ACCA F3 (INT) Financial Accounting - 2010 - Study text - Emile Woolf Publishing
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Chapter 6: Non-current assets
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IAS 16
Property, plant and equipment
Choice of depreciation method
Review of the remaining useful life and expected residual value
Disclosure requirements
6 IAS 16 Property, plant and equipment
The accounting standard IAS 16 deals with accounting for tangible non-current
assets (property, plant and equipment). Some of the rules in this standard have
already been explained (for example, measuring the cost of a non-current asset, and
accounting for revaluations). One or two additional rules that you should be aware
of are explained below.
6.1 Choice of depreciation method
The depreciation method used should reflect the way in which the economic
benefits of the asset are consumed by the business over time. The main choice is
between the straight line method and the reducing balance method. The reducing
balance method is often chosen for assets such as vehicles which lose greater
amounts of value in their early years as the reducing balance method reflects this
with larger depreciation charges in earlier years.
6.2 Review of the remaining useful life and expected residual value
When the remaining useful life of an asset is considered to be significantly different
from the original expectation, annual depreciation charges should be changed, and
based on the revised expectation of the remaining useful life.
It is unlikely that the estimated residual value of an asset will be revised, unless the
asset is re-valued. When the residual value is revised, the annual depreciation
charge should be based on the revised expected residual value.
(This requirement in IAS 16 is consistent with the requirement in IAS 8 Accounting
policies, changes in accounting estimates and errors. A change in the estimated
remaining useful life of a non-current asset, or in the estimate of its residual value, is
a change in accounting estimate.)
Example
An item of equipment was purchased two years ago on 1 January Year 1. Its cost
was $75,000, its expected life was 8 years and its expected residual value was
$15,000.
Due to technological changes, the estimated life of the asset was re-assessed during
Year 3. The total useful life of the asset is now expected to be 6 years and the
residual value of the equipment is expected to be $10,000.
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The financial year of the entity ends on 31 December.
The change in the estimate is made in Year 3, which means that the first financial
year in which the change can be applied is Year 3.
When the asset was first acquired, the annual depreciation charge was ($75,000 –
$15,000)/8 years = $7,500.
The net book value of the asset after two years was therefore $60,000 (= $75,000
minus depreciation for two years at $7,500 per year).
For Year 3, the expected remaining useful life is 4 years and the residual value is
now $10,000.
The revised annual depreciation charge from Year 3 onwards should be:
($60,000 - $10,000)/4 years = $12,500.
The deprecation charge in Year 3 should be $12,500.
The net book value of the asset at the end of Year 3 is $47,500 (= $60,000 –
$12,500).
If you have to deal with this type of problem in your examination, take care with the
year from which the change in accounting estimate applies. A change in estimate
might be made at the end of a financial year, as part of the process of preparing the
financial statements. When this happens, the revised estimate can be applied to the
year that has just ended. In the example above, the change of estimate might not be
recognised until the end of Year 3, but it can be applied to the financial statements
for Year 3.
Exercise 8
An machine was purchased three years ago on 1 January Year 2. It cost $150,000 and
its expected life was 10 years with an expected residual value was $20,000.
Due to technological changes, the estimated life of the asset was re-assessed during
Year 5. The total useful life of the asset is now expected to be 7 years.
The financial year of the entity ends on 31 December.
What is the depreciation charge for the year ending 31 December Year 5?
6.3 Disclosure requirements
IAS 16 requires certain disclosures in the financial statements, as notes to the
statements. For each class of non-current asset, a note should show:
the gross carrying amount of the non-current assets (cost or valuation) at the
beginning and end of the period, and additions and disposals during the period
accumulated depreciation of the non-current assets at the beginning and end of
the period, and the depreciation charge for the period and accumulated
depreciation of assets disposed of.
An example of the way in which this information is presented in a note to the
accounts is shown below.
Chapter 6: Non-current assets
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Machinery
Motor
vehicles
$ $
Costorvaluationatthebeginningoftheyear 470,000175,000
Additionsduringtheyear 60,000 35,000
Disposalsduringtheyear (45,000) (57,000)
Costorvaluationattheendoftheyear 485,000153,000
Accumulateddepreciationatthebeginningoftheyear 160,000 68,000
Depreciationchargefortheyear 46,000 32,000
Accumulateddepreciationondisposals (38,000) (42,000)
Accumulateddepreciationattheendoftheyear 168,000 58,000
Netbookvalueatthebeginningoftheyear 310,000107,000
Netbookvalueattheendoftheyear 317,000 95,000
Note: If there are any revaluations of assets during the year, the effect of
revaluations should also be shown. A revaluation will:
add to the cost or valuation of the non-current assets during the year, and also
reduce the accumulated depreciation on non-current assets (by the reduction in
accumulated depreciation at the time of the revaluation).
Example
The financial year of Entity V ends on 30 June. At 1 July Year 6, the balance on the
plant and machinery account was $500,000 and the accumulated depreciation for
plant and machinery was $116,000. During the year to 30 June Year 7, the entity
disposed of an item of plant and machinery that had cost $30,000 and whose net
book value was $8,000 at the time of the disposal.
