HAPTER

NON-CURRENT ASSETS
1. Assets
The general definition of an asset is, 'something or someone of use or value'.
That's a good starting point, but we need to be more specific than that in financial
reporting!

As we know, assets make up half of the balance sheet and are an important aspect of
the accounting equation (Capital = Assets - Liabilities). But what counts as an asset?
Let's try to get a clearer idea.

Tangible and intangible assets

So, you probably think you already know what an asset is; things like buildings,
cars, cash, machinery are all assets. Well, that's true – these are known as
tangible assets, but that's only half of the story.

In 1997, P. Diddy sampled the classic Police song, 'Every Breath You Take,' for a
tribute track to his late best friend, Notorious B.I.G. called, 'I’ll Be Missing You'.
However, Diddy hadn’t received legal permission to use the sample, which, had he
done so, would have resulted in only having to give up 25% of the song royalties to
Sting.

This meant that, unfortunately for Diddy (and fortunately for Sting, who owns 100%
of the original), Diddy’s carelessness to properly retain permission for the sample
resulted in Sting reaping 100% of the royalties for the P. Diddy version.

To this day, Sting is reported to have earned between $20-$40 million for 'Every
Breath You Take,' and at least $2,000 a day from P. Diddy’s Grammy award winning,
best selling single of all time, 'I’ll Be Missing You.'

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So, the copyright that Sting had for the song was obviously something of value, but
is it an asset? The short answer is: yes. A copyright is an example of what we call an
intangible asset. Intangible assets are assets that do not have a physical presence.

So, assets can be of two different types:

Tangible assets Buildings, land, machines, inventories, cash.

Intangible assets Copyrights, goodwill, patents, brands.

For this chapter we don't need to look at intangible assets and so we are only going
to be interested in tangible assets. These are the main physical assets that we listed
earlier; buildings, machinery, equipment, inventory, money, etc.

Current and non-current assets

Now, tangible assets may be further classified into sub-classes of either non-current
or current assets.

Current assets
Current assets are assets that are reasonably expected to be sold, consumed or
used through the normal course of business operations within one year. So, of
the assets mentioned above, cash (currencies) and inventory (stock) are considered
as tangible current assets, because they come in and go out of a business on a daily
basis, and are thus short-term.

Non-current assets
In contrast, non-current assets are long-term and cannot easily be converted into
cash within a short period of time. These assets are not normally sold directly to the
consumers/end-users of an entity and instead go towards helping business
operations. Typically, non-current assets are things that the company has for 12
months or longer.

For example, a warehouse is a non-current asset, since it is a long-term store of the

inventory (which will sell in the short-term). In this case, the warehouse will be used
for as long as it is sufficient to the needs of the business, making it long-term (non-
current).

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However, the inventory will be sold and replenished whenever stock levels get low,
making it short-term (current). So, from the above list, buildings, land and machines
are examples of non-current tangible assets.

IAS 16 Property, Plant, and Equipment

Now we are ready to take a look at the formal definition for non-current assets (also
known as fixed assets). The accounting standard relating to this is IAS 16 Property,
Plant and Equipment (shortened to PP&E or PPE).

Now, for our purposes, Property, Plant and Equipment can be used interchangeably
with non-current assets. This is because all non-current assets fall into on of the
categories of property, plant or equipment.

For example, a building counts as property; plant refers to the kind of machinery that
you may find in a factory, for example; and equipment is more general, including
things like computers, phones, desks, etc.

Standard definition
Before we move on then, let's take a quick look at how IAS 16 defines PPE. Property,
plant and equipment are tangible assets that:

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• are held by an entity for use in the production or supply of goods or

services, for rental to others, or for administrative purposes, and;

• are expected to be used during more than one period.

Let's break down some of these key terms:

Aspect of definition Explanation

This means it is used by the company in order to help

'held by an entity for make money rather than to be sold for money.
use'
e.g. A warehouse used to store inventory (property).

This means the asset contributes to the main operations

'production or supply of the company.
of goods and services'
e.g. Machinery used in production (plant).

This just means that PPE can be leased to external

parties but it still needs to be shown in the financial
'for rental to others' statements of the owner.
e.g. Renting out machinery for external use.

'for administrative This refers to the administrative needs of the company.

purposes' e.g. An office or office building (property).

This refers to the 'long-term' aspect of the asset,

'used during more specifying that the asset must be used over multiple
than one period' periods.
e.g. A 5-year lease on a warehouse.

2. Capital and revenue

During the normal course of operation, a business will need to spend money in order
to make money. This might be buying materials to transform into products, or it may
be purchasing new machinery to increase production output. These costs are
actually quite different from an accounting perspective, and so we can
distinguish two kinds of expenditure:

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Capital expenditure: This is expenditure on non-current assets, such as

purchasing new land, buildings and equipment, since it is money spent on increasing
the earning capabilities of the company in the future.

