Lecture 5 notes

Question 1

What are the concepts we have learnt so far?

Answer 1

SOFP format Income statement format Revenue recognition Expense recognition ( prepaid expense and accured expense) Valuing Current assets Inventory -initial valuation write down Receivables : Bad and doubtful debts.

Question 2

What are we going to learn today?

Answer 2

Valuing non-current assets PPE initial valuation, deprication and dispoals Revaluation upward, impairment.

Question 3

What is PPE?

Answer 3

It is a tangible asset that is held for use in production or supply of goods or services, for rental to others or for administrative purposes.

Question 4

With PPE what is the expectation of it?

Answer 4

It is expected to be used for more than one period.

Question 5

For an initial measurement of PPE what do you write Financial statement would you put this on and what would you write?

Answer 5

The value of PPE you note down in your SOFP is written in 2 parts 1) The amount you paid to buy the