is expected to enhance the service potential of
the asset
Additions or extensions that become an integral part

of an existing asset:
are to be depreciated over the assets remaining life
Contractual implications of building

depreciation
Recognition
of building depreciation will
increase expenses and decrease profits

unfavourable movements in accounting-based ratios
How would managers facing possible debt-covenant
violations would be do?
Clinch (1983) found cash-flow effects associated
with the decision to comply/not comply with the

requirement to depreciate buildings, as follows
non-compliance with depreciation requirement led to greater
Additions or extensions that retain a separate identity

are to be depreciated on the basis of their own useful life
of debt contracts
19
Is allocating historical cost of an asset over its

useful life really that appropriate?
Non-current assets can be carried at cost, or can be
revalued to fair value
20
Disclosure requirements
For each class of property, plant and
equipment the following must be disclosed
If an asset is carried at cost, and that amount is

depreciated over the expected useful life, whilst at the
same time the organisation is paying out all profits in the
form of dividends, then what happens if the cost to
replace the asset has quadrupled across the life of the
asset?
Have profits tended to be overstated in real terms?
Have dividend payments tended to be excessive?
auditing costs
benefits included cost savings associated with avoiding violation
measurement basis used for gross carrying

amount
depreciation methods used
useful lives or depreciation rates used
gross carrying amount and accumulated
depreciation at beginning and end of period
reconciliation of carrying amount at beginning and
end of period
21
Relevant accounting standards
22
PART 2:
There are three standards of particular relevance

1. AASB 116 Property, Plant and Equipment
Requirements for revaluations, depreciation and
determining acquisition cost of property, plant and
equipment
2. AASB 138 Intangible Assets
Revaluation of intangible assets and other issues
Revaluation of
non-current assets
(Chapter 6)
3. AASB 136 Impairment of Assets When to

recognise an impairment loss
23
24
Impairment losses
Revaluation of assets
If a non-current assets carrying amount exceeds its

recoverable amount it must be written down to its
recoverable amount
Impairment losses
In Australia, entities may revalue many non-
current assets
Asset revaluations what are they?
fair value, less costs to sell
recognising a reassessment of the carrying amount

of a non-current asset to fair value as at a particular
date
excludes recoverable amount write-downs (i.e.
impairment losses)
Impairment losses can be reversed in subsequent periods

Worked Example 6.2 (p. 199)
Impairment losses will at times be determined by reference

to a cash generating unit rather than to a specific asset.
See Worked Example 6.4 (p. 202)
25
26
The use of fair values
Measuring property, plant and equipment

Measured at either cost or fair value
Changing from cost to fair value and there was a
previous impairment loss (changes of method need to be
disclosed)
any increase in an assets carrying amount is first recognised
as income; and
any excess above the amount if no impairment loss was
recognised is transferred to a revaluation reserve
Any revaluation of non-current assets must be to fair value

(AASB 116)
The required disclosures regarding asset revaluations
are
effective date of revaluation
whether an independent valuer was involved
methods and assumptions applied
extent to which fair values were determined, with reference to
observable prices in active markets or recent market transactions
If a class of non-current assets is measured at cost,
for each revalued class, the carrying amount if the cost model was
if an assets carrying amount > recoverable amount, an
used
impairment loss must be recognised
the revaluation reserve, indicating change for the period and any
this would not constitute a revaluation

restrictions on distribution of the balance to shareholders

27
The use of fair values (cont.)
Revaluation increments
Revaluations must be made with sufficient regularity

so the carrying amount of each asset in the class
does not differ materially from its fair value (AASB
116)
If values change regularly and changes are material,
revaluations might be necessary each reporting
period
Dr
Cr
Asset
Revaluation reserve
Note: Reserve is usually the Asset Revaluation

Reserve, a special reserve set up just for such
adjustments.
Revaluation reserve is part of shareholders funds
(owners equity)
If a revalued asset is a depreciable asset, any balance
of accumulated depreciation is credited to the asset
account prior to revaluation
Otherwise every three to five years is sufficient
28
29
30
Depreciation on revaluation NET METHOD
Depreciation on revaluation GROSS METHOD
Net Amount Method: for treatment of

accumulated depreciation on revaluation
Gross Amount Method: for treatment of

accumulated depreciation on revaluation
Journal entry
Dr
Cr
Dr
Cr
Accumulated depreciation may be restated

proportionately with the change in gross carrying amount
of the asset, so the carrying amount after revaluation
equals the revalued amount
Journal entry
Dr
Asset
Cr
Accumulated depreciation
Cr
Revaluation reserve
Accumulated depreciation
Asset
Asset
Asset Revaluation reserve
Subsequent depreciation is to be based on the revalued

amount of the asset

31
32
Reversal of revaluation decrements and increments
Revaluation decrements
Revaluation decrements are recognised as an
expense in the income statement
Dr
Cr
If a revaluation decrement reverses a previous increment for the
same asset, then the reversal entry is:

Dr
Dr
Loss on revaluation of asset

Asset
Cr
Revaluation reserve
Loss on revaluation
Asset
If a revaluation increment reverses a previous decrement for the
same asset:
Dr
Asset
Cr
Cr
Gain on revaluation
Revaluation reserve (the excess)
PS. Do not forget that for ALL journals, you must include a notation!

