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ACC101: INTRODUCTION TO ACC101: INTRODUCTION TO ACCOUNTINGACCOUNTING

Lecture 10Lecture 10

Lecturer: Kleanthis Zisimos Lecturer: Kleanthis Zisimos

Lecture PreviewLecture Preview

This Lecture focuses on long-term assets This Lecture focuses on long-term assets used in the operation of a company. These used in the operation of a company. These assets can be grouped into plant assets, assets can be grouped into plant assets, natural resource assets, and intangible natural resource assets, and intangible assets. We give emphasis to the tangible assets. We give emphasis to the tangible assets and their depreciationassets and their depreciation

Plant Assets Plant Assets Plant assets are tangible assets used in a Plant assets are tangible assets used in a

company's operations that have a useful life of company's operations that have a useful life of more than one accounting period. Plant assets more than one accounting period. Plant assets are also called plant and equipment, property, are also called plant and equipment, property, and fixed assetsand fixed assets

Plant assets are set apart from other assets Plant assets are set apart from other assets because they are used in operations and have because they are used in operations and have useful lives extending over more than one useful lives extending over more than one accounting periodaccounting period ..

Plant assets are recorder at cost when Plant assets are recorder at cost when purchased. This is consistent with the cost purchased. This is consistent with the cost principle. Cost includes all normal expenditure principle. Cost includes all normal expenditure necessary to get the asset in place and ready necessary to get the asset in place and ready for usefor use

Plant Assets Plant Assets (continued)(continued)

A plant asset’s cost includes the purchase cost A plant asset’s cost includes the purchase cost plus freight, unpacking, assembling and plus freight, unpacking, assembling and installing installing

Repairing costs of assets are not added to the Repairing costs of assets are not added to the cost but are charged to an expense account cost but are charged to an expense account called repairscalled repairs

LandLand. When land is purchased for a building site, . When land is purchased for a building site, its cost includes the total amount paid for the its cost includes the total amount paid for the land, including any real estate commissions, title land, including any real estate commissions, title insurance fees, legal fees and any accrued insurance fees, legal fees and any accrued property taxes paid by the purchaserproperty taxes paid by the purchaser

Plant Assets Plant Assets (continued)(continued)

• BuildingBuilding. Building account is charged for the . Building account is charged for the costs of purchasing or constructive a building costs of purchasing or constructive a building that is used in operations. When purchased that is used in operations. When purchased the cost includes the cost includes purchase price, purchase price, brokerage brokerage fees, taxes, title fees and attorney costs. fees, taxes, title fees and attorney costs. When a company constructs a building its When a company constructs a building its costs include materials and labour plus a costs include materials and labour plus a reasonable amount of indirect overhead cost.reasonable amount of indirect overhead cost.

Machinery and equipmentMachinery and equipment. Cost includes . Cost includes purchase price taxes, transportation, purchase price taxes, transportation, installing, assembling and testinginstalling, assembling and testing

Plant Assets Plant Assets (continued)(continued)

Example. What is the cost of a new Example. What is the cost of a new machine which is purchased at a gross machine which is purchased at a gross value of 700 000, taxes 49000 discount value of 700 000, taxes 49000 discount given after 21000, freight 3500, assembly given after 21000, freight 3500, assembly costs 3000,foundation costs 2500 and costs 3000,foundation costs 2500 and maintenance 4200 maintenance 4200

AnswerAnswer700000+49000-700000+49000-

21000+3500+3000+2500=73700021000+3500+3000+2500=737000

Capital ExpendituresCapital Expenditures

• Capital expendituresCapital expenditures, , also called balance also called balance sheet expenditures, are additional costs of sheet expenditures, are additional costs of plant assets that provide benefits extending plant assets that provide benefits extending beyond the current period. They are debited beyond the current period. They are debited to asset accounts and reported on the to asset accounts and reported on the balance sheet. Capital expenditures increase balance sheet. Capital expenditures increase or improve the type or amount of service an or improve the type or amount of service an asset provides. Examples are roofing asset provides. Examples are roofing replacement, plant expansion, and major replacement, plant expansion, and major overhauls of machinery and equipment.overhauls of machinery and equipment.

