Accounting for Non-Current Assets (AS Level: Topic 1.3)
Hello future accountant! This chapter is all about the big, valuable items a business owns—the things that stick around for more than one year. We call these non-current assets (NCAs).
Understanding how to account for NCAs is crucial because they represent huge investments (like factories and vehicles). Getting the accounting wrong can drastically mislead anyone reading the financial statements! Don't worry, we'll break down the tricky parts like depreciation and disposal step-by-step.
1. Capital Expenditure vs. Revenue Expenditure
This is one of the most important distinctions in Accounting. It determines whether an expenditure appears on the Statement of Financial Position (SOFP) as an asset, or on the Statement of Profit or Loss (SOPL) as an expense.
What's the Difference?
Think of it this way: Is the money spent to buy something new and long-lasting, or just to keep things running day-to-day?
1.3.1 Capital Expenditure (CapEx)
- Definition: Expenditure incurred on acquiring or significantly improving non-current assets (NCA). It provides a benefit to the business for more than one accounting period.
- Accounting Treatment: The cost is recorded as a non-current asset on the Statement of Financial Position (SOFP).
- Examples: Buying a new machine, adding a new wing to the factory, upgrading a lorry engine to increase its capacity.
1.3.1 Revenue Expenditure (RevEx)
- Definition: Expenditure incurred for the day-to-day running of the business or for maintaining the existing condition of non-current assets. It provides a benefit for only the current accounting period.
- Accounting Treatment: The cost is recorded as an expense on the Statement of Profit or Loss (SOPL).
- Examples: Repairing a broken window, fuel for the company car, annual maintenance services, wages, electricity bills.
The Effect of Incorrect Treatment (A Common Mistake!)
A common trick question in exams is asking what happens if you treat CapEx as RevEx (or vice versa).
Scenario A: Treating Capital Expenditure as Revenue Expenditure (The most common error)
Example: A business buys a new delivery van ($20,000) and incorrectly records it as a general expense.
- Effect on Profit: Expenses are overstated by $20,000. Profit for the year is understated.
- Effect on Asset Value: Non-current assets are understated by $20,000.
Scenario B: Treating Revenue Expenditure as Capital Expenditure
Example: The business pays for routine oil change on the van ($200) but adds this cost to the van's value.
- Effect on Profit: Expenses are understated by $200. Profit for the year is overstated.
- Effect on Asset Value: Non-current assets are overstated by $200.
Capital: BIG money, LONG life, goes to SOFP (Asset).
Revenue: Small money, SHORT life, goes to SOPL (Expense).
2. The Purpose and Calculation of Depreciation
Non-current assets don't last forever. The use of these assets contributes to generating revenue, but their value decreases over time. Accounting needs to reflect this fall in value.
1.3.2 What is Depreciation?
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
Important Note: Depreciation is not the same as falling market value. It is an application of the Matching Concept (or Accruals Concept). We are matching the cost of the asset with the revenue it helps generate over its lifetime.
Factors that Cause Non-Current Assets to Depreciate
- Wear and Tear: Physical deterioration from usage (e.g., car mileage, machinery running hours).
- Obsolescence: Becoming outdated due to technological advancements (e.g., an old computer model).
- Passage of Time: Certain assets, like leases, simply expire over time.
- Extraction/Depletion: Relevant for natural resources (mines, quarries).
The Prudence Concept supports depreciation. Assets should not be overstated, and expenses (depreciation charge) should be recognised to ensure profits aren't overstated.
Key Terminology in Depreciation
- Cost: The original purchase price plus all costs necessary to get the asset ready for use (e.g., delivery, installation).
- Useful Life: The estimated period over which the asset is expected to be used by the entity.
- Residual Value (or Scrap Value): The estimated selling price of the asset at the end of its useful life.
- Depreciable Amount: Cost less Residual Value. This is the total amount that must be spread (depreciated) over the asset’s life.
- Net Book Value (NBV): Cost less Accumulated Depreciation. This is the value presented on the SOFP.
3. Methods of Calculating Depreciation
The syllabus requires understanding two main methods. The choice of method depends on the pattern of economic benefit derived from the asset (1.3.2).
Method 1: Straight-Line Method (SLM)
This method charges a fixed amount of depreciation expense each year throughout the asset's life. It assumes the asset is used evenly over time. This is usually the most appropriate method for assets like buildings or furniture.
Calculation using Cost and Residual Value:
$$\text{Annual Depreciation} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life (Years)}}$$
Calculation using Rate:
$$\text{Annual Depreciation} = \text{Cost} \times \text{Rate} (\%)$$
Example: A machine costs $50,000, has a residual value of $5,000, and a useful life of 5 years.
$$\text{Annual Depreciation} = \frac{\$\text{50,000} - \$\text{5,000}}{\text{5 years}} = \$\text{9,000}$$
Method 2: Reducing Balance Method (RBM)
This method charges a fixed percentage rate against the asset's Net Book Value (NBV) at the start of the year. This results in a higher depreciation charge in the early years and a lower charge later. This is usually the most appropriate method for assets that lose value rapidly or become obsolete quickly (like vehicles or technology).
Calculation:
$$\text{Annual Depreciation} = \text{Net Book Value (at start of year)} \times \text{Rate} (\%)$$
Example: A machine costs $50,000 and the RBM rate is 20%.
