Financial accounting mgt101 power point slides lecture 20

Financial Accounting

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Lecture – 20

Recap

• What are fixed assets

• How to record purchase and disposal of fixed assets

• Classification of fixed assets

• What is depreciation

• Methods of depreciation

• Policies of Depreciation

• Capital Work In Progress

• Revaluation


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Areas Covered In this Lecture

• In this Lecture We Will Cover Following Areas A reminder of Journal Entries For Capital Work In

Progress, and Its Presentation in Balance Sheet How to Treat Disposal of Asset in Case we are charging

depreciation on the Basis of Use Revaluation of fixed Assets


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Capital Work In Progress

• The issue of capital work in progress arises when construction of a Fixed Asset asset is not complete at the time of preparing the balance sheet.

• Since the asset is not complete therefore it can not be classified in fixed assets

• Also no depreciation is charged as the asset is not in use and we had said that Depreciation is a Charge for the Use of the asset.

• Therefore the Costs Incurred to the date of the Balance Sheet Date on the construction of that incomplete asset are accumulated in an account called Capital Work In Progress.

• The Journal Entries are as follows:


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Lecture – 20

Capital Work In Progress Journal Entries

• At the time of Payment for the construction:Debit Capital Work In Progress AccountCredit Cash / Bank / Payable

• At the time when the asset is completed and put in useDebit Fixed Assets (relevant account)Credit Capital Work in Progress Account

• Balance in the Capital Work in Progress Account therefore becomes ZERO when the asset is completed and its use is started.

• REMEMBER no depreciation is charged on capital work in progress.

• Capital Work in Progress is presented after Fixed Assets and before other long term assets in Balance Sheet.

• Its presentation in balance sheet is shown in the following slide


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Lecture – 20

Capital Work In Progress Presentation

Name of the Entity

Balance Sheet As At

Particulars Amount Rs. Amount Rs.

AssetsFixed AssetsCapital Work in ProgressOther Long Term AssetsCurrent Assets

xxxxxxxxx

Total xxx

LiabilitiesCapitalProfit

xxxxxx xxx

Long Term LiabilitiesCurrent Liabilities

xxx

Total xxx


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Lecture – 20

Dep. and Disposal in Case Depreciation on the Basis of Use

• We discussed two policies for charging depreciation: One was to charge depreciation on the basis of use, And the other was to charge full depreciation on the year

of purchase and charging no depreciation in the year of sale.

• In the second case it is easier to charge depreciation and calculate WDV at disposal.

• But in the first case the calculations are a little bit difficult we will therefore revise them for you.

• Just to remind you the data of the example was:


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Lecture – 20

Example

• ABC Co. prepares it’s accounts on December 31, every year.

• On Dec 31 Year 4 the machinery included: One machine purchased on July 1, Yr 1 for Rs. 50,000 One machine purchased on Jan 1, Yr 2 for Rs. 75,000 One machine purchased on April 1, Yr 3 for Rs. 100,000 Machine 1 is disposed off on Sep 30, Yr 4.

• Depreciation is charged at 25% reducing balance method.

• Show the calculations of depreciation on machinery for the four years, applying following policies: (1) Dep. is charged on the basis of use (2) Full Dep. on the year of purchase and no Dep. in the

year of disposal.


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Yr 1: One machine purchased on July 1, Yr 1 for Rs. 50,000• Policy 1

WDV Opening Balance 0Purchase 50,000

50,000Dep. (50,000 x 25%) x 6/12 (6,250)WDV Closing Balance 43,750

• The purpose of revising the same problem is mainly to explain the working of disposal in case this policy is adopted, but we have shown the first three years as well here for your convenience.

• Students should remember on thing that two different accounts namely Cost and Accumulated Depreciation are used but for the purpose of explaining the working we are deducting the depreciation figure from cost in first year and WDV in subsequent years.


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Yr 3: One machine purchased on April 1, Yr 3 for Rs. 100,000• Policy 1

WDV Opening Balance 89,062Purchase 100,000

189,062Dep. (89,062 x 25%) (22,265)Dep. (100,000 x 25%) x 9 / 12 (18,750)WDV Closing Balance 148,047

Yr 2: One machine purchased on Jan 1, Yr 2 for Rs. 75,000

• Policy 1WDV Opening Balance 43,750Purchase 75,000

118,750Dep. (118,750 x 25%) (29,688)WDV Closing Balance 89,062


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• If we had been been presenting this example properly then the figures would have been as follows:

• Cost Machinery AccountYear 1 Rs. 50,000Year 2 Rs. 75,000Year 3 Rs. 100,000

225,000• Accumulated Depreciation

Year 1 Rs. 6,250Year 2 Rs. 29,688Year 3 Rs. 22,265 + 18,750 = 41,015

76,953• WDV = 225,000 – 76,953 = 148,047, Which is the same as

shown in the previous working.


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Lecture – 20

• In the year 4 we have to dispose off the Machine 1 on Sep 30, Yr 4.

• Therefore we have to calculate it’s Accumulated Depreciation / WDV at the time of disposal:

• WDV of machine sold this yearCost YR 1 50,000Dep Yr 1 (50000 x 25 %) 6/12 6,250

WDV YR1 43,750Dep Yr 2 (43750 x25%) 10,938WDV YR2 32,812Dep Yr 3 (32,812 x 25%) 8,203WDV YR3 24,609Dep Yr 4 (24,609 x 25%) x 9 / 12 4,614WDV YR4 19,995


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Yr 4: Machine 1 is disposed off on Sep 30, Yr 4.