Revenue expenditure: This is expenditure on current assets, such as inventories,

since it is money spent on keeping the company currently in business.

However, when it comes to repairing, replacing or sometimes updating non-

current assets, these costs are classified as revenue expenditure. Let's see why
this is the case with an example.

Example
Terry owns and runs a pub. Since the smoking ban, a lot of his regulars have been
complaining that he doesn't have an outdoor smoking area and they have been
using different pubs for this reason.

Terry also has a pool table in the pub, which was recently damaged and needs a new
felt surface. So, Terry makes plans to invest in two things: a new outdoor smoking
area for his pub and a new felt for his pool table. Which of these costs do you think is
a capital expenditure? Which one is a revenue expenditure?

Well, clearly the smoking area will be an asset that increases his potential
customers. Therefore, this will be capitalised.

And, since the new felt on the pool table is just a repair, this is revenue
expenditure. However, let's suppose that with the repair of the felt, Terry was also
given new pool balls, a new set of billiard and snooker balls (which he’d never had
before) and a new range of pool cues.

Which of these does Terry classify as revenue and which as capital? Well, the felt, the
pools balls and pool cues are essentially replacement, and so they are all revenue.
However, the new billiard and snooker balls are brand new, and so they should be
billed to capital expenditure.

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3. Recognition (initial measurement)

Recognition criteria
Okay, so the classification is all done but this is financial reporting, so what we are
really interested in is how and when to record PPE in the accounts and financial
statements.

An asset is recognised in the financial statements if it fulfils two criteria:

• It is probable that any future economic benefit associated with the asset will
flow to or from the entity; and,

• The asset has a cost or value that can be measured reliably.

Let's take a closer look at these criteria.

Economic benefit
It obviously makes sense for the entity to only recognise an asset as PPE if the
future economic benefit from its use becomes probable and will flow to the
entity.

For instance, going back to our warehouse example, we can ask whether this would
meet the first criterion. To do so, we need to identify exactly what would be the
economic benefit associated with the asset. This means identifying whether the risk
and rewards associated with the asset are transferred.

What of our example?

• Risk - Well, the warehouse is a store of the inventory and so it keeps all of the
products dry and safe and ready for sale. If there were a leak in the roof, the
entity would be responsible for the damage caused to inventory and for
repairing it.

• Rewards - The reward (or money) associated with this asset (the warehouse)
will be from the sale of the inventory that it houses. In this case, the
warehouse contains only the products that the entity sells, and so the reward
(revenue from the sale of goods) will flow to the entity.

• So far so good, it's an asset we should recognise. We're not finished yet
though.

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Control
Another aspect of of this criteria is establishing control. Control of the asset
determines recognition, and so it is very important to identify who controls and
asset upfront. In our example, the entity is in control of the warehouse as the sole
owner.

Indirect economic benefit

As you may have noticed from the example, the associated economic benefit need
not always be direct. For instance, the warehouse itself was not directly making any
money for the entity, but without it there would be nowhere to store inventory and
so the warehouse indirectly contributes to the economic benefits of the company.

Cost
An important criterion for recognition is that we should be able to reliably
measure the cost of an asset. Whether an asset has been purchased (which is the
most likely scenario) or created by the company, there is a certain amount of cost
attached to it.

Cost does not only mean invoice price. It also includes amounts incurred to bring
the asset to the location where it needs to be and condition the asset to become
operational. Attributable costs may also include labour charges to get the asset to
its finished stage.

Example: purchased asset

FTP Ltd have just agreed to purchase machinery “A”, which has been bought and
shipped from overseas:

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£
Original cost (as per supplier’s invoice) 50,000
Delivery of machinery from overseas to factory site
Freight charges (for shipment of machinery) 1,400
Brokerage and handling fees 85
Import duties (for importing machinery) 2,500
Cartage (delivery of machinery to factory) 285
Preparation charges incurred
Excavation charges (for site preparation) 2,300
Installation and machine assembly 1,000
Initial set-up and machinery testing 1,000
Staff training to operate machine 500
Total cost recognised for machinery “A” 59,070

All the expenditures listed above have been added to the total cost of the asset. This
is because they all contributed in bringing the asset to its required location (the
factory), as well as preparing the asset to be in a workable condition (assembly and
set-up). Therefore, the total cost of £59,070 would be recorded as the cost of
machinery “A” in the financial statements.

Example: produced asset

For assets that are created or produced by the company, the same concept applies.
However, when it comes to non-current assets, it is less likely to be made in house.

