ACCOUNTING FOR NON-CURRENT ASSETS

Introduction

Noncurrent assets are those assets held by a business for its own use over a long period of time and
not for resale. Such can be tangible noncurrent assets, natural resources or intangible noncurrent
assets. IAS 16 Property Plant and Equipment, stipulates the procedures of accounting for noncurrent
assets. IAS16 has the of prescribing “the accounting treatment for property, plant, and equipment.
The principal issues are the recognition of assets, the determination of their carrying amounts, and
the depreciation charges and impairment losses to be recognised in relation to them”. IAS 16
expressly excludes the following assets from its treatment:

• Assets classified as held for sale in accordance with IFRS 5

• Exploration and evaluation assets (IFRS 6)
Biological assets related to agricultural activity (IAS 41)
• Mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative
resources Plant, property and equipment have the following characteristics:

1. They are acquired for use in operations and not for resale.

2. They are long term in nature and are therefore subject to depreciation.

3. They have a physical existence.

Accounting for noncurrent assets is involved with the following concerns:

• Determination of the cost of acquisition

• Determination of the basis of allocating the cost of non-current assets over their useful lives
• Accounting for the disposal of non-current assets

Asset Recognition

According to IAS 16 non-current assets should be recognized when:

• It is probable that future economic benefits associated with the item will flow to the entity.
• The item’s cost can be measured reliably.

Notice that these conditions are similar to our basic definition of an asset. Also notice that the
definition is phrased in terms of economic benefits, rather than of the item itself. This means that
some expenditure not directly incurred to purchase the asset, but necessary nonetheless to
guarantee the continued productive use of the asset may still be included in the asset’s cost. For
example, safety equipment mandated by legislation may not provide direct revenue to the business,
but is necessary in order to continue operating the equipment legally. Thus, these costs should be
capitalized as part of the asset’s cost, and if significant, may even be identified as a separate
component of the asset.

The definition of PPE does not contain any guidance on how to define an individual element of PPE.
This means that the accountant will need to apply professional judgment to determine the
segregation of various PPE components. We need to depreciate assets based on their useful lives,
and because we need to consider the accounting treatment of subsequent expenditures, it is
important to define the separate components of a PPE item properly at the time of recognition.
Accountants will usually consider the value of the component relative to the whole asset, along with
the useful life and other qualitative and practical factors when making these determinations.
IAS 16 also indicates that spare parts, stand-by equipment, and servicing equipment should be
recognized as property, plant, and equipment if they meet the definition. If they don’t meet the
definition, then it is more appropriate to classify these items as inventory. This is an area where
materiality and the accountant’s professional judgment will come into play, as the capitalization of
these items may not always be practical.

Asset Measurement (Valuation, Depreciation, Depletion and Appreciation)

PPE assets are initially measured at their cost, which is the cash or fair value of other assets given to
acquire the asset. A few key inclusions and exclusions need to be considered in this definition. Any
cost required to purchase the asset and bring it to its location of operation should be capitalized. As
well, any further costs required to prepare the asset for its intended use should also be capitalized.
The following is a list of some of the costs that should be included in the capitalized amount:

Purchase price, including all non-recoverable tax and duties, net of discounts

• Delivery and handling

• Direct employee labour costs to construct or acquire the asset
• Site preparation
• Other installation costs
• Net material and labour costs required to test the asset for proper functionality
• Professional fees directly attributable to the purchase
• Estimates of decommissioning and site restoration costs

Costs that should not be included in the initial capitalized amount include:

• Initial operating losses

• Training costs for employees
• Costs of opening a new facility
• Costs of introducing a new product or service
• Costs of reorganization and operation at a new location
• Administration and general overhead costs
• Other revenue or expenses that are incidental to the development of the PPE
• Self-Constructed Assets

When a company chooses to build its own PPE, further accounting problems may arise. Without a
transaction with an external party, the cost of the asset may not be clear. Although the direct
materials and labour needed to construct the asset are usually easy to identify, the costs of
overheads and other indirect elements may be more difficult to apply. The general rule to apply here
is that only costs directly attributable to the construction of the asset should be capitalized. This
means that any allocation of general overheads or other indirect costs is not appropriate. As well,
any internal profits or abnormal costs, such as material wastage, are excluded from the capitalized
amount.
Depreciation is the systematic allocation of the depreciable amount of noncurrent assets over the
useful life of such assets. It involves the application of the accounting principle of matching to non-
current assets. IAS 16 identifies the depreciable amount as the cost of an asset or other amount
substituted for cost less its residual value. Amortization is the systematic allocation of the cost of an
intangible asset or a deferred liability over the useful life. Depletion is usually provided for on assets
of a wasting character e.g. mines.
Depreciation

Depreciation basically involves allocating the depreciable amount of a noncurrent asset over a
specified useful life. It is a classic approach to application of the indirect matching principle of
accounting. An exact understanding of the following terms is important in order to account for
depreciation