• Policy 1WDV Opening Balance 148,047Dep. Machine 1 (4,614)Dep. Others (148,047 – 24,609) x 25% (30,860)

112,573WDV of Asset Disposed (19,995)WDV Closing Balance 92,578

• WDV of machine sold this yearCost yr 1 50,000Dep Yr 1 (50000 x 25 %) 6/12 6,250

WDV YR1 43,750Dep Yr 2 (43750 x25%) 10,938WDV YR2 32,812Dep Yr 3 (32,812 x 25%) 8,203WDV YR3 24,609Dep Yr 4 (24,609 x 25%) x 9 / 12 4,614WDV YR4 19,995


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Lecture – 20

Revaluation of Fixed Assets

• We briefly discussed Revaluation of Fixed Assets in the last lecture.

• Since this is an advanced area in accounting of fixed assets, therefore we will not go into details but still you should have a fair understanding of the area.

OR

• We will discuss the details when we cover RESERVES, a component of LIABILITIES, but it is important to understand the basics and effect on fixed assets account at this point.


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Lecture – 20

The Need For Revaluation

• Revaluing means “Valuing Again”. This means that the Revaluation of something is required when we think that the value shown in Balance Sheet is does not represent its real worth.

• The theory behind revaluation is as follows: We have said that the balance sheet shows the financial

position of an entity at a specific date. And we record fixed assets at their purchase cost in the

books of accounts. Now the fixed assets are assets that have physical

existence and are used by the business for a long time. Therefore unlike Debtors, Creditors, Cash, Bank and other balance sheet items they may have a value different than the one appearing in the accounts. It may be less or more than the WDV / book value.


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Lecture – 20

The Need For Revaluation

• Take the example of Land. A company may use a piece of land on which its factory or office is built for many years. This period can extend to ten, fifteen, twenty years or even more.

• You know that the value of land is almost always on the rise. So at some time the company may think that the land is not being shown at its real worth in the accounts.

• Same can be the case with other assets like Building, Machinery etc.

• Therefore the need of revaluation arises to show the fixed assets of the company at their fair value.

• FAIR VALUE – is the value that an asset would fetch in a transaction between two knowledgeable parties in an arms length deal (market value where seller and buyer both have a fair idea of market).


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Rules For Revaluation

• But when we stop using one policy that is stating Fixed Assets at their original cost the way we have been doing before then we have to follow some rules.

• The major rules and regulations governing revaluation are as follows: Once the fixed assets are stated at revalued amount then

the exercise of revaluation has to carried out at regular intervals. The frequency of revaluation depends intervals depend on the movement in the fair market values.

This means that you cannot use this to get results of your choice i.e. getting the assets revalued when the market values are high but not doing it again when the market values drop or vice versa. Again once you state the balances at revalued amount the revaluation has to be carried out at regular intervals.


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Rules For Revaluation

The work of revaluation has to be carried out by an expert authorized in this respect by regulatory authorities. You can not just say it yourself that as of today we have revalued our assets to such and such value.

If we decide to revalue an asset say a piece of land or machinery then we have to revalue the whole class to which that asset belongs i.e. Land and Plant and Machinery respectively. It is not possible to revalue selected assets within one classification. For example if an organization owns four different pieces of land and it decides to revalue Land, then all the land will have to be revalued. Again this rule has been framed to prevent malpractice of obtaining desired results by selected revaluation.


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Accounting for Revaluation

• Lets assume that a whole class of assets say Plant and Machinery or Land and Building was purchased in Year 1 for Rs. 200,000. Depreciation is charged at 20% on straight line.

• After the end of Year 3, Cost of the asset is still Rs. 200,000 and its accumulated depreciation is Rs. 120,000 (40,000 x 3). This means that book value or WDV of the asset is Rs. 80,000.

• At the time of revaluation it is discovered that the Fair Value of the asset is Rs. 140,000.

• Now there are two methods of recording this revaluation:


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• (1) Step 1 The accumulated depreciation is charged off against the cost of the asset

Debit Accumulated Dep. Account 120,000

Credit Plant and Machinery 120,000

This will reduce cost to Rs. 80,000

Step 2 Cost of the asset is increased to Rs. 140,000. The credit is given to a new account Revaluation Reserve Account. This account will have a credit balance and will be shown as a liability in balance sheet.

Debit Plant and Machinery Account 60,000

Credit Revaluation Reserve Account 60,000

This will increase the cost to the desired level of Rs. 140,000 (80 + 60)


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• (2) In this method both Cost and Accumulated Depreciation are increased in a proportionate manner so that the resulting Book Value is equal to the revalued amount.

• In this case WDV is Rs. 80,000 and the desired Book Value is Rs. 140,000. This is an increase of Rs. 60,000 or 75% of 80,000. So we have to increase both cost and Acc. Dep. by 75% to get the desired WDV.

• 75 of cost 200,000 is 150,000

Debit Plant and Machinery Account 150,000

Credit Revaluation Reserve Account 150,000

75 of Acc. Dep. 120,000 is 90,000

Debit Revaluation Reserve Account 90,000

Credit Accumulated Dep. Account 90,000

• The net result is an increase in WDV by Rs. 60,000 (150 – 90) and an increase in revaluation reserve by Rs 60,000 (150 – 90)


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Treatment of Revaluation Reserve

• One might think what is the purpose of the whole exercise. At on side we have increased an asset and on the other a liability has increased.

• It would have made more sense if the Credit was given to P&L Account. Then we would have said that the business gained from Appreciation in the value of a fixed asset.

• Ultimately this reserve also becomes part of the P&L but we will cover that at a later stage.


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Treatment of Revaluation Loss

• It is not necessary that revaluation produces a gain. It can also result in a loss.

• In this case the calculation is made the same way but instead of Revaluation Reserves Account a Loss on Revaluation of Fixed Assets account is used which is charged to P&L straightaway.

Financial accounting mgt101 power point slides lecture 20

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