33
Accounting for profit on disposal of a revalued

non-current asset
34
Accounting for profit on disposal of a revalued

non-current asset (cont.)
Gain or loss from derecognition of the item is to be

calculated as the difference between (AASB 116)
When an asset is sold, any resulting balance in the

revaluation reserve (AASB 116)
net disposal proceeds (if any); and
may be transferred directly to retained earnings
the assets carrying amount
cannot be transferred to the profit and loss account
Derecognition
Refer to Worked Examples 6.9, 6.10 and 6.11 (p208)
the point in time when an asset is removed from the
balance sheet
when an asset is sold; or
when no future economic benefits are expected from an
assets use or disposal
35
36
Offsetting revaluation increments and decrements
Consideration of present values

Recoverable amount is the higher of an assets net
selling price and its value in use (AASB 136)
Estimating value in use (AASB 136) involves:
estimating future cash inflows and outflows from the
continued use and subsequent disposal of the asset; and
applying the appropriate discount rate to future cash
flows
if say one item of land increased in fair value by $10 million
and another item of land decreased in fair value by $1 million

(and assuming no prior revaluations), then a loss of $1
million would be recognised in the income statement.
Why? Well only the one that constituted an expense would
be recognised in P/L. The other would be an increase in

Asset, increase in Equity, both found in the Balance Sheet.
Discounting future cash flows will decrease the

calculated recoverable amount
Increments and decrements may be offset only to the

extent that they relate to a particular asset
37
Economic consequences of asset revaluations
38
Disclosure requirements
If contracts in place are tied to reported profits (debt or

management compensation), management might
have an incentive not to revalue
However, if assets are increased a revaluation might
loosen constraints such as debt-to-assets restrictions
Firms subject to political scrutiny might be more likely
to undertake upward revaluation resulting in a
reduction in profits
AASB 116 includes various disclosure
requirements relating to the revaluation of

non-current assets
These were previously discussed under the
heading The use of fair values
As the perceived competence of independent valuers

increases, audit time might be reduced
39
40
Status of newly converged accounting

standards
AASB 116 Property, Plant and Equipment
Depreciation requirements for property, plant and
equipment
Amortisation of intangible assets
41

Lecture 4

Hochgeladen von

Dokumentinformationen

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Lecture 4

Hochgeladen von

Copyright:

Verfügbare Formate

PART 1:

HI6025: Accounting Theory

Holmes Institute 2015

Depreciation of assets (cont.)

In determining how to allocate the cost of an

Holmes Institute 2015

Determination of useful life

Method of cost apportionment

Factors to consider (AASB 116)

Should best reflect the economic

reality of the assets use

wear and tear through physical use

Refer to Worked Example 5.2 (p. 178)

Refer to Worked Example 5.3 (p. 179)

Holmes Institute 2015

Example of Prime Cost (SL) method

Depreciation expense is calculated as

Cost Residual (salvage) value

Entry to record depreciation expense at end of each

be derived from the asset are expected to be

Jun 30 Depreciation Expense Machinery

Accumulated Depreciation Machinery

Holmes Institute 2015

Example of SoD method

(Cost less residual value) is multiplied by successively

smaller fractions to calculate depreciation expense

Example Sum-of-years digits depreciation

Depreciation Total accum Carryin

Holmes Institute 2015

Example RB (DV) depreciation method

Holmes Institute 2015

When to start depreciating an asset

From the time an asset is first put into use, or

Units produced in current period x (cost residual

is held ready for use

If constructing an asset, it is not depreciated

This method is appropriate where useful life

until ready for use

200,000 units x ($1,000,000-100,000)

2,000,000 (total ex. Prod.) = $90,000

Holmes Institute 2015

actually used for a number of periods, the

Holmes Institute 2015

Land and buildings

Revision of depreciation rate and method

Residual value and useful life must be

Where acquired together, cost must be

apportioned between land and buildings

If expected useful life or residual value are

buildings to be systematically depreciated

Depreciation method must also be reviewed

Holmes Institute 2015

Sale of a depreciable asset (cont.)

Gain or loss from de-recognition of

Journal entries to record sale (if for cash)

Gain on derecognition of asset

Refer to Worked Example 5.3 (p. 179)

Holmes Institute 2015

Modifying existing non-current assets

Additions or extensions that become an integral part

Contractual implications of building

increase expenses and decrease profits

Clinch (1983) found cash-flow effects associated