• Cost: The shilling amount assigned to a particular asset, usually the ordinary and necessary
amount expended to get an asset in place and in condition for its intended use.
• Useful life: The is the service life of a noncurrent asset. It is the life of an asset to an
enterprise, usually relating to the anticipated period of productive use of the item.
• Salvage value: Also called residual value. This is the amount expected to be realized at the
end of an asset’s service life; for example, the anticipated future sales proceeds for used
equipment.
• Depreciable amount: The cost minus the salvage value. It is also called the depreciable base.
Depreciable base is the amount of cost that will be allocated to the service life.
• Book value: Also called net book value. This refers to the statement of financial position
amount at a point in time that reveals the cost minus the amount of accumulated
depreciation

Methods of Calculation

Various methods can be used in providing for depreciation. These include:

1. Straight-line method: a method of allocating the depreciable base of an asset equally over
the useful life of the assets.

Depreciation = Cost value - Salvage value

Useful life

2. Reducing balance method: also called written down value method. Depreciation is
computed on the net book value of a non-current asset at the beginning of an accounting
year. This is an accelerated method that assumes that the asset is more useful when new
and its contribution to the business declines with age.

Depreciation =NBV b/f * Depreciation Rate

3. Production units’ method: a method of allocating the depreciable base of an asset over its
useful life-based solely on usage or units produced per time period. The expense would vary
for very year in accordance with the productivity of the non-current asset for such year.

Depreciation = Cost - Salvage value

Estimated useful life output

Expense =Production in a period * Depreciation per unit

4. Sum of years’ digits method: the method charges a large part of the cost of an asset in the
early years. This approach can assume accelerated depreciation like the reducing balance
depreciation approach or decelerated depreciation in a rare case if the noncurrent asset
 becomes more useful with time.

Depreciation = Cost - Salvage value

Sum of years' digits

Expense = Depreciation per year unit Digit * Appropriate year digit

Example:

ABC Ltd buys a factory machine at Sh. 10,000,000 including the purchase price and all other
capitalizable costs like installation, freight, taxes, commissions and borrowing costs. The most
conservative estimates indicate that the plant facility would be useful for 5 years a time over which
it is expected to churn out an output equivalent to 100,000,000 units. At the end of the useful life, it
is expected to have a salvage value of Sh.2,000,000 after considering all incidental costs of disposal.
Pre pare depreciation schedules based on as many methods as you can assuming that the output
from the machine was 25m, 15m, 20m 30m and 10m for years 1,2,3,4 and 5 respectively.

Acquisition Cost

IAS 16 indicates that “An item of property, plant and equipment

should initially be recorded at cost. Cost includes all costs necessary to bring the asset to working
condition for its intended use. This would include not only its original purchase price but also costs
of site preparation, delivery and handling, installation, related professional fees for architects and
engineers, and the estimated cost of dismantling and removing the asset and restoring the site”.
Accordingly, cost as the amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire an asset at the time of its acquisition or construction or, where
applicable, the amount attributed to that asset when initially recognized in accordance to the
specific requirements of other IFRSs. This can be compared to the fair value which is the amount for
which an asset could be exchanged between knowledgeable willing parties in an arm’s length
transaction. The cost of non-current assets comprises its purchase price plus any other incidental
cost to bring them in their present condition and location less discounts and rebates on such
purchase. The incidental costs include import duties, taxes on purchase, and other attributable costs
such as:

• Stamp duties and commission,

• Employee benefit costs arising directly out of the construction or acquisition of the asset
• Testing costs
• Costs of site preparation
• Assembly and installation costs,
• Professional fees, etc. These costs form the historical cost basis of valuing noncurrent assets.

Expenditures that improve the service potential of the noncurrent assets are capitalized while the
rest are charged into the income statement. According to IAS 23, borrowing costs can be

capitalized for qualifying assets i.e. when they are incurred on

assets that take a long time to get ready for use. Capitalization

ends when the construction of the assets is completed. Further,

IAS 16 states that “If an asset is acquired in exchange for another asset (whether similar or dissimilar
in nature), the cost will be measured at the fair value unless

1. the exchange transaction lacks commercial substance or

2. the fair value of neither the asset received nor the asset given up is reliably measurable. If the
acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset
given up.”

Example:

ABC Ltd has acquired a machinery item to be used in its manufacturing processes. The ex-factory list
price by the vendor is Sh.450,000 although ABC benefited from a trade discount of Sh.25,000. Other
costs incurred in the process of acquiring and installing this machine included value added tax of
Sh.45,000; demurrage charges for delay in clearing at the port Sh. 28,000; Repairs for minor
damages during installation Sh.14,000; Freight cost of Sh.15,000; freight insurance Sh.9,000 and
installation charges Sh.18,000. Pass a journal entry to show the acquisition of the machine

Solution

Class

Note

There are two types of expenditures that can be associated with noncurrent assets:

1. Capital expenditures- these include the cost of purchasing or expanding noncurrent assets in a
substantial manner.

2. Revenue expenditures- these incorporate expenditures for ordinary repairs, maintenance,

fuelling, etc which help in maintaining assets in the current use.