Revenue ExpendituresRevenue Expenditures

• Revenue expendituresRevenue expenditures, also called , also called income income statement expenditures, statement expenditures, are additional costs are additional costs of plant assets that do not materially of plant assets that do not materially increase the asset's life or productive increase the asset's life or productive capabilities. They are recorded as expenses capabilities. They are recorded as expenses and deducted from revenues in the current and deducted from revenues in the current period's income statement-Examples of period's income statement-Examples of revenue expenditures are cleaning, revenue expenditures are cleaning, repainting, adjustments, and lubricantsrepainting, adjustments, and lubricants

Natural resources and Intangible Natural resources and Intangible assetsassets

Natural recoursesNatural recourses are assets that are physically are assets that are physically consumed when used like mineral deposits, oil and consumed when used like mineral deposits, oil and gas fieldgas field

These assets represent soon-to-be inventories of These assets represent soon-to-be inventories of raw materials that will be converted into one or raw materials that will be converted into one or more products. Until the conversion takes place , more products. Until the conversion takes place , they are non current assets and are shown in the they are non current assets and are shown in the balance sheet balance sheet

Intangible assetsIntangible assets are long term rights, privileges or are long term rights, privileges or competitive advantages that belong to the owner competitive advantages that belong to the owner of such non-physical assets used in operations. of such non-physical assets used in operations.

Examples are patents, copyrights, licences, Examples are patents, copyrights, licences, leaseholds, goodwill and trademarkleaseholds, goodwill and trademark

DepreciationDepreciation Depreciation is the process of allocating the Depreciation is the process of allocating the

cost of a plant asset to expense in the cost of a plant asset to expense in the accounting periods benefiting from its use. accounting periods benefiting from its use.

Depreciation is that part of the original cost Depreciation is that part of the original cost

of a plant asset that is consumed during its of a plant asset that is consumed during its period of use by the business.period of use by the business.

Factors in computing Factors in computing DepreciationDepreciation

CostCost. The cost of a plant asset consists of all . The cost of a plant asset consists of all necessary and reasonable expenditures to necessary and reasonable expenditures to acquire it and to prepare it for its intended acquire it and to prepare it for its intended use.use.

Residual Value / Salvage ValueResidual Value / Salvage Value. It is an . It is an estimate the asset’s value at the end of its estimate the asset’s value at the end of its benefit period. The total amount of benefit period. The total amount of depreciation to be charged off over an asset’s depreciation to be charged off over an asset’s benefit period equals the asset’s cost minus its benefit period equals the asset’s cost minus its residual value.residual value.

Useful lifeUseful life. Useful life of a plant asset is the . Useful life of a plant asset is the length of time it is productively used in a length of time it is productively used in a company’s operation.company’s operation.

Depreciation methodsDepreciation methods Depreciation methods are used to allocate Depreciation methods are used to allocate

a plant asset’s cost over the accounting a plant asset’s cost over the accounting periods in its useful life.periods in its useful life.

We have four methods of depreciation:We have four methods of depreciation:

1)1) The straight line methodThe straight line method

2)2) The units of output method The units of output method

3)3) The declining balance methodThe declining balance method

4)4) Sum of the years digit methodSum of the years digit method

Depreciation methodsDepreciation methods1) 1) The straight line method.The straight line method. In this method, the In this method, the

number of years of use is estimated. The cost number of years of use is estimated. The cost is then divided by the number of years. This is then divided by the number of years. This gives the depreciation charge for each year.gives the depreciation charge for each year.

Ex. A van was bought for Ex. A van was bought for €€ 22,000 and we 22,000 and we thought we would keep it for 4 years and thought we would keep it for 4 years and then sell it for then sell it for €€ 2,000. 2,000.

Cost (22,000) - Estimated disposal value (2,000)Cost (22,000) - Estimated disposal value (2,000) = = 20,00020,000 = 5000 = 5000 Number of expected years of use (4)Number of expected years of use (4) 4 4

€€ 5,000 is the depreciation each year for four 5,000 is the depreciation each year for four years.years.

Depreciation methodsDepreciation methodsUnits of output methodUnits of output method This method establishes the total expected units of output This method establishes the total expected units of output

expected from the asset. Depreciation based on cost less expected from the asset. Depreciation based on cost less salvage value, is then calculated for the period by taking that salvage value, is then calculated for the period by taking that period's unit output as a proportion of the total expected period's unit output as a proportion of the total expected output over the life of the asset.output over the life of the asset.

Ex. A machine is expected to be able to produce 10,000 units Ex. A machine is expected to be able to produce 10,000 units over its useful life. It has cost over its useful life. It has cost €€ 6,000 and has an expected 6,000 and has an expected salvage value of salvage value of €€ 1,000. In year 1 a total of 1,500 units are 1,000. In year 1 a total of 1,500 units are produced, and in year 2 the production is 2,500 units.produced, and in year 2 the production is 2,500 units.

DepreciationDepreciation=(Cost - salvage value) x period's production=(Cost - salvage value) x period's production ( total expected production ( total expected production )) Year 1: Year 1: €€5,000 x 1500 /10000= 5,000 x 1500 /10000= €€ 750 Depreciation 750 DepreciationYear 2: Year 2: €€ 5,000 x 2500 / 10000= 5,000 x 2500 / 10000= €€ 1250 depreciation 1250 depreciation

Depreciation methodsDepreciation methods3)3) The declining balance methodThe declining balance method In this method, In this method,

a fixed percentage for depreciation is deducted a fixed percentage for depreciation is deducted from the cost in the first year. In the second from the cost in the first year. In the second and later years the same percentage is taken and later years the same percentage is taken of the reduced balance (i.e. cost less of the reduced balance (i.e. cost less depreciation already charged). depreciation already charged).

