Chap 13 Accounting for Non-Current Assets 1

1 Identify the characteristics of a depreciable non-current asset.

Depreciable assets have a finite life; and will be useful for a fixed period of time.

1 Explain how depreciation ensures Relevance in the reports.

Depreciation ensures that the Income Statement includes information that may affect decision-making about profit, by showing the expense related to non- current assets that has been incurred in the current Period. Put simply, to omit this information would undermine decision-making.

1 Show the formula for calculating depreciation expense using the rate of depreciation.

Depreciation expense = Historical cost X Depreciation rate

1 Identify three costs that might be included in the cost of a non-current asset.

· the purchase price/supplier's price · delivery costs · modification costs · installation costs.

1 Show the formula for calculating the rate of depreciation.

(Depreciation expense divided by Hstorical Cost) X 100

1 State the formula for calculating depreciation using the straight-line method.

(Historical cost minus Residual Value) divided by useful life

1 Define the term 'carrying value'.

... is the value of a non-current asset that is yet to be incurred/allocated as an expense, including any residual value.

1 Explain why the balance of the Accumulated depreciation account is greater than the depreciation expense in the second year of the asset's life.

Accumulated Depreciation includes the balance of any depreciation expense accumulated from the previous Period, plus the Depreciation expense from the current Period.

1 Explain why it is not necessary to calculate depreciation for assets such as land.

Assets like land should not be depreciated as they have an infinite life so they may be used, but they are never 'used up' or consumed: the economic benefit they provide is not consumed over time.

1 Explain what assets and expenses have in common.

Assets, in common with expenses, are necessary to help earn revenue and generate profit. They both provide an economic benefit to the business that assists in the earning of revenue.

1 State the effect of depreciation expense on the Accounting equation.

Assets-Decrease (Increase Accumulated depreciation of NCA) Liabilities -No effect Owner's Equity -Decrease (Increase Depreciation of NCA decreases profit)

1 Explain why calculating depreciation expense using the rate may not allocate the entire cost of a non-current asset over its life.

Because the Residual value is not allocated as a depreciation expense which will not be incurred by the current business, but by a different entity when it takes control of the asset

1 Explain why depreciation may be said to undermine the Faithful representation of the reports.

Both the residual value and useful life are estimates, meaning the amount calculated as depreciation expense may not be neutral (without bias) and thus may not provide a Faithful representation of the real world value of the expense.

1 Explain why Depreciation expense is reported in the Income Statement but Accumulated depreciation is not.

Depreciation expense represents the value of the non-current asset incurred in the current Period, so it is reported in the Income Statement with all the 'Other expenses' to ensure profit is calculated accurately. Accumulated depreciation represents the value of the non-current asset incurred in total over a number of Periods, so it is a negative asset (not an expense), and so must not be reported in the Income Statement

1 Explain the effect of depreciation on a firm's bank balance.

Depreciation has no effect on a firm's bank balance because depreciation does not involve any payment of cash. The cash payment relating to each non-current asset will be recorded only at the time when the asset is purchased.

1 Referring to the Accrual basis assumption, explain the purpose of depreciating non-current assets.

Depreciation is an attempt to calculate how much of the asset's value has been consumed in the current Period. This allows for the depreciation expense incurred in the current Period to be compared against the revenues earned in that Period so that an accurate profit can be determined.

1 Show the General Journal entries to record the balance day adjustment for depreciation expense.

Depreciation of Non-current asset Debit Accumulated depreciation of Non-current asset -Credit

1 Explain why each non-current asset must be depreciated individually rather than as a total.

Each depreciable non-current asset must be depreciated individually because each is different in terms of its useful life and residual value.

1 Explain how depreciation contributes to the Faithful representation of the reports.

Even though it is difficult to verify the Residual value and Useful life, and therefore the exact amount of depreciation expense, reporting no depreciation expense would mean an even less Faithful representation of the firm's performance. That is, the depreciation expense calculated using estimates of Residual value and Useful life may not be correct, but it is less incorrect than reporting no depreciation expense at all. As a result, depreciation based on estimates still provides a more Faithful representation than leaving out depreciation altogether.

1 Explain why GST is excluded from the cost of a non-current asset.

GST is excluded because it actually represents a reduction in the GST liability owed to the ATO and does not become part of the cost of a non-current asset.

1 Explain why GST is excluded from the consideration of depreciation.

GST is excluded because it is not included in the cost of a non-current asset; it actually represents a reduction in the GST liability owed to the ATO.

1 Explain why the amount of GST paid reported in the Cash Flow Statement is likely to be different from the amount of GST paid on the cash purchase of a non-current asset.

GST paid as reported in the Cash Flow Statement includes the amount of GST paid on the cash purchase of a non-current asset plus the GST paid on any other cash payments (such as inventory or expenses).

1 State one reason why the ledger accounts must name the asset being depreciated.

Given that most businesses will depreciate more than one non-current asset, it is imperative to identify precisely which asset is being depreciated. (This ensures that each asset is reported accurately in the Balance Sheet.)

1 Explain the process for calculating depreciation expense when the firm has had control of the asset for less than a year.

If by balance day the firm has had control of the asset for less than a year, the depreciation expense figure will need to be applied on a pro-rata basis; if the business has had the asset for only one month, then only one month's worth of depreciation expense (1/12 of a year) should be charged as an expense.

1 Explain how the cash purchase of a non-current asset is reported in the Income Statement.

In terms of the Income Statement, the cash purchase of a non-current asset does not create a revenue or expense so there is nothing to report (until the balance day adjustments are recorded for depreciation expense and any prepaid expenses which have been incurred).

