Lecture 4(1)

7/18/2019 Lecture 4(1)

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7/18/2019 Lecture 4(1)


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Holmes Institute 20157

Straight-line method

Depreciation expense is calculated as

Cost Residual (salvage) value

Useful life

This method is appropriate when benefits tobe derived from the asset are expected to beuniform throughout the asset’s useful life


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

Entry to record depreciation expense at end of eachyear

Jun 30 Depreciation Expense – Machinery 7 500

Accumulated Depreciation – Machinery 7 500(Depreciation expense for the year)


Sum-of-digits method

(Cost less residual value) is multiplied by successivelysmaller fractions to calculate depreciation expense

Numerator in fraction

changes each year, and is the years remaining ofthe asset’s useful life at the beginning of the period

Denominator in fraction

calculated by adding the years in the asset’s usefullife; or

n(n +1)/2 where n is the useful life

This method is appropriate when economic benefitsexpected to be derived are greater in the early yearsthan later years


Example of SoD method

Example Sum-of-years digits depreciation

Cost $33 000Residual $ 3 000Estimated useful life of 4 years

1 + 2 + 3 + 4 = 10

Year Depreciable amount Fraction Depreciationfor the year Total accumdepn Carrying amt

1 $30 000 x 4/10 = $12 000 $12 000 $21 000

2 30 000 x 3/10 = 9 000 21 000 12 000

3 30 000 x 2/10 = 6 000 27 000 6 000

4 30 000 x 1/10 = 3 000 30 000 3 000


Declining-balance method

Depreciation expense is calculated on the asset’s

opening written-down value

Written-down value

cost (or revalued amount) less accumulateddepreciation

Percentage used for depreciation expense iscalculated as 1 nth root of (residual value/cost)

This method is appropriate when economicbenefits expected to be derived are greater in theearly years than in later years


Example RB (DV) depreciation method

Cost $33 000Residual $ 3 000Estimated useful life of 4 years

Depreciation rate = 1 – (3000/33,000)yx 0.25 = 45% (approx)

YearCarrying amt at

beg of yr RateAnnual

depreciation expCarrying amt at

end of yr

1 $33 000 x 45% $14 850 $18 150

2 18 150 x 45% 8 168 9 982

3 9 982 x 45% 4 482 5 490

4 5 490 2 490 3 000

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Holmes Institute 2015 13

Production basis

Depreciation expense is calculated as:

Units produced in current period x (cost residual

value)Total expected production

This method is appropriate where useful lifemight be related more to production output thantime

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

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


When to start depreciating an asset

From the time an asset is first put into use, oris held ready for use

If constructing an asset, it is not depreciateduntil ready for use

If an asset is able to be used but is notactually used for a number of periods, theasset is still depreciated from the time it wasable to be used


Revision of depreciation rate and method

Residual value and useful life must bereviewed at least annually (AASB 116)

If expected useful life or residual value aredifferent from that previously expected:

entity must revise depreciation rate

Depreciation method must also be reviewedannually


Land and buildings

Where acquired together, cost must beapportioned between land and buildings

buildings to be systematically depreciatedover time

land not usually depreciated owing tounlimited useful life


Derecognition of assets

Gain or loss from de-recognition ofasset (disposal)

difference between net disposalproceeds (measured at fair value) andasset’s carrying amount

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Sale of a depreciable asset (cont.)

The profit or loss on sale is generally referred to asa gain or loss on derecognition

Recognised on a ‘net basis’ in the income statement

Journal entries to record sale (if for cash)

Dr Cash at bank

Dr Accum. depreciation - asset

Cr Gain on derecognition of asset

Cr Asset

Refer to Worked Example 5.3 (p. 179) Holmes Institute 2015

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Modifying existing non-current assets

Expenditure on modifications or improvements shouldbe capitalised where expenditure is material; and

expenditure is expected to enhance the service potential ofthe asset

Additions or extensions that become an integral partof an existing asset:

are to be depreciated over the asset’s remaining life

Additions or extensions that retain a separate identity

are to be depreciated on the basis of their own useful life


Contractual implications of building

depreciation Recognition of building depreciation willincrease expenses and decrease profitsunfavourable movements in accounting-based ratios

How would managers facing possible debt-covenantviolations would be do?

Clinch (1983) found cash-flow effects associatedwith the decision to comply/not comply with therequirement to depreciate buildings, as follows non-compliance with depreciation requirement led to greater

auditing costs

benefits included cost savings associated with avoiding violationof debt contracts


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Is allocating historical cost of an asset over its

useful life really that appropriate?

