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Acc week 6

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  • 1. WEEK 6 ACCOUNTING FOR FIXED ASSET
  • 2. In Your Textbook...
    • Roshayani Arshad, et al. (2007), Financial Accounting An Introduction , 2 nd Edition, Malaysia, McGraw Hill.
    • Chapter 13: Accounting for Property, Plant and Equipment
  • 3. Nature of Fixed Assets Fixed assets are long term or relatively permanent assets Fixed assets are tangible assets because they exist physically. They are owned and used by the business and are not held for sale as part of normal operations.
  • 4. Classifying Costs Is the purchased item long-lived? Yes Is the asset used in production purpose? No Expense Yes Fixed Assets No Investment
  • 5. Cost of Fixed Assets
  • 6.
    • Purchase price
    • Sales taxes
    • Permits from government agencies
    • Broker’s commissions
    • Title fees
    • Surveying fees
    • Razing or removing unwanted buildings
    Land
  • 7.
    • Architects’ fees
    • Engineers’ fees
    • Insurance
    • Repairs & reconditioning
    • Sales taxes
    • Permits from government agencies
    Buildings
  • 8.
    • Sales taxes
    • Delivery
    • Installation
    • Repairs (purchase of used equipment)
    • Reconditioning (purchase of used equipment)
    • Insurance
    Machinery and Equipment
  • 9.
    • The cost of an asset =
    • The sum of all the costs incurred to bring the asset to the location and condition necessary for its intended use.
    In a nutshell...
  • 10. Nature of Depreciation All fixed assets except land lose their capacity to provide services. This loss of productive capacity is recognized as Depreciation Expense . Physical depreciation occurs from wear and tear while in use and from the action of the weather. Functional depreciation occurs when a fixed asset is no longer able to provide services at the level for which it was intended, e.g., personal computer.
  • 11. Depreciation Expense Factors Initial Cost Residual Value - = Depreciable Cost Useful Life 1 Periodic Depreciation Expense 2 3 4 5
  • 12.
    • The period over which the company expects to derive economic benefits from the asset.
    • Determined by factors such as technological progress and changes in demand.
    Useful Life of a Fixed Asset
  • 13.
    • Also known as ‘Scrap Value’.
    • The estimated amount receivable when the fixed asset is put out of use by the business.
    • If there is any estimated residual value, need to minus this amount from the cost of fixed asset before calculating the amount of depreciation charged.
    Residual Value
  • 14. Straight-Line Reducing- Balance Other Units-of-Production Source: Accounting Trends & Techniques, 56 th . ed., American Institute of Certified Public Accountants, New York, 2002. Use of Depreciation Methods
  • 15. Facts Original Cost.....………….. RM24,000 Estimated Life in years….. 5 years Estimated Life in hours….. 10,000 Estimated Residual Value... RM2,000
  • 16. Straight-Line Method Cost – estimated residual value Estimated life = Annual depreciation
  • 17. Straight-Line Method RM 24,000 – RM2,000 5 years = RM 4,400 annual depreciation
  • 18. Straight-Line Method The straight-line method is widely used by firms because it is simple and it provides a reasonable transfer of cost to periodic expenses if the asset is used about the same from period to period.
  • 19.
    • 1 $24,000 $24,000 $4,400 $19,600
    • 2 24,000 $ 4,400 19,600 4,400 15,200
    • 3 24,000 8,800 15,200 4,400 10,800
    • 4 24,000 13,200 10,800 4,400 6,400
    • 5 24,000 17,600 6,400 4,400 2,000
    Accum. Depr. Book Value Depr. Book Value at Beginning at Beginning Expense at End Year Cost of Year of Year for Year of Year Cost ($24,000) – Residual Value ($2,000) Estimated Useful Life (5 years) = Annual Depreciation Expense ($4,400) Straight-Line Method
  • 20. Reducing Balance Method
    • The fixed asset depreciates at a fixed percentage.
    • The depreciation amount will diminish with every successive period.