During the year, the entity purchased plant and machinery costing $45,000. The
depreciation charge for plant and machinery for the year to 30 June Year 7 was
$39,000. The entity does not revalue plant and machinery.
Required
Show how the note on non-current assets in the financial statements of Entity V
would report the movements in plant and machinery during the year to 30 June
Year 7, to comply with the requirements of IAS 16.
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Answer
Plantand
machinery
$
Costat1JulyYear6 500,000
Additions 45,000
Disposals (30,000)
Costat30JuneYear7 515,000
Accumulateddepreciationat1JulyYear6 116,000
Depreciationchargefortheyear 39,000
Accumulateddepreciationondisposals(30,000–8,000) (22,000)
Accumulateddepreciationat30JuneYear7 133,000
Netbookvalueat1JulyYear6 384,000
Netbookvalueat30JuneYear7 382,000
Chapter 6: Non-current assets
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Intangible assets
Definition of intangible assets
Accounting for non-current intangible assets
7 Intangible assets
7.1 Definition of intangible assets
An intangible asset is an asset without a physical existence or substance, from which
benefits will be obtained over the long-term future. An intangible asset may be
included in the statement of financial position as a non-current asset, but only if
expenditure has been incurred to obtain it, and it therefore has a measurable cost.
Examples of non-current intangible assets are:
the cost of purchased patents, copyrights, trademarks and similar rights
the cost of goodwill, but only if this has been purchased
the cost of development expenditure.
Goodwill
Goodwill may be purchased when one business entity buys another. It is the
difference between the purchase price for the acquired business and the fair value of
the net assets of the business. For example if Entity X purchases another business for
$200,000 and the fair value of the net assets of the acquired business is $150,000,
there is purchased goodwill of $50,000. This will be included in the statement of
financial position of Entity X as an intangible asset.
However internally-generated goodwill – the value of the business that is
attributable to the reputation and customer relationships of the business or the skills
of its employees built up – must not be reported as an intangible asset (because it
does not have a value that can be reliably measured).
(Goodwill also features sometimes in partnership accounts, when a new partner is
introduced into the partnership. Partnership accounts are described in a later
chapter.)
7.2 Accounting for non-current intangible assets
The accounting treatment for intangible assets is similar to the accounting treatment
of tangible non-current assets (property, plant and equipment).
The asset is shown in the statement of financial position as a non-current asset.
Intangible assets are shown separately from tangible non-current assets.
A non-current asset is depreciated. However, the term used for the depreciation of
intangible assets is amortisation, and intangible assets are amortised over the
period in which they are expected to provide benefits to the company. The straight-
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line method is normally used and the residual value of a non-current intangible
asset will be zero.
In the statement of financial position, an intangible asset is shown at cost less the
accumulated amortisation (and less any impairment losses, although impairment
losses are not included in the syllabus for your examination).
Exceptions to the requirement to amortise intangible assets
IAS 38 Intangible assets makes an important exception to the general rule that
intangible non-current assets are amortised. This exception applies to purchased
goodwill.
IAS 38 also states that intangible assets with an ‘indefinite’ useful life should not be
amortised. An intangible asset has an indefinite life when there is no foreseeable
limit to the time that the asset is expected to generate economic benefits. However,
IAS 38 does not specify any examples.
Example
Big Sound Company purchased music rights from another business at a cost of
$12,000. The music rights are expected to provide future economic benefits to the
company over six years.
The company will show the music rights as an intangible asset in the statement of
financial position. The annual charge for amortisation in the income statement
should be $2,000 ($12,000/6 years). In the statement of financial position, the asset
will be shown at the cost of $12,000 less the accumulated amortisation.
There should be an amortisation charges account (expense account) and an
allowance for amortisation account (credit balance) in the main ledger. This is the
same as a depreciation account and an accumulated depreciation account that are
used for items of property, plant and equipment.
Chapter 6: Non-current assets
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Research and development expenditure
The difference between research and development
Accounting for research and development expenditure
Development expenditure as an intangible asset
Amortisation of development expenditure
8 Research and development expenditure
8.1 The difference between research and development
Many businesses spend large amounts of money on research and development, in
order to discover new products and bring them to the market.
Research is original and planned work that is undertaken with the intention of
discovering new scientific or technical knowledge.
Development is the application of knowledge obtained from research to design
a new product or service or process for commercial use. Development costs are
incurred before the product, service or process is introduced into commercial
use.
Research takes place first. If the results of the research are positive, an entity may
then go on to develop new products or operating methods. Development therefore
follows on from successful research.
8.2 Accounting for research and development expenditure
The problem with research and development expenditure is that successful
development work on new products or techniques creates value for the future, in
the form of higher revenues, lower operating costs, and higher profits. These
benefits might be obtained over a period of many years in the future.
It could therefore be argued that the costs of successful developments should not be
treated as an operating expense in the year when the expense occurs. Instead, the
expenses should be spread over the years in the future when the benefits are
expected to occur.