1 Define the term non-current asset and list three examples of non-current assets

Non-current assets are the economic resources controlled by the business which are not held for resale but rather are used for a number of years, providing economic benefits for more than the next 12 months. Examples:· Premises,· Shelving · Vehicles,· Office equipment.

1 Referring to one Accounting assumption, explain why Residual value is deducted from Historical Cost when calculating depreciation using the straight-line method.

Residual value is deducted from the Historical cost, as this is the amount that will not be incurred by the current business, but by another Accounting entity. As a result, it must not be allocated as an expense in the reports of the current business entity.

1 Explain why the lines for Carrying value and Accumulated depreciation move in opposite directions over the life of the asset.

The Accumulated depreciation grows at a constant rate, increasing every year by the amount of the Depreciation expense. At the same time, the Carrying value starts at the Historical cost and moves in exactly the opposite direction, decreasing every year by the amount of the Depreciation expense.

1 Explain why the line for Carrying value does not end at zero.

The Carrying value line decreases until it reaches the Residual value which may not be zero as the asset may be assumed to have some value when it is disposed.

1 Explain why the Depreciation expense account must be closed at the end of the Period.

The Depreciation expense account must be closed to the Profit and Loss Summary account in order to calculate profit for the current Period, and to reset the Depreciation expense account to zero in preparation for the next Period.

1 Referring to the Going concern assumption, explain the key difference between an asset and an expense.

The Going concern assumption states that the business will continue to operate into the future. An asset provides economic benefit into the future, while an expense will not provide any further economic benefit beyond the current Period. It could be said that expenses refer to economic benefits that have already been consumed, whereas assets refer to economic benefits that are yet to be consumed.

1 Define the term 'cost' as is relates to non-current assets.

The cost of a non-current asset is defined as all costs incurred in order to bring the asset into a location and condition ready for use, which will provide a benefit for the life of the asset.

1 Explain why the line for Depreciation expense under the straight-line method is 'flat'.

The line for Depreciation expense under the straight-line method is 'flat' as the amount of Depreciation expense is constant every year, creating a straight line across the life of the asset.

1 Explain why it would be unethical to omit the effects of depreciation from the Income Statement and Balance Sheet.

The omission from the reports of the effects of depreciation is actually unethical as omitting depreciation expense would mean the reports would not include all Relevant information which might make a difference to decision-making. Specifically, an Income Statement which did not report depreciation expense would understate expenses and overstate profit, and it might lead the owner to make poor decisions about expense control. As a result, a Balance Sheet which did not include the effects of depreciation would overstate owner's equity, but it would also overstate the value of non-current assets, which might negatively affect decisions about asset replacement and those based on the net worth of the business.

1 Explain how the receipt of a loan is reported in the Cash Flow Statement.

The receipt of a loan is reported in the Cash Flow Statement as a Financing inflow as it is a cash inflow that changes the firm's financial structure (making it more reliant on borrowed funds).

1 Explain the assumption about how assets contribute to revenue that underlies the straight-line method of depreciation.

The straight-line method of calculating depreciation expense assumes that non-current assets contribute evenly to revenue, doing the same job in the last year of their life as they did in their first. As a result, this method assumes that the value of a non-current asset is incurred evenly over its life and allocates the same depreciation expense every year.

1 Referring to the appropriate Qualitative characteristic, explain why the original purchase price of a non-current asset must be reported in the Balance Sheet.

To ensure the reports continue to provide a Faithful representation of the asset it must always be reported initially at its Historical cost (its original purchase price) as this amount is Verifiable by reference to the source document, and thus neutral and free from bias.

1 Referring to one Qualitative characteristic, explain why non-current assets must be reported at their Carrying value in the Balance Sheet.

To ensure the reports provide a Relevant valuation of the asset, the carrying value of the asset must be reported as this valuation is capable of making a difference to decision making. For example, the owner will be able to see if the asset is nearing the end of its useful life (low carrying value) and may need replacement.

1 Referring to one Accounting assumption, explain why it is not always accurate to report depreciation expense per annum.

Under the Period and Accrual basis assumptions, the business must report depreciation expense incurred in the current Period. If the Period is less than a year, or the firm has had control of the asset for less than a year, it is not accurate to report depreciation expense per annum.

1 Referring to one Accounting assumption, explain the difference between Depreciation expense and Accumulated depreciation.

Whereas depreciation expense refers to the amount incurred in the current Period, Accumulated depreciation refers to the total depreciation that has accumulated over the life of the asset so far (over a number of Periods).

1 Explain why yearly costs are excluded from the cost of a non-current asset.

Yearly costs are excluded as their benefit will be consumed within a year, and so they do not fit the definition of the 'cost' of a non-current asset.

1 Define the terms: Depreciation

is the (process of the) allocation of the cost of a non-current asset over its useful life.

Define the terms: Depreciation expense

is the part of the cost of a non-current asset that has been consumed in the current Reporting Period.

1 Define the following terms: ·· Useful life -

the estimated period of time for which the non-current asset will be used by the current entity to earn revenue. This is usually measured in years.

1 Define the following terms: · Residual value -

the estimated value of the non-current asset at the end of its useful life

1 Define the following terms: · Historical Cost -

the original purchase price of the non-current asset

1 Explain how the following items related to the cash purchase of a non-current asset are reported in the Cash Flow Statement: · non-current asset -

will be reported as an Investing outflow as it is a cash outflow for the purchase of a non-current asset

Explain how the following items related to the cash purchase of a non-current asset are reported in the Cash Flow Statement:· GST paid -

will be reported as an Operating outflow as it is a cash outflow related to the day-to-day trading activities of the firm

Explain how the following items related to the cash purchase of a non-current asset are reported in the Cash Flow Statement:· Prepaid expenses -

will be reported as an Operating outflow as it is a cash outflow related to the day-to-day trading activities of the firm