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CHAPTER 20

NON-CURRENT ASSETS: ACQUISITION AND DEPRECIATION

DISCUSSION QUESTIONS

SOLUTIONS

1. Discuss which of the following should be included in the cost of equipment: (a) installation
charges, (b) freight charges, (c) cost of building foundations, (d) new parts needed to replace
those damaged while unloading, (e) borrowing costs incurred to finance the purchase of the
equipment. What is the general principle to be followed in determining what should be
included in the cost of property, plant and equipment?
The cost of property, plant and equipment should include all of the expenditure needed to
obtain the asset and to get it to a condition and location ready for the use intended by the
purchaser. All of the expenditure listed, with the exception of (c), (d) and (e), should be
included in the cost of the equipment. The cost of building foundations should be treated as
part of the cost of property. The cost of the new parts needed to replace those damaged while
unloading should be charged to expense. Borrowing costs must be treated as an expense.
However, if the property, plant and equipment is being constructed and satisfies the definition
of a qualifying asset under IAS 23/AASB 123, the borrowing costs must then be included as
part of the cost of the property, plant and equipment. See the text for further discussion.

4. F. Murk acquired land, a building and office equipment for a lump sum payment of $2 800
000. Fair values of each asset as determined by an independent valuer are land, $840 000;
building, $1 860 000; office equipment, $500 000. How much of the total payment of $280
000 should be allocated to each asset? Is the accounting treatment of lump-sum acquisitions
appropriate if the assets acquired constitute a business? Explain.

According to IFRS 3/AASB 3 Business Combinations, paragraph 2(b), when the acquisition
of a number of assets for a lump-sum does not constitute a business combination, the cost of
the lump-sum acquisition must be allocated on the basis of the fair values on purchase date of
the assets acquired.

The total cost of $2 800 000 is allocated to each asset on the basis of their fair values by use
of the following formula:

Total fair values of assets amount to $3 200 000. The allocation is as follows to each asset:
Cost of land = $840 000 x $2 800 000 = $735 000
$3 200 000

Cost of building = $1 860 000 x $2 800 000 = $1 627 500


$3 200 000

Cost of off. equip = $500 000 x $2 800 000 = $437 500


$3 200 000

A business is defined in IFRS 3/AASB 3, Business Combinations, as follows:


An integrated set of activities and assets that is capable of being conducted
and managed for the purpose of providing a return in the form of dividends,
lower costs or other economic benefits directly to investors or other owners,
members or participants.

For the acquisition to be a business combination, the assets acquired for the lump-sum
must constitute a business. If so the acquirer must then account for the acquisition as a
business combination, which involves recognising the assets acquired at “fair value”
rather than cost, and recording the acquisition of unidentifiable net assets (i.e.
goodwill) as well. See the next chapter for further details.

10. ‘With proper maintenance, certain equipment will last almost indefinitely, in which
case depreciation is not necessary.’ Discuss.
Depreciation results not only from wear and tear, but also from technical and commercial
obsolescence which causes assets to have limited useful lives. Hence, although assets can be
well maintained, their useful lives are still limited to the requirements of the entity (see the
definition of ‘useful life’ in the standard), and depreciation is still necessary to allocate the
cost or depreciable amount of an asset over its limited useful life to reflect the pattern of the
expected receipt/usage of economic benefits .

EXERCISE SOLUTIONS

Exercise 20.3 Determining cost

The only items in the list which would not be part of the cost of the machine are the cost of repairing
the minor damage to the machine during testing and, assuming that the “purchase” discount is a
settlement discount, it too would be excluded as this is a discount for paying early.

Hence, the total cost of the machine is:

Invoice price $16 000


Purchase discount taken 320
Freight cost 400
Cost of transit insurance 100
Installation costs 1 200
Testing of machinery prior to use 150
$17 530

Exercise 20.5 Depreciation methods

A. 1. Straight-line: ($32 000 - $12 000)/4


= $5 000

2. Sum-of-the-years’ digits: 4+3+2+1 =


10
($32 000 - $12 000) 4/10 = $8 000
3. Diminishing-balance:

4 12000
1 – = 22% (approx.)
32000

= 1 - .78 = .22

$32 000 x .22 = $7 040

4. Units-of-production:
Expense per kilometre = ($32 000 - $12 000)/200 000 = $0.1
0.1 x 78 000 = $7 800

B. 1. Straight-line: ($32 000 – $12 000)/4 x 9/12 = $3 750


2. Sum-of-the-years’-digits: (4/10 x $20 000) 9/12 = $6 000
3. Diminishing- balance: ($32 000 x .22) 9/12 = $5 280
4. Units-of-production: $0.1 x 60 000 = $6 000

Exercise 20.6 Revision of depreciation rates

A.
Depreciation Expense $5 188
Accumulated Depreciation – Equipment $5 188
Depreciation expense for year ended 30 June 2016.