Revaluation of Non-Current Assets

The historical cost of a non-current asset can be adjusted in the process of revaluation of those
assets. Under the revaluation model considered under IAS 16, revaluations should be carried out
regularly, so that the carrying amount of an asset does not differ materially from its fair value at the
balance sheet date.

Revalued assets are depreciated in the same way as under the cost model. If a revaluation results in
an increase in value, IAS16 stipulates that “it should be credited to other comprehensive income and
accumulated in equity under the heading” revaluation surplus” unless it represents the reversal of a
revaluation decrease of the same asset previously recognised as an expense, in which case it should
be recognised as income”. According to IAS 16 “a decrease arising as a result of a revaluation should
be recognised as an expense to the extent that it exceeds any amount previously credited to the
revaluation surplus relating to the same asset”. The standard further stipulates that when a revalued
asset is disposed of, any revaluation surplus may be transferred directly to retained earnings, or it
may be left in equity under the heading revaluation surplus. The transfer to retained earnings should
not be made through the income statement. Revaluation of noncurrent assets is aimed at making
sure that the book values of noncurrent assets reflect current replacement values. In all cases
depreciation is charged on historical cost values or revalued amounts if any adjustments are made.
The usual practice is to create a revaluation reserve account into which the revaluation is treated as
follows: The frequency of revaluations depends upon the changes in fair values of the items of PPE
being revalued. If the fair value of a revalued asset differs materially from its carrying value, then a
further revaluation is required. If a PPE experiences significant and volatile changes in its fair value, it
may be necessary to revalue on an annual basis.
Dr. Non-current asset XX

Cr. Revaluation reserve XX

Example:

ABC Ltd purchased equipment was purchased on 1.1.2010 at Sh.2,500,000. It is the policy of the
company to depreciate it on a straight-line basis over 20 years. The company revalued the buildings
on 31st December 2012 to Sh.2,000,000. Determine the loss on revaluation at 31.12.2012.

Solution

Class

Disposal of Non-Current Assets

A business can dispose of noncurrent assets in several ways. These include:

1. Sale of the noncurrent assets: there arises a gain or loss on disposal.

2. Exchange with other assets: there arises a gain or loss upon exchange.

3. Abandonment: when abandoned, the assets is scrapped off at no value leading to a loss at
disposal.

4. Involuntary conversion through such events as fire, theft, earthquakes etc

When a non-current asset is scrapped, sold or exchanged for new assets, the cost and the
accumulated depreciation of the asset is removed from the books and a gain or a loss on disposal is

recognized.

The relevant journal entries upon disposal include:

a. When the assets are sold for cash:

Dr. Cash XX

Dr. Accumulated depreciation XX

Dr. Loss on disposal XX

Cr. Non-current asset XX

Cr. Profit on disposal XX

b. When the assets are discarded

Dr. Accumulated depreciation XX

Dr. Loss on disposal XX

 Cr. Non-current asset XX

c. When assets are exchanged for other assets:

when exchanged for new assets, an allowance may be allowed on the old asset and the difference
between this allowance and the cost of the new asset paid for in cash. The allowance given on the
old asset could be less than the book value in which case it is exchanged at a loss or vice versa.

i. If exchanged at a loss

Dr. Asset (new at cost value) XX

Dr. Accumulated depreciation XX

Dr. Loss on disposal XX

Cr. Cash XX

Cr. Asset (old) XX

ii. If they are exchanged at a gain

Dr. Asset (new at cost less gain) XX

Dr. Accumulated depreciation XX

Cr. Cash XX

Cr. Asset (old) XX

The accounting procedure is to include depreciation up to the time of disposal and to remove the
related accounts from the records of the business. Gains or losses on disposal should be included in
the income statement alongside the income from the operations of a business.

Example:

The following abridged trial balance relates to ABC Ltd as at 31st December 2012. The company
depreciates buildings at 5% straight line and does not depreciate land.

Sh. Sh.
Land 600,000
Buildings 2,400,000
Buildings cumulative depreciation 1,200,000
Revaluation reserve 225,000
Retained earnings 300,000
Profit for the year before adjustments 600,000
Other items 1,500,000 2,175,000
4,500,000 4,500,000
Prepare a schedule for plant, property and equipment assuming that the land and buildings were
revalued on the 1st of January 2012 on the 31st of December 2012 at Sh.1,500,000 and Sh.675,000
for buildings and land respectively given that the residual value of the buildings at the revaluation
time is estimated at Sh.600,000.

Exercise:

ABC Ltd had acquired equipment at Sh.1,000,000 at 1.1.2008 to be used for 20 years. The company
depreciates equipment on a straight-line basis. It sold the equipment on 30th June 2012 at
Sh.750,000. Determine the loss or gain on disposal.