Nonetheless, let’s take the example of a computer manufacturer purchasing

components to build personal computers that they also use in their office (which
would come under equipment). The following components are bought to build a
complete PC, with labour charges attributed to making one personal computer are
also included:

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£
Original cost (as per supplier's invoice) -
Monitor 30
Keyboard & Mouse 20
Housing and other parts 40
CPU and motherboard 70
Labour – component assembly 40
Total cost recognised for each PC 200

The total of £200 would be recognised as the cost of each personal computer in the
financial statements.

4. Subsequent measurement
So let's imagine that we've bought a new piece of machinery for our company and
we've got as far as recognition (or initial measurement) in the books. We've identified
that it is a long-term asset from which (indirect) economic benefits are expected to
flow and we've also calculated an initial cost of £40,000:

Debit PPE £40,000

Credit Bank £40,000

PPE
Bank £40,000

Now it's a year later and you wonder how the asset now needs to be shown in the
financial statements. Do we use the same figure as last year or do we need to find an
up to date market price (or the 'fair value')?

Well, it turns out that the decision is up to you! Non-current assets can be
subsequently measured using either the cost model or the revaluation model.

Historic cost model

Simply put, under the cost model (or sometimes know as the historic cost model),
assets are recorded by the amount paid (or consideration given) for them at the

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time of their acquisition. Even if the fair value of an asset significantly increases
afterwards, the entity will continue to use the historic cost as the basis of measuring
the asset. Depreciation and impairment losses are the only adjustments made in this
model (more on these later).

So, the machinery that was purchased had an initial cost of £40,000. A year later,
based on the fair value of the asset in the current market the machinery is now worth
£42,000. However, if the company is using the cost model as its accounting policy,
the subsequent measurement for the machinery in the financial statements will
remain at the historic cost of £40,000.

Revaluation model
The revaluation model is when the asset is subsequently recorded at fair value
(the re-valued amount). The re-valued amount, then, is the fair value of an asset at
revaluation date, less subsequent depreciation and impairment (again, more on these
later). Initially, the asset is still initially recorded using its original cost. It is only
subsequently that any movement in fair value will need to be recognised.

Let us take the previous example of the machinery with historic cost of £40,000. A
year later, the asset is re-valued and found to now have a fair value of £42,000. If the
company chooses the revaluation model as its accounting policy, then the additional
increase of £2,000 would need to be recorded.

Increase in value
If the value increases, the added amount is recognised in 'other comprehensive
income' (this is a section of the Income Statement) as “revaluation reserve”. With
our previous example, the entries will be as follows:

Debit PPE £2,000

Credit Revaluation reserve (I/S) £2,000

PPE
B/f £40,000
Revaluation reserve £2,000 C/f £42,000
£42,000 £42,000
B/d £42,000

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Revaluation reserve
Income statement £2,000 PPE £2,000
Income Statement
Revaluation reserve £2,000

Decrease in value
However, if the value decreases, the difference will only be recorded in other
comprehensive income provided there is a balance in the revaluation reserve
account to cover it.

As an example, let’s say the machinery is re-valued at £39,000, a decrease. Also, there
is currently nothing in the revaluation reserve account. The company, using the
revaluation model, will then need to make the following transaction entries:

Debit Loss on revaluation (Income Statement) £1,000

Credit PPE £1,000

PPE
B/f £40,000 Loss on revaluation £1,000
C/f £39,000
£40,000 £40,000
B/d £39,000

Income Statement
Loss on revaluation £1,000

The loss on revaluation is immediately recognised as an expense since there is no

balance in the revaluation reserve account to offset.

If there is an insufficient balance in the revaluation reserve account, then the

difference will offset the account balance first, and the rest is then expensed in
the income statement.

Once again, let us use the same example, but this time, we assume a credit balance
of £400 in the revaluation reserve account related to this property. The entries will be
shown as follows:

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Debit Revaluation reserve £400

Debit Income statement (Loss on revaluation) £600
Credit PPE £1,000

The credit balance in the revaluation reserve account is cleared first. Then the
remaining loss is expensed. Here is the same process in the individual accounts:

PPE
B/f £40,000 Income statement £600
Revaluation reserve £400

Revaluation reserve
PPE £400 B/f £400

Income Statement
PPE £600

When to re-value
Although the frequency of revaluation is not specified, the company will be required
to undertake valuation on a regular basis (usually annually). This way, the carrying
amount reflected for the asset will always include any increase (or decrease) in value.

When doing subsequent measurements using the revaluation model, the fair value
of land and building should be market-related and should be appraised by a
professional.

Of course, all this is a bit of a hassle, particularly if you had a lot of assets to value
each year; as a result many companies prefer the historic cost model.