Ex. A machine is bought for 10,000 and Ex. A machine is bought for 10,000 and depreciation is to be charged at 20 per cent. depreciation is to be charged at 20 per cent. Calculations for the first three years would be Calculations for the first three years would be as follows:as follows:

Cost 10000Cost 10000First year: depreciation (20%) 2000First year: depreciation (20%) 2000Second year: dep {20% of 8,000(1000-2000)} 1600Second year: dep {20% of 8,000(1000-2000)} 1600Third year: depreciation {20% of 6,400(8000-1600)} 1280Third year: depreciation {20% of 6,400(8000-1600)} 1280

Depreciation methodsDepreciation methods

Sum of the years digit methodSum of the years digit method. Higher depreciation . Higher depreciation is charged early in the life of an asset. is charged early in the life of an asset.

Ex. F=Given an asset costing 3000 and useful life 5 Ex. F=Given an asset costing 3000 and useful life 5 years calculate the depreciationyears calculate the depreciation

From year 1 (purchase) the asset will last for 5 yearsFrom year 1 (purchase) the asset will last for 5 years

From year 2 the asset will last for 4 yearsFrom year 2 the asset will last for 4 years

From year 3 the asset will last for 3 yearsFrom year 3 the asset will last for 3 years

From year 4 the asset will last for 2 yearsFrom year 4 the asset will last for 2 years

From year 5 the asset will last for From year 5 the asset will last for 1 years1 years

Sum of these digits 15Sum of these digits 15

Depreciation methodsDepreciation methods

Sum of the years digit method Sum of the years digit method (continued)(continued)

11stst year 5/15 of year 5/15 of € €3000= 3000= €€ 1000 depreciation 1000 depreciation

22dd year 4/15 of year 4/15 of € €3000= 3000= €€ 800 depreciation 800 depreciation

33rtrt year 3/15 of year 3/15 of € €3000= 3000= €€ 600 depreciation 600 depreciation

44thth year 2/15 of year 2/15 of € €3000= 3000= €€ 400 depreciation 400 depreciation

55thth year 1/15 of year 1/15 of € €3000= 3000= €€ 200 depreciation 200 depreciation

Depreciation methodsDepreciation methods

Journal Entries for depreciationJournal Entries for depreciation Dr CrDr Cr1.Depreciation of asset X1.Depreciation of asset X Accumulated Depreciation XAccumulated Depreciation X

Journal Entries for closing the accountsJournal Entries for closing the accounts2. Income Statement X2. Income Statement X Depreciations of asset XDepreciations of asset X

3. Accumulated Depreciation X3. Accumulated Depreciation XBalance sheet (subtracted from asset) XBalance sheet (subtracted from asset) X

Disposal Of AssetDisposal Of Asset

The general approach of accounting for the The general approach of accounting for the disposal of assets is the followingdisposal of assets is the following

1.1. Record depreciation up to the date of disposalRecord depreciation up to the date of disposal2.2. Remove account balances of the disposal Remove account balances of the disposal

assets ( open disposal account)assets ( open disposal account)3.3. Record any cash receivedRecord any cash received4.4. Record any gain or loss from the disposalRecord any gain or loss from the disposal

Disposal Of AssetDisposal Of Asset Example. On 31/3/2011 we sold for 7000( van bought 1/1/08 Example. On 31/3/2011 we sold for 7000( van bought 1/1/08

for 16 000 euro). Accumulated depreciation on 31/12/2010 is for 16 000 euro). Accumulated depreciation on 31/12/2010 is 12000 euro. Record the journal entries using straight lime 12000 euro. Record the journal entries using straight lime methodmethod

Dr CrDr Cr 1.Depreciation of Van (4000*3/12) 1000 1.Depreciation of Van (4000*3/12) 1000 Accumulated Depreciation 1000Accumulated Depreciation 10002. Van Disposal Account 160002. Van Disposal Account 16000 Van 16000Van 160003. Accumulated Depreciation 130003. Accumulated Depreciation 13000 Van Disposal Account 13000Van Disposal Account 130004. Cash 70004. Cash 7000 Van Disposal Account 7000Van Disposal Account 70005. Van Disposal Account 40005. Van Disposal Account 4000 Profit on Disposal 4000Profit on Disposal 4000

Exercises to be solved in the classExercises to be solved in the class

Case study exercises page 467-476Case study exercises page 467-476

Book “Fundamental accounting Book “Fundamental accounting principles”principles”