Non-current assets can be carried at cost, or can berevalued to fair value

If an asset is carried at cost, and that amount isdepreciated over the expected useful life, whilst at thesame time the organisation is paying out all profits in theform of dividends, then what happens if the cost toreplace 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?


Disclosure requirements

For each class of property, plant andequipment the following must be disclosed

measurement basis used for gross carryingamount

depreciation methods used

useful lives or depreciation rates used

gross carrying amount and accumulateddepreciation at beginning and end of period

reconciliation of carrying amount at beginning andend of period


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Relevant accounting standards

There are three standards of particular relevance

1. AASB 116 ‘Property, Plant and Equipment’ Requirements for revaluations, depreciation anddetermining acquisition cost of property, plant andequipment

2. AASB 138 ‘Intangible Assets’

Revaluation of intangible assets and other issues

3. AASB 136 ‘Impairment of Assets’ When to

recognise an ‘impairment loss’


PART 2:

Revaluation of

non-current assets

(Chapter 6)


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Depreciation on revaluation – NET METHOD

Net Amount Method: for treatment ofaccumulated depreciation on revaluation

Journal entryDr Accumulated depreciation

Cr Asset

Dr Asset

Cr Asset Revaluation reserve

Subsequent depreciation is to be based on the revaluedamount of the asset

Worked Example 6.5 (p. 205)


Gross Amount Method: for treatment of

accumulated depreciation on revaluation

Accumulated depreciation may be restatedproportionately with the change in gross carrying amountof the asset, so the carrying amount after revaluationequals the revalued amount

Journal entryDr Asset

Cr Accumulated depreciation

Cr Revaluation reserve

Worked Example 6.6 (p. 205)

Depreciation on revaluation – GROSS METHOD


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Revaluation decrements

Revaluation decrements are recognised as anexpense in the income statement

Dr Loss on revaluation of asset

Cr Asset

Refer to Worked Example 6.7 (p. 206)


Reversal of revaluation decrements and increments

If a revaluation decrement reverses a previous increment for thesame asset, then the reversal entry is:

Dr Revaluation reserve

Dr Loss on revaluationCr Asset

If a revaluation increment reverses a previous decrement for thesame asset:

Dr AssetCr Gain on revaluation

Cr Revaluation reserve (the excess)

PS. Do not forget that for ALL journals, you must include a notation!

Refer to Worked Example 6.8 (p. 207)


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Accounting for profit on disposal of a revaluednon-current asset

Gain or loss from derecognition of the item is to becalculated as the difference between (AASB 116) net disposal proceeds (if any); and

the asset’s carrying amount

Derecognition

the point in time when an asset is removed from thebalance sheet

when an asset is sold; or

when no future economic benefits are expected from anasset’s use or disposal


Accounting for profit on disposal of a revaluednon-current asset (cont.)

When an asset is sold, any resulting balance in therevaluation reserve (AASB 116) may be transferred directly to retained earnings

cannot be transferred to the profit and loss account

Refer to Worked Examples 6.9, 6.10 and 6.11 (p208)


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Consideration of present values

Recoverable amount is the higher of an asset’s net

selling price and its value in use (AASB 136)

Estimating value in use (AASB 136) involves:

estimating future cash inflows and outflows from thecontinued use and subsequent disposal of the asset; and

applying the appropriate discount rate to future cashflows

Discounting future cash flows will decrease thecalculated recoverable amount


Offsetting revaluation increments and decrements

Increments and decrements may be offset only to theextent that they relate to a particular asset

if say one item of land increased in fair value by $10 millionand another item of land decreased in fair value by $1 million(and assuming no prior revaluations), then a loss of $1million would be recognised in the income statement.

Why? Well only the one that constituted an expense wouldbe recognised in P/L. The other would be an increase in

Asset, increase in Equity, both found in the Balance Sheet.


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Economic consequences of asset revaluations

If contracts in place are tied to reported profits (debt ormanagement compensation), management mighthave an incentive not to revalue

However, if assets are increased a revaluation mightloosen constraints such as debt-to-assets restrictions

Firms subject to political scrutiny might be more likely

to undertake upward revaluation resulting in areduction in profits

As the perceived competence of independent valuersincreases, audit time might be reduced


Disclosure requirements

AASB 116 includes various disclosurerequirements relating to the revaluation ofnon-current assets

These were previously discussed under theheading ‘The use of fair values’


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Status of newly converged accounting

standards

AASB 116 ‘Property, Plant and Equipment’

Depreciation requirements for property, plant andequipment

Amortisation of intangible assets


Lecture 4(1)

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