    • Formula :-
    Depreciation expense per annum = Rate of depreciation x Net Book Value (NBV) of asset
  • 21. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 Reducing-Balance Method $24,000 x .40
  • 22. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 Reducing-Balance Method
  • 23. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 2 14,400 40% 5,760 Reducing-Balance Method $14,400 x .40
  • 24. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 2 14,400 40% 5,760 15,360 8,640 Reducing-Balance Method
  • 25. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 2 14,400 40% 5,760 15,360 8,640 3 8,640 40% 3,456 18,816 5,184 Reducing-Balance Method
  • 26. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 2 14,400 40% 5,760 15,360 8,640 3 8,640 40% 3,456 18,816 5,184 4 5,184 40% 2,074 20,890 3,110 Reducing-Balance Method
  • 27. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 2 14,400 40% 5,760 15,360 8,640 3 8,640 40% 3,456 18,816 5,184 4 5,184 40% 2,074 20,890 3,110 5 3,110 40% 1,244 22,134 1,866 Reducing-Balance Method STOP!
  • 28. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 2 14,400 40% 5,760 15,360 8,640 3 8,640 40% 3,456 18,816 5,184 4 5,184 40% 2,074 20,890 3,110 5 3,110 40% 1,244 22,134 1,866 Reducing-Balance Method If we use this approach in Year 5, we will end the year with a book value of $1,866. Remember, the residual value at the end of Year 5 is expected to be $2,000, so we must modify our approach.
  • 29. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 2 14,400 40% 5,760 15,360 8,640 3 8,640 40% 3,456 18,816 5,184 4 5,184 40% 2,074 20,890 3,110 5 3,110 --- 1,110 Reducing-Balance Method $3,110 – $2,000
  • 30. Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End 1 $24,000 40% $9,600 $9,600 $14,400 2 14,400 40% 5,760 15,360 8,640 3 8,640 40% 3,456 18,816 5,184 4 5,184 40% 2,074 20,890 3,110 5 3,110 --- 1,110 22,000 2,000 Desired ending book value Reducing-Balance Method
  • 31. Comparing Straight-Line With the Reducing-Balance Method Straight-Line Method Depreciation ($) 5,000 4,000 3,000 2,000 1,000 0 Life (years) Declining-Balance Method Life (years) 1 2 3 4 1 2 3 4
  • 32. 16 17 18 19 Accumulated Depreciation — Office Equipment 4,400 00 Dec. 31 4,400 Depreciation Expense Dec. 31 4,400 Accumulated Depreciation — Office Equipment 53 Recording Depreciation in the Book Depreciation Expense 4,400 00 31
  • 33. The balance sheet would show the office equipment at cost, less the accumulated depreciation. Office equipment $24,000 Less accumulated depreciation 4,400 $19,600 Book value
  • 34. Alternative Method
    • The depreciation expense is debited directly into the P&L account.
    • Adjusting entries :-
      • Amount charged for the period:-
        • Debit Profit & Loss Account.
        • Credit Accumulated Depreciation Account.
    In this case, the depreciation for the period being posted to the P&L account is being described as “depreciation” and not by the name of the account it is being posted from. This clearly is not the convention usually adopted when posting entries between ledger accounts and is very much ‘the exception to the rule’.
  • 35. 16 17 18 19 Accumulated Depreciation — Office Equipment 4,400 00 Dec. 31 4,400 Profit & Loss a/c Dec. 31 4,400 Accumulated Depreciation — Office Equipment 53 Recording Depreciation in the Book – Alternative Method Profit & Loss 4,400 00 31
  • 36. Lecture Exercise 1
    • On 1 January 2003, Tim bought a machine costing $20,000. It was decided that it would be depreciated at 20% per annum.
    Year ended 31 Dec 2003 2004 2005 Accumulated Depreciation 31 Dec 2005 Book value of machine on 31 Dec 2005 (i) Depn – Straight line method (ii) Depn – Reducing balance method
  • 37. Lecture Exercise 1: Solution
    • On 1 January 2003, Tim bought a machine costing $20,000. It was decided that it would be depreciated at 20% per annum.
    Year ended 31 Dec 2003 $ 2004 $ 2005 $ Accumulated Depreciation 31 Dec 2005 $ Book value of machine on 31 Dec 2005 ($) (i) Depn – Straight line method 4,000 4,000 4,000 12,000 8,000 (ii) Depn – Reducing balance method 4,000 3,200 2,560 9,760 10,240
  • 38.
    • MedLab Bhd., a manufacturer of lozenges, purchased a new piece of equipment which was priced at RM400,000 from an equipment manufacturer.