- Year 1 Depreciation: $\$50,000 \times 20\% = \$10,000$. NBV is $40,000.
- Year 2 Depreciation: $\$40,000 \times 20\% = \$8,000$. NBV is $32,000.
For RBM, always use the NBV at the start of the year, not the original cost. Also, do not deduct the residual value from the NBV before calculating the depreciation charge, as the calculation naturally leaves the residual value remaining (or close to it) over the asset's life.
SLM is best when benefits are even.
RBM is best when benefits (and thus value) drop faster initially.
4. Measuring Non-Current Asset Value
The syllabus requires understanding two models for measuring NCAs after their initial purchase (1.3.2).
Model 1: The Cost Model
The vast majority of AS Level calculations rely on the Cost Model.
- Under the cost model, the asset is carried in the Statement of Financial Position at its Cost less any Accumulated Depreciation and any accumulated impairment losses.
- $$\text{SOFP Value (NBV)} = \text{Cost} - \text{Accumulated Depreciation}$$
Model 2: The Revaluation Model
This model is used for assets, usually land and buildings, whose value can be reliably measured by reference to the market.
- Under the revaluation model, the asset is carried at its Fair Value (market value) at the date of the revaluation, less any subsequent accumulated depreciation and impairment losses.
- A revaluation involves formally changing the recorded value of the asset. This requires a new calculation of the remaining useful life and residual value, which will then affect the future depreciation charge.
In the real world, businesses often prefer the Cost Model because it is more objective (based on verifiable receipts). Revaluing assets (Revaluation Model) requires expert estimates, which can introduce subjectivity.
5. Double Entry Accounting for NCAs
Accounting for NCAs involves three main ledger accounts: the Asset Cost Account, the Accumulated Depreciation Account, and the Disposal Account.
A. Acquisition of Non-Current Assets
When an NCA is purchased, it is capital expenditure.
- Debit: Non-Current Asset Account (at Cost)
- Credit: Bank/Cash/Creditor (for the amount paid)
B. Recording Depreciation
Depreciation is charged annually.
Step 1: Record the annual expense (Charge)
- Debit: Depreciation Expense (SOPL)
- Credit: Accumulated Depreciation Account (SOFP)
The Accumulated Depreciation account is a negative asset account, showing the total depreciation charged on that asset up to the present date.
Step 2: Carry the expense to the Profit or Loss Account
- Debit: Statement of Profit or Loss (or Income Statement)
- Credit: Depreciation Expense Account
C. Disposal of Non-Current Assets
When an asset is sold or scrapped, the business must remove it from the books. This is a crucial area requiring the use of a Non-Current Asset Disposal Account.
Step-by-step Disposal Process:
Step 1: Transfer the COST of the asset being disposed of.
- Debit: Non-Current Asset Disposal Account
- Credit: Non-Current Asset Account (at Cost)
Step 2: Transfer the ACCUMULATED DEPRECIATION relating to the disposed asset.
- Debit: Accumulated Depreciation Account
- Credit: Non-Current Asset Disposal Account
Step 3: Record the proceeds received from the sale (if any).
- Debit: Bank/Cash/Trade Receivables
- Credit: Non-Current Asset Disposal Account
Step 4: Balance the Disposal Account to find the profit or loss on disposal.
- If Credit side is larger: Profit on Disposal (Revenue/Gain)
- If Debit side is larger: Loss on Disposal (Expense)
Step 5: Transfer the profit or loss to the SOPL.
- For a Profit: Debit Disposal Account, Credit SOPL
- For a Loss: Debit SOPL, Credit Disposal Account
Disposal including Part Exchange
A part exchange occurs when the old asset is traded in towards the purchase of a new asset.
We treat the trade-in allowance offered by the seller as the sale proceeds (Step 3 above) of the old asset.
Example: If an old van (NBV $4,000) is traded in for a new van, and the seller gives a trade-in allowance of $5,000:
- The disposal account receives $5,000 credit (the 'sale proceeds').
- Since the proceeds ($5,000) are greater than the NBV ($4,000), there is a Profit on Disposal of $1,000.
6. Financial Statements Presentation (1.3.2)
A. Statement of Profit or Loss (SOPL)
The SOPL includes two elements related to NCAs:
- Depreciation Charge: The total depreciation calculated for the year (an operating expense).
- Profit or Loss on Disposal: Any gain (profit) or loss made from selling old assets.
B. Statement of Financial Position (SOFP)
NCAs are presented under the non-current asset section, usually shown at their cost, less accumulated depreciation, to arrive at the net book value.
Presentation Format (Extract):
| Cost/Valuation (\$) | Accumulated Depreciation (\$) | Net Book Value (\$) | |
|---|---|---|---|
| Non-Current Assets: | |||
| Land and Buildings | X | (Y) | X-Y |
| Fixtures and Fittings | A | (B) | A-B |
| Total Non-Current Assets | Z |
Remember: The Accumulated Depreciation account balance shown in the SOFP is the total of all depreciation charged on assets still owned by the business.
Depreciation applies the Matching Concept.
Use SLM for even benefit; use RBM for decreasing benefit.
Disposal requires clearing both the Cost and the related Accumulated Depreciation to find the profit or loss.
You’ve mastered the backbone of non-current asset accounting! Keep practicing those ledger entries—they are key to securing marks in this section.