5. Depreciation
Introduction
So far, so good, but there is one major aspect of accounting for non-current assets
that we've not yet looked at: depreciation. In simple terms, depreciation is how we

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include the cost of an asset in the accounts over time. Let's consider an example
to understand why we do this.

Imagine that a company needs to buy a brand new machine for their factory due to a
recent increase in demand that the current facilities can't keep up with. The new
machine will cost £300,000, but the company has only been making around £500,000
in revenue each year, and so if we include the entire cost of the machinery in the year
in which it is purchased it will significantly reduce profit for the year (perhaps even
causing a loss). However, in the following year the profits will shoot back up again
since there is no extra cost to include:

Year 1 (£) Year 2 (£)

Revenue 500,000 510,000
Cost of new machinery (300,000) -
Other costs (250,000) (265,000)
Profit/(loss) (50,000) 245,000

In addition, charging the entire cost of the machinery at once doesn't really make
sense because the asset will presumably last for several years. Therefore, spreading
that cost out over the time that the asset is expected to be useful (its 'useful life')
gives a better representation of how the cost of the asset is 'absorbed' by the
company. And that is precisely what depreciation is: is the systematic reduction of
the value of a tangible asset over its useful life.

So, going back to our example, we would estimate the useful life of the
machinery (that's just how long we can expect it to be useful) and spread the
cost over that many years. So, if we use a useful life of 4 years we would get an
annual depreciation charge of £75,000 (£300,000 ÷ 4):

Year 1 (£) Year 2 (£) Year 3 (£) Year 4 (£)

Revenue 500,000 510,000 525,000 540,000
Depreciation (75,000) (75,000) (75,000) (75,000)
Other costs (250,000) (265,000) (270,000) (275,000)
Profit/loss 175,000 170,000 180,000 190,000

As you can see, this method gives a far more accurate portrayal of the company's
financial activity, which is ultimately the key function of financial reporting!

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Depreciation: Key ideas

Before we get into the specifics of accounting for depreciation, let's just formalise
and define some of the ideas we've just considered:

Useful life
Useful life refers to the duration that an asset will be purposeful to the business.
Most tangible assets have useful lives that are limited between 2 to 20 years and all
these assets are subject to depreciation. However, it does not always correspond with
how long the asset will actually last.

After all, a computer could physically last for 20 years (albeit it might become slow
and cumbersome as it “grows” older). But due to the speed of technological
advancement and changes, the computer might only be truly useful for 3 years.
Therefore, 3 years, not 20, is considered as the useful life of the computer.

The useful life of an asset should be periodically reviewed by the company

(normally around balance sheet date). This way, any significant changes on future
depreciation charges can be adjusted.

Residual value
Residual value is how much an asset will be worth at the end of its useful life.
This is also known as the 'salvage value' or scrap value. The residual value of an asset
can generally be estimated using an agreement or appraisal.

Any estimated cost related to the disposal of an asset (for instance, the cost of
removal or demolishing) can be deducted from its residual value.

If an asset has a residual value, then the residual value will be the lowest amount to
which that said asset can be depreciated.

As an example, let us take a motor vehicle with a cost of £3,000 and has a useful life
of 5 years. This vehicle can be sold back to the car dealership or used as a deposit for
a new one at the end of its useful life. The agreed upon residual value is £400. There
would also be a collection fee of £50 (when the dealership collects the vehicle).

The residual value of the vehicle will be £350 (£400 less collection fee of £50). The
depreciable amount of £2,650 (cost £3,000 less calculated residual value of £350) will
be depreciated over 5 years, giving a charge of £530 per year:

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Year 1 (£) Year 2 (£) Year 3 (£) Year 4 (£) Year 5 (£)
Book Value 3,000 2,470 1,940 1,410 880
Depreciation (530) (530) (530) (530) (530)
Carry value 2,470 1,940 1,410 880 350

The depreciation charge

The depreciation charge is shown as an expense in the profit and loss statement.
Companies depreciate assets for accounting and tax purposes.

Depreciation starts as soon as the asset has reached the location and working
condition it requires.

For example, say an office space was bought by a company at the start of the year, in
January, for the purpose of relocating its sales department. This office space required
revamping (fitting walls and doors, etc.) so that it could become a safe, free and
work-friendly environment. In June of the same year, the renovations were finally
completed and the sales department moved into the office space. Depreciation
would therefore only commence in June since that is the time the office space
started becoming useful to the company.

6. Calculating depreciation
When it comes to calculating how much an asset has depreciated in a given
accounting period, there are two main methods used:

• The straight-line method

• The reducing-balance method

IAS 16 requires that the depreciation method used should reflect the pattern in
which the asset’s economic benefits are consumed by the entity. For instance,
assets that are 'used up' more in earlier years and less later on (such as a machine
that deteriorates and becomes less productive over time) need to be depreciated in a
way that reflects that usage.

