Depreciation

Non Current/Fixed Assets

• Fixed assets are those assets: that have a long life, are used in the business for future generation of income, are not bought with the main purpose of resale. not easily and quickly convertible into cash

Fixed assets are also called “Depreciable Assets”

Fixed Assets Register

• Different record for each class of assets• Date of purchase• Detailed particulars of asset• Location of asset• Record of depreciation

Depreciation• IAS-16 defines depreciation as “ the measure of

the cost or revalued amount of the economic benefit of the tangible non current asset that has been consumed during the period”

• In simple words it is the cost of using a non current asset

• It is a systematic allocation of the cost of a depreciable asset to expense over its useful life.

Note: No depreciation is charged on land.

Useful Life

• Useful Life / Economic Life is the time period for asset is expected to operate efficiently.

• It is the life for which an asset is estimated to provide more benefit than the cost to run it.

Grouping of Fixed Assets

• Major groups of Fixed Assets: Land Building Plant and Machinery Furniture and Fixtures Office Equipment Vehicles

Recording

• Purchase of a Fixed AssetDebit Asset Account (relevant classification)Credit Cash / Bank or Payable Account

Recording

Depreciation• Two different accounts are used

Depreciation Expense Account Accumulated Depreciation Account

Accumulated Depreciation Account – over the years the periodic depreciation is accumulated in this account.

Book Value OR Written Down Value (WDV)

Cost of the Asset LessAccumulated Depreciation

Recording

Depreciation

Debit Depreciation Expense AccountCredit Accumulated Account

Depreciation for the year is charged to:i. Cost of Goods Soldii. Administrative Expensesiii. Selling Expenses

• In balance sheet Fixed Assets are shown at Cost less Accumulated Depreciation i.e. Written Down Value (WDV)

Recording the Depreciation

• Journal EntryDebit Depreciation Expense AccountCredit Accumulated Depreciation Account

• Presentation• Profit and Loss Account

Revenue- Cost of Sales- Admin, Selling and Financial Expenses

• Balance SheetFixed Assets- Accumulated Depreciation

Methods of Calculating Depreciation

• Straight Line Method• Reducing Balance or Written Down Value Method

Residual Value

• It is the estimated value of the asset at the end of it’s useful life.

Straight Line Method of Calculating Depreciation

Depreciation = (Cost – Residual Value) / Life of The Asset

Example Straight Line Method

• Cost of the Asset = Rs. 100,000• Life of the Asset = 5 years• Annual Depreciation = 20 % of cost or Rs. 20,000

Written Down Value Method

• Cost of the Asset = Rs. 100,000• Annual Depreciation = 20%

Year 1 Depreciation = 20 % of 100,000 = 20,000 Year 1 WDV = 100,000 – 20,000 = 80,000 Year 2 Depreciation = 20 % of 80,000 = 16,000 Year 2 WDV = 80,000 – 16,000 = 64,000

Disposal of Asset

Cost of Asset = 100,000Life Of the Asset = 5 YearsDepreciation Method = Straight LineResidual Value = Rs. 10,000Sale Price After Five Years= Rs. 15,000

Did we lose Rs. 85,000 (100,000 – 15,000) on the disposal of this asset?

Method of Depreciation = Straight line

Total Depreciation in Five Years = 18,000 x 5 = 90,000

Book Value After Five Years = 100,000 - 90,000= 10,000

Profit on Disposal = 15,000 – 10,000= 5,000

Recording of Disposal

Recording of DisposalDebit Fixed Asset Disposal A/c 100,000Credit Fixed Asset Cost A/c 100,000

(with the cost of asset)

Debit Accumulated Dep. A/c 90,000Credit Fixed Asset Disposal A/c 90,000

(with the depreciation accumulated to date)

Debit Cash / Bank / Receivable A/c 15,000Credit Fixed Asset Disposal A/c 15,000

(with the price at which asset is sold)

Disposal of Asset Account

Fixed Asset Disposal AccountDEBIT CREDIT

Cost Account 100,000 Acc. Dep. Account 90,000Cash / Bank 15,000

100,000 105,000P & L Account 5,000

105,000 105,000Total Total

Revaluation of Assets

• 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.

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).

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.

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.

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.

Accounting for Revaluation

Step 1 The accumulated depreciation is charged off against the cost of the assetDebit Accumulated Dep. Account 120,000Credit Plant and Machinery 120,000This will reduce cost to Rs. 80,000Step 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 60,000Credit Revaluation Reserve Account 60,000This will increase the cost to the desired level of Rs. 140,000 (80 + 60)

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.

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.