This accounting problem is dealt with by the accounting standard IAS 38 Intangible
assets. IAS 38 has the following requirements.
Research costs
Research costs must always be accounted for as an expense. They are charged as an
expense for the accounting period in which the expenditure is incurred.
This is because research might not be successful, and it is not possible to link current
research to the success of future development on new products or techniques. Since
research costs cannot be linked to future benefits, the cost should be treated as an
expense in the financial period when the costs occur.
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Development costs
Development costs are either:
treated as an expense, or
‘capitalised’, and treated as an intangible non-current asset.
IAS 38 specifies when each of these accounting treatments of developments costs is
appropriate.
8.3 Development expenditure as an intangible asset
Development costs should be treated an intangible non-current asset only if all of
the following matters can be demonstrated:
the technical feasibility of completing the development work, so that the item
will be made available for commercial use or sale
the intention to complete the item that is being developed, and use it or sell it
the ability of the company to use or sell the item
how the intangible asset will probably generate future economic benefits for the
business. If the development costs relate to a product or service, there must be
evidence that a market exists for the product or the service. If the item is being
developed for internal use, there must be evidence that it will have a commercial
use.
the availability of adequate technical resources, financial resources and other
resources to complete the development work
that the cost of the development work for the intangible asset can be measured
reliably.
When development expenditure is treated as a non-current asset, the item
‘development expenditure’ or ‘development costs’ will be reported as an intangible
asset in the statement of financial position.
Development costs must be capitalised if all the criteria in the list above are met.
Otherwise they must not be capitalised and must be charged as an expense in the
period when they are incurred.
Development costs cannot be capitalised retrospectively. If all the criteria for
capitalisation are met, only those costs incurred from that time onwards are
capitalised. Costs incurred in the past and treated as revenue expenditure cannot
now be capitalised as a non-current asset.
8.4 Amortisation of development expenditure
The cost of the intangible asset for development expenditure should be the amount
of the development expenditure incurred.
This asset should be amortised over the period when it will bring economic benefit
to the company. Amortisation of the intangible asset should not begin until the
economic benefits start to be enjoyed.
Chapter 6: Non-current assets
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Example
During Year 5, a company incurs costs of $105,000 on research and $240,000 on
development. Of the total development costs, $60,000 does not meet the criteria for
recognition as a non-current asset. The other development costs are expected to
bring economic benefits to the company over a period of four years, beginning in
Year 6.
The accounting treatment of the research and development expenditure should be
as follows:
Research and development expenses to be included as an expense in Year 5 =
$105,000 + $60,000 = $165,000.
Development costs that should be ‘capitalised’ and reported as an intangible
non-current asset at the end of Year 5 = $180,000 (= $240,000 – $60,000).
Amortisation of the development expenditure should begin from Year 6. If the
amortisation is charged by the straight-line method, it will be $45,000 in each
year for the four years Year 6 – Year 9.
Practice multiple choice questions
1 A business purchased an asset on 1 July 2007 at a cost of $160,000. It has an expected
life of five years, and is being depreciated at the rate of 25% per year by the reducing
balance method. The asset was sold on 30 June 2010 for $60,000.
What was the gain or loss on disposal?
A Gain $4,000
B Loss $4,000
C Gain $7,500
D Loss $7,500
(1 mark)
2 A company’s land and buildings were valued as follows:
Cost Accumulated
depreciation
Net book
value
$ $ $
Land 600,000 0 600,000
Buildings 1,500,000 150,000 1,350,000
The land is re-valued to $700,000 and the building to $1,700,000.
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What entries should be made in the main ledger to record the revaluation?
Dr Cr
$ $
A
Landandbuildings 450,000
Revaluationreserve 450,000
B
Landandbuildings:accumulated
depreciation
150,000
Landandbuildings 300,000
Revaluationreserve 450,000
C
Landandbuildings 300,000
Landandbuildings:accumulateddep’n 150,000
Revaluationreserve 150,000
D
Revaluationreserve 300,000
Landandbuildings 300,000
(2 marks)
3 The plant and machinery at cost account of a business for the year ended 31 December
2009 was as follows:
Plantandmachinery–cost
2009
$
2009
$
1JanBalance 720,000 30SeptTransferdisposalaccount 63,000
1JulyCash 36,000 31DecBalance 693,000
–
–––––– –––––––
756,000 756,000
–
–––––– –––––––
The company’s policy is to charge depreciation at 20% per year on the straight line
basis,withproportionatedepreciationintheyearsofpurchaseanddisposal.
What should be the depreciation charge for the year ended 31 December 2009?
A $138,600
B $144,450
C $143,550
D $138,150
(2 marks)
4 A company purchased an asset on 1 July 2006 at a cost of $140,000. The asset had an
expected life of ten years and a residual value of $20,000. Straight-line depreciation is
used. The company’s financial year ends on 30 June.
At 30 June 2010, the estimated remaining life of the asset from that date is now
expected to be only three more years, but the residual value is unchanged.
What will be the net book value of the asset as at 30 June 2010, for inclusion in the
statement of financial position?
A $83,000
B $76,000