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The straight-line method

Using the straight-line method, the depreciation is calculated by charging an
equal amount of the cost of the asset to each accounting period during the
asset's useful life. This is the kind of depreciation we've looked at in our examples
so far.

When presented on a graph, the depreciation amount appears as a straight line,

which is where the name comes from.

Formula
The depreciation is calculated using the following formula:

Original cost – Estimated residual value

Depreciation per annum =
Estimated useful life

Useful life can be in days, months or years, but you have to be consistent. Usually,
though, depreciation is calculated over several years.

Example
Terry owns and runs a pub. Since his government imposed a smoking ban in pubs, a
lot of his regulars have been complaining that he doesn't have an outdoor smoking
area and they have been using different pubs for this reason. So, Terry makes plans
to invest in a new outdoor smoking area for his pub. Since the smoking area would
count as property, it will be recognised as a non-current asset and needs to be
depreciated.

The smoking area is not the kind of thing that is 'used up' more in earlier years, so
we will use the straight line method of depreciation. The relevant figures are as
follows:

Cost of the smoking area (as of 01st Jan 20X1) £13,750

Estimated useful life 10 years
Estimated residual value £500

So, putting these numbers into the equation gives us:

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£13,750 - £500
Depreciation per annum = = £1,325
10

So, in the statement of financial position, the carrying amount is reduced by £1,325
every year. In the income statement, this amount is charged as an expense and
subtracted from the profits. Here is how we calculate the carrying amount for the
statement of financial position:

Cost Acc. Depreciation Carrying amount

20X1 Non-current assets £13,750 £1,325 £12,425
20X2 Non-current assets £13,750 £2,650 £11,100
20X3 Non-current assets £13,750 £3,975 £9,775
20X4 Non-current assets £13,750 £5,300 £8,450
20X5 Non-current assets £13,750 £6,625 £7,125
20X6 Non-current assets £13,750 £7,950 £5,800
20X7 Non-current assets £13,750 £9,275 £4,475
20X8 Non-current assets £13,750 £10,600 £3,150
20X9 Non-current assets £13,750 £11,925 £1,825
20Y0 Non-current assets £13,750 £13,250 £500

You'll notice in this table, that we accumulate depreciation on this asset year by year
by adding on the current charge to the balance at the start of each year. This is called
accumulated depreciation.

Accumulated depreciation is removed from the cost of an asset during workings in

the statement of financial position, leaving the asset’s carrying amount in the
statement.

The non-current asset account will therefore show the cost of the asset. The asset’s
cost in this account will only change if it is re-valued at a later date.

Smoking Area
Jan X1 Bank £13,750

Accumulated depreciation is not charged to the individual asset accounts and is

instead credited to an accumulated depreC6ciation account. This effectively reduces
the cost of the asset to its carry value on the statement of financial position.

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Accumulated depreciation
Dec X1 Balance c/d £1,325 Dec X1 Depreciation £1,325
£1,325 £1,325
Jan X2 Balance b/d £1,325
Dec X2 Balance c/d £2,650 Dec X2 Depreciation £1,325
£2,650 £2,650

At the end of X1, the carrying value of the asset is £13,750 - £1,325 = £12,2425. One
year later it is £13,750 - £2,650 = £11,100. The value gradually reduces in the
accounts over the life of the asset.

The annual depreciation charge is an expense for a specific accounting period. At the
end of the year the depreciation expense account is closed off, with the expense
charged to the statement of profit loss and presented in the income statement.

Depreciation
Dec X1 Acc. Dep £1,325 Dec X1 P&L £1,325

The reducing-balance method

Sometimes, assets won't depreciate by the same amount each period and so we can't
use the straight-line method. What happens with these assets is that they depreciate
more early on and less when they are older.

This is usually the case with assets that have a higher production or value making
rate when they are new (imagine production line equipment that can produce 100
items an hour when new, but after time can only produce 50 items an hour).

When this is the case we use the reducing-balance method. This is where a constant
percentage of depreciation is applied to the remaining proportion of the asset
yet to be depreciated. The way we spread the cost reflects the output of the asset
over time. On a graph the depreciation charge would appear as a downwards sloping
curve.

Formula
Reducing-balance depreciation is calculated using the following formula:

Depreciation per annum = (Original cost – Acc. Depreciation) x Rate %

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The rate of depreciation is defined according to the estimated pattern of an asset's

use over its life term. You don't need to worry about how it is calculated for now as it
will always be given to you in a question if you are required to use the reducing
balance method.