    • Transportation costs involved amounted to RM1,000 while the insurance against damage for the equipment amounted to RM400. Installation costs amounted to RM8,600.
    • MedLab Bhd uses the straight-line method for calculating depreciation. Assume that the equipment can be used for 8 years and the salvage value is estimated to be RM10,000. The company’s financial year ends on the 31st of December each year.
    • Calculate the depreciation charges and prepare the adjusting journal entries at the end of its accounting years.
    Lecture Exercise 2
  • 39.
    • Annual depreciation: (RM410,000 – RM10,000)/8
    • = RM50,000
    • Journal entries:
    • 31 Dec Depreciation expense RM50,000
    • Provision for Depreciation RM50,000
    Lecture Exercise 2: Solution Cost of fixed assets: RM Invoice price of equipment 400,000 Transportation costs 1,000 Insurance charges 400 Installation costs 8,600 410,000
  • 40. Accounting for Fixed Asset Disposals
    • When fixed assets lose their usefulness they may be disposed of in one of the following ways:
    • 1. discarded ,
    • 2. sold , or
    • 3. traded (exchanged) for similar assets.
    • An asset account must be credited to remove the asset from the ledger, and the related Accumulated Depreciation account must be debited to remove it’s balance from the ledger.
  • 41. When fixed assets are sold, the owner may break even, sustain a loss, or realize a gain. 1. If the sale price is equal to book value , there will be no gain or loss . 2. If the sale price is less than book value , there will be a loss equal to the difference. 3. If the sale price is more than book value , there will be a gain equal to the difference. Sale of Fixed Assets
  • 42. Sale of Fixed Assets Equipment costing $10,000 is depreciated at an annual straight-line rate of 10%. The equipment is sold for cash on October 1. Accumulated Depreciation (last adjusted December 31) has a balance of $7,000. Oct. 1 Depreciation Expense —Equipment 750 00 Accumulated Depr. — Equipment 750 00 $10,000 x ¾ x10%
  • 43. Sale of Fixed Assets Assumption 1: The equipment is sold for $2,250, so there is no gain or loss. Oct. 1 Cash 2 250 00 Accumulated Depr. — Equipment 7 750 00 Equipment 10 000 00
  • 44. Sale of Fixed Assets Assumption 2: The equipment is sold for $1,000, so there is a loss of $1,250. Oct. 1 Cash 1 000 00 Accumulated Depr. — Equipment 7 750 00 Equipment 10 000 00 Loss on Disposal of Fixed Assets 1 250 00
  • 45. Sale of Fixed Assets Assumption 2: The equipment is sold for $2,800, so there is a gain of $550. Equipment 10 000 00 Gain on Disposal of Fixed Assets 550 00 Accumulated Depr. — Equipment 7 750 00 Oct. 1 Cash 2 800 00
  • 46. Lecture Exercise 3
    • Grace Bakery bought a new oven on 1 st January 2005 for RM200,000. It was decided that depreciation is at 10%p.a. on cost. Accumulated depreciation up to 31 st December 2007 will be RM60,000. If the oven is sold at RM100,000 on 31 st December 2007, show the relevant journal and ledger entries.
  • 47. Lecture Exercise 3 Solution
    • Journal entries:
    • Dr Disposal a/c RM200,000
    • Cr Equipment a/c RM200,000
    • Dr Acc. depreciation a/c RM60,000
    • Cr Disposal a/c RM60,000
  • 48.
    • Dr Bank a/c RM100,000
    • Cr Disposal a/c RM100,000
    • Dr Inc.–loss on disposal RM40,000
    • Cr Disposal a/c RM40,000
  • 49.
    • Alternatively:
    • Dr Acc. Depreciation RM60,000
    • Bank a/c RM100,000
    • Inc. statement-loss on disp. RM40,000
    • Cr Equipment a/c RM200,000
    • Ledger entries:
  • 50.
  • 51.
  • 52.
    • Glad Bhd purchased a machine on 1 st January 2003 for RM60,000. It was sold on 31 st December 2005 for RM30,000. The asset was depreciated using the straight line method. It was extimated to have a useful life of 5 years and a scrap value of RM20,000. On 31 st December 2005, accumulated depreciation amounted to RM24,000.
    • Show the relevant journal and ledger entries to effect the sale of this asset.
    Lecture Exercise 4

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