Non Current Assets Part 2 Notes

Long Lived Assets –Part 2

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In this lesson we study about the depreciation of tangible long lived assets, methods of depreciation, purpose, and amortization of intangibles and the disposal treatment..

Definition

IAS 16 defines depreciation as ‘the measure of the cost or revalued amount of the economic benefits of the tangible non current asset that has been consumed during the period’.

In other words

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Depreciable amount is the cost of an asset less its residual value.

In simple terms, depreciation is a mechanism to reflect the cost of using a noncurrent asset.

Depreciation matches the cost of using a noncurrent asset to the revenues generated by that asset over its useful life.

Why is it important?

Causes of Depreciation:

1. Some Assets get worn or torn out due to its constant use in production.

2. Some Assets get decreased in their value with the passage of time.

3. Some Assets may meet an accident and therefore it may get depreciated in its value.

Reasons For Providing Depreciation in Financial statements:

1. To reveal the correct profit or loss of a business.

2. To show correct financial position of a business.

3. To make provision for replacement of an asset.

Lecture Notes

Methods of calculating depreciation

There are generally three methods of providing depreciation

1. Straight Line Method:

This is also termed as fixed installment method. Under this method Fixed Percentage on original cost is written off the asset every year.

The amount of depreciation is calculated as follows.

Annual Depreciation = Cost of the Asset - Scrap Value

Useful life

Rate of Depreciation = Annual Depreciation x 100

Cost of Asset - Scrap Value

2. Reducing Balance Method:

This method is also known as Diminishing balance method or written down value method. Under this method depreciation is charged at a fixed rate on the reduced balance every year.

3. Revaluation Method:

Sometimes it is not possible to maintain detailed records of certain types of fixed Assets, such as very small items of equipment packing cases and hand tools. In such case the revaluation method is used. Under this method the assets are revalued at the end of each year and this value is compared with the value at the beginning of the period. The difference is treated as depreciation.

Formula = Value of Assets beginning + Purchases of Assets during the period – value of Asset at the end.

Accounting for depreciation

Whichever method is used to calculate depreciation, the accounting remains the same:

Dr Depreciation expense (IS) X

Cr Accumulated depreciation SFP X

The accumulated depreciation account is a statement of financial position account and as the name suggests is cumulative, i.e. reflects all depreciation to date.

• On the statement of financial position it is shown as a reduction against the cost of noncurrent assets:

$

Cost X

Accumulated depreciation (X)

___

NBV X

Consistency and subjectivity for depreciation Accounting

Different estimates would result in varying levels of depreciation and, consequently, profits.

In order to reduce such manipulation and increase consistency of treatment, IAS 16 requires the

following:

• Depreciation method should be reviewed at each year end and changed if the method used no longer reflects the pattern of use of the asset.

• Residual value and useful life should be reviewed at each year end and changed if expectations differ from previous estimates.

Selling (Disposal) of a Long lived asset

Key Points to remember:

1. Reduce value of assets.

2. Remove depreciation on the item that has been sold.

3. Work out the money received from the disposal (sale).

4. Have we made a profit or a loss on the sale of the machinery?

5. Post this profit/loss to the income statement.

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