Example
Taking the same figures as before – but let's assume that Terry invests in an asset
that depreciates more at the start, and less at the end. Let's say the rate of annual
depreciation is 31%.

£
Original cost 13,750.00
Year 1 depreciation 4,262.50 (13,750.00 x 0.31)
9,487.50
Year 2 depreciation 2,941.13 (9,487.50 x 0.31)
6,546.37

When the useful life of the asset is over (end of life) all that should remain is the
estimated residual value.

When it comes to recording the data in the ledger and financial statements, we can
do it in the same way as we did for the straight-line method, but with the
appropriate changes:

Accumulated depreciation
Dec X1 Balance c/d £4,262.50 Dec X1 Depreciation £4,262.50
£4,262.50 £4,262.50
Jan X2 Balance b/d £4,262.50
Dec X2 Balance c/d £7,203.63 Dec X2 Depreciation £2,941.13
£7,203.63 £7,203.63

Depreciation
Dec X1 Acc. Dep £4,262.50 Dec X1 P&L £4,262.50
Dec X2 Acc. Dep £2,941.13 Dec X1 P&L £2,941.13

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The carrying amount (or Net Book Value) at the end of each year is as follows:

Cost Acc. Depreciation Carrying amount

20X1 Non-current assets £13,750 £4,262.50 £9,487.50
20X2 Non-current assets £13,750 £7,203.63 £6,546.37

7. De-recognition
Introduction
De-recognition deals with the retirement or disposal of an asset. It is the removal
of an asset from an entity’s statement of financial position. An asset is usually
de-recognised because it has been donated, scrapped or sold, for instance, if a
company invests in new machinery, which leaves the old machinery available for sale.

De-recognition also takes place when an entity’s contractual right to an asset and
its future economic benefits has expired. For example, if you owned a warehouse,
but in the contract ownership passes on to another person after 5 years, at the end
of the 5th year you would need to remove it from the accounts/statements.

Gain and loss on disposal

Gains and losses on the disposal of an asset arise when there is a difference
between the proceeds received and the net carrying value of an asset at the
date of disposal.

Any gains or losses with regards to the disposal are recognised in the profit and
loss statement as either income or expense. Gains on the disposal of asset cannot
be classified as revenue because this transaction falls outside of the primary activities
of an entity.

Example
Machinery which was originally purchased for £10,000 has accumulated depreciation
of £6,200 and so had a net carrying amount of £3,800. This machinery was sold for
£4,000.

This means the selling company made a gain of £200 (£4,000 - £3,800) on the sale of
the asset.

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The entries will be recorded as follows:

Firstly we recognise the money received from the bank (and increase in an asset is a
debit – DeAd clic)

Bank
Disposal £4,000

We put the credit into a 'disposal account' which groups together everything related
to the sale and helps us calculate the profit or loss on sale.

Disposal
Bank £4,000

Next we need to take the asset out of the machinery account where it was originally
recorded at its cost. To put an asset in is a debit (DeAd clic) and so to take it out
must be the other side of the account i.e. a credit:

Machinery
Disposal £10,000

And the other side of the double entry also goes to the disposal account:

Disposal
Machinery £10,000 Bank £4,000

So that's the asset removed from the machinery account, but the accumulated
depreciation is still in the books. Let's remove that:

Accumulated depreciation
Disposal £6,200

The other side of the double entry again goes to the disposal account which can now
be balanced to find the profit or loss on disposal:

Disposal
Machinery £10,000 Bank £4,000
Profit (income st.) £200 Acc. depreciation £6,200
£10,200 £10,200

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So we see here our £200 profit which is taken to the profit and loss statement and
then on to the income statement as a gain in the period.

Revaluation reserve
If an asset to be disposed of was previously re-valued, any surplus recorded in the
revaluation reserve associated with said asset can be transferred directly to the
retained earnings.

We do this because we are essentially 'closing down' the revaluation reserve

associated with the asset and relocating the balance to retained earnings (which are
the accumulated profits of the entity). This transfer should also be included in the
statement of changes in equity.

Let us take the same situation as above with the sold machinery, but imagine that
£2,000 of the asset value was actually due to an upwards revaluation of the asset in
the past. The double entry for that will look like this:

Revaluation reserve
Retained earnings £2,000 B/f £2,000
Balance £0

Retained earnings
Revaluation reserve £2,000

We've been using DEAD CLIC a lot to help us with our double entry, but rarely have
we used the two C's. That's Credit and Capital. Here's a nice example of that though.
Increasing a capital account (retained earnings) is a credit!

Disposal via part-exchange

Sometimes, the value of an old asset goes towards the purchase price of a
replacement asset, in what is know as a part-exchange agreement (PEA). For
example, if a new machine costs £50,000, you may exchange an old machine worth
£15,000 and pay the difference of £35,000 in cash.