Original asset cost $60 000


Residual value 10 000
Depreciable amount over original 8 years $50 000
Depreciation recorded to 30 June 2015
(2 years @ $6 250) 12 500
Carrying Amount $37 500
Revised remaining useful life(6+2) 8 years
Revised depreciable amount 41 500
($60 000 – $12 500 – $6 000)
Revised annual depreciation: $41 500  8 = $5 188

B.
Original cost $60 000
Accumulated depreciation at 30 June 2016
(12 500 + 5 188) 17 688
Carrying amount at 30 June 2016 $42 312
Optional

Exercise 20.10 Acquisition and depreciation

A.

Cost of the lathe includes purchase price of $31 500 + shipping charges $500 + insurance in
transit $150 + installation costs $1 000 + test run costs $350 = $33 500.

Doubtful?: If it is the company’s policy to insure its machinery before use then even the
insurance costs against future damage for the first year ($250) are part of the cost of getting
the asset to a location and condition ready for use. These costs should be treated as part of the
initial cost of the asset. Hence, the total initial cost of the lathe is $33 750.

B.

Depreciation for year ended 31 December 2014:

1. Depreciation straight line = ($33 750 - $3 000) ÷5 = $6 150


2. Units of production = $30 750 ÷30 000 x 6 200 = $6 355
3. Diminishing balance = $33 750 x .38 = $12 825
4. Sum-of-years-digits = $30 750 x 5/15 = $10 250

C.

Accounting for depreciation represents the process whereby the decline in future economic benefits of
an asset through usage, wear and tear, and obsolescence is progressively brought to account as a
periodic charge against income. Two differing views exist as to how depreciation should be measured
by accountants:
 Depreciation is the fall in market or fair value of the asset. In other words, depreciation should be
calculated as the difference between an asset’s selling market value (fair value) at the beginning
and end of a period. The decline in the asset’s fair value during the period represents depreciation;
but if fair values rise then the asset is said to appreciate. This is the valuation approach to
depreciation.
 Depreciation should be measured by allocating the asset’s cost or depreciable amount over its
estimated useful life, i.e. the period over which the future economic benefits embodied in the asset
are expected to be consumed by the entity. This is referred to as the allocation approach.
This allocation approach is favoured in IAS 16/AASB 116. In other words, depreciation in practice is
measured and recorded using a process of allocating the asset’s cost or depreciable amount, rather
than determining current valuations. As the asset is used, its depreciable amount is said to expire
gradually or be used up. The allocation method used must reflect the pattern in which the asset’s
future economic benefits are expected to be consumed or lost by the entity.

Problem 20.2 Depreciation methods and partial years

A.
(i)
List price $96 250
Freight costs 2 800
Insurance in transit 15
Installation costs 250
Total cost $99 450

Machine A 99 450
Cash at Bank 99 450

(ii)
Recorded cost $99 450
Residual value 9 000
Depreciable amount 90 450
Useful life 6
Annual depreciation 90 450/6

Depreciation Expense - Machine A 15 075


Accumulated Depreciation - Machine A 15 075

B.
(i)
Recorded cost $200 000
Residual value 16 000
Depreciable amount 184 000
Useful life 4
Annual depreciation $46 000

(ii)
Year ended Carrying Amt Rate Annual Accumulated
30 June at Beginning Depreciation Depreciation
of Year Expense
2014 $200 000 50% $100 000 $100 000
2015 $100 000 50% $50 000 $150 000
2016 $50 000 50% $25 000 $175 000
2017 $25 000 0% $9 000 $184 000

(iii)
2014 17 000
2015 14 000
2016 10 000
2017 9 000

Rate per unit = $184 000/50 000 = $3.68 per unit

Annual Depreciation Expense


Year: Activity: Rate: Period Depreciation:
2014 17,000 $3.68 $62,560
2015 14,000 $3.68 $51,520
2016 10,000 $3.68 $36,800
2017 9,000 $3.68 $33,120

C.
The highest depreciation amount for the year ended 30 June 2014 is $100,000 as calculated by the
diminishing balance method.
The highest depreciation expense for the year ended 30 June 2015 is $51,520 as reported by the units-
of-production method.

Across the four years, each depreciation method will report the same total depreciation, equal to the
total of the depreciable amount of the asset, namely $184,000. The asset has reached the end of its
useful life after four years.