The accounting process is similar to a regular disposal.

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1. Record the cash payment

Firstly let's account for the cash payment portion. This is exactly the same as we saw
when there was a payment in full:

Machinery
Bank £35,000

Bank
Machinery £35,000

2. Record the part-exchange value

Notice that so far we have £35,000 of assets recorded but that the value of the
machine is £50,000. We need another debit of £15,000 to recognise the full value of
the asset:

Machinery
Machinery £35,000
Disposal £15,000

The credit is taken to a disposal account:

Disposal
Machinery £15,000

Now the full £50,000 is recognised in the asset account.

3. Take the old machine out of the accounts and recognise the
gain/loss on disposal
Let's say the old machine cost £40,000 originally, and had accumulated depreciation
on it of £30,000, meaning its net book value was £10,000.

When it's part-exchanged for £15,000, a £5,000 profit has been made. We therefore
need to recognise the profit as well as take the asset out of the cost and
accumulated depreciation accounts. Here's the relevant double entry:

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Take out the old machine from the machinery account (credit)

Machinery
Machinery £35,000 Disposal £40,000
Disposal £15,000

Take out the accumulated depreciation from the accumulated depreciation account
(a debit):

Accumulated depreciation
Machinery £30,000

Put the other side of the double entries into the disposal account and balance to find
the profit or loss:

Disposal
Machinery £40,000 Machinery £15,000
Profit (income state.) £5,000 Acc. depreciation £30,000
£45,000 £45,000

And we find there is £5,000 balance as we'd expect which is taken to the profit and
loss account and then on to the income statement.

8. Comprehensive example
Let's pull all this together to do an all-inclusive question...

Company PP specialises in the manufacture of plumbing pipes. 5 years ago, the

company decided to purchase machinery C to help in its production. Machinery C
had a cost price of £80,000 and was supplied by an overseas vendor.

Recognition/Initial measurement
With its delivery, machinery C attracted import duties of £4,000 and transport cost of
£2,500 to get it to the factory. Moreover, machinery C required setting up and
assembly, which cost the company a further £1,500.

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Solution
Let's start by calculating the cost, since it's already been established in the question
that machinery C is a non-current asset (PPE). Remember that the total cost will
include associated costs of getting the asset to the location and condition in which in
needs to be:

Cost price £80,000

Import duties £4,000
Transport cost £2,500
Set-up/assembly £1,500
Total cost £88,000

Subsequent measurement and depreciation

calculation
Machinery C started operating the same year in which it was purchased. It had an
expected useful economic life of 15 years. From the outset, Company PP selected to
adopt the revaluation model as its accounting policy and in year 3, the asset is
revalued at £90,000. They also use a 25% reducing balance depreciation method.

Solution
Okay, so we need to calculate the depreciation for 5 years using a reducing-balance
rate of 25%. Let's start with just the first year:

Year 1:

Cost price £88,000

Less: depreciation (£22,000) (£88,000 x 25%)
Net carrying amount £66,000

So, here we have started with the total cost of £88,000 that we calculated in the
previous question. Next we need to calculate the depreciation charge. The reducing-
balance formula is:

Depreciation per annum = (Original cost – Acc. Depreciation) x Rate %

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Therefore, depreciation for year one is (£88,000 - 0) x 25% = £22,000.

So that is the basic idea, let’s see how that’s done in the accounts. So, the asset
account will always show the cost value of the asset. We also have a corresponding
accumulated depreciation account and the combination of these two accounts give
us the carry value of the asset:

Machinery
Cost £88,000

We also need to make entries regarding the depreciation:

Depreciation
Machinery C £22,000

Depreciation is an expense, so this is a debit (DEad clic). It is then added as a credit

to the accumulated depreciation account:

Acc. Depreciation
Depreciation £22,000

So the balance of the asset account less the balance of the accumulated depreciation
will equal the carrying value of the asset:

£88,000 - £22,000 = £66,000.

Year 2:
We can follow the same ideas in year 2:

Net carrying amount from year 1 £66,000

Less: depreciation (£16,500) (£66,000 x 25%)
Net carrying amount £49,500

And in the accounts:

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Machinery
Balance b/d £88,000 Balance c/d £88,000
£88,000 £88,000
Balance b/d £88,000

Depreciation
Machinery C £16,500

Acc. Depreciation
Balance b/d £22,000
Balance c/d £38,500 Depreciation £16,500
£38,500 £38,500

£88,000 - £38,500 = £49,500.

Year 3:
Okay, so we know from the question that company PP are using the revaluation
model for subsequent measurement. Revaluation occurs every 3 years, and so we
need to record the revaluation in year 3. This means that we will need to set up a
revaluation reserve for the change in value of the asset.

Now, since the asset has been revalued to £90,000, we need to first record the
increase in the asset account. We'll balance that account off while we're at it:

Machinery
Balance b/d £88,000
Revaluation reserve £2,000 Balance c/d £90,000
£90,000 £90,000
Balance b/d £90,000

And also show this in the revaluation reserve:

Revaluation reserve
Machinery £2,000

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We also need to deal with the accumulated depreciation on the asset. Since the asset
at cost has increased by £2,000, we need to add back the amount that was
depreciated in years 1 and 2. We do this by debiting the accumulated depreciation
account and crediting the revaluation reserve:

Acc. Depreciation
Revaluation reserve £38,500 Balance b/d £38,500
£38,500 £38,500

Revaluation reserve
Machinery £2,000
Acc. Depreciation £38,500

And balancing the revaluation reserve gives us:

Revaluation reserve
Machinery C £2,000
Balance c/d £40,500 Acc. Depreciation £38,500
£40,500 £40,500
Balance b/d £40,500

Since the asset was revalued in year 3, there is no need to depreciate it, since the
revalued amount is an accurate estimate of its carry value.

Notice that the total in the revaluation reserve is the £90,000 revaluation less the
£49,500 carrying value at the start of the year (= £40,500).

Year 4:
So now, the cost of the asset is £90,000 and we can continue depreciating it as usual.

Machinery C in year 3 £90,000

Less: depreciation (£22,500) (£90,000 x 25%)
Net carrying amount £67,500

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Year 5:

Net carrying amount from year 4 £67,500

Less: depreciation (£16,875) (£67,500 x 25%)
Net carrying amount £50,625

De-recognition
At the end of year 5, company PP decided to decommission machinery C and replace
it with a new machine. A local scrap dealer has agreed to buy machinery C for
£54,000.

Firstly, we debit the bank account with the proceeds of the disposal:

Bank
Disposal £54,000

We then put the credit into a disposal account which groups together everything
related to the sale and helps us calculate the profit or loss on sale.

Disposal
Bank £54,000

Next we need to take the asset out of the machinery account where it was originally
recorded at its cost:

Machinery
Balance b/f £90,000 Disposal £90,000

And the other side of the double entry also goes to the disposal account:

Disposal
Machinery £90,000 Bank £54,000

So that's the asset removed from the machinery account, but the accumulated
depreciation is still in the books. Remember that we cleared the accumulated
depreciation account when we revalued the asset in year 3, so we just need to count
the depreciation since the revaluation. Depreciation for years 3 and 4 were £22,500
and £16,875 respectively, giving a total accumulated depreciation of £39,375:

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Accumulated depreciation
Disposal £39,375 Balance b/f £39,375

The other side of the double entry again goes to the disposal account, which can
now be balanced to find the profit or loss on disposal:

Disposal
Machinery £90,000 Bank £54,000
Profit (income st.) £3,375 Acc. depreciation £39,375
£93,375 £93,375

So we see here our £3,375 profit, which is taken to the profit and loss statement and
then on to the income statement as a gain in the period.

Revaluation reserve
So, finally, we need to transfer the balance of the revaluation reserve to retained
earnings. In year 3 we set up the revaluation reserve and it ended up with a balance
of £40,500. This shows the increase from machinery C’s value in year 2 of £49,500 to
£90,000 in year 3. All we do now is debit the reserve and credit the retained earnings
(a capital account):

Revaluation reserve
Retained earnings £40,500 Balance b/d £40,500

Retained earnings
Revaluation reserve £40,500

9. Non-current asset register

Imagine a company such as Ford Motors and how many non-current assets they
have. The buildings, property, land, machines, factories, robots et al. That’s a lot of
stuff! How on earth do they keep track of it all?

Well, entities have what is called a non-current asset register, which is a list of all of
a company’s non-current assets. It’s essential insofar that it enables entities to keep

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tabs on and control their assets. Here’s an example of what a non-current asset
register might look like:

Asset Description Date Cost (£) Acc. Dep (£) Carry value (£)
No. acquired
1823 Central office 02/05/X4 250,450 75,135 175,315
1824 Storage depot 15/01/X7 45,000 3,375 41,625
1825 Equip - Laptop 08/08/X6 550 440 110
1826 Furniture - Desk 09/08/X6 249 199 50

As you can see, the assets have:

• Unique codes

• The date of acquisition

• Historic cost

• Accumulated depreciation

• Carry value

An asset register may contain more columns, such as:

• Depreciation method used

• Current location

• Estimated useful life

Or any other relevant information that may be useful to managers to help them
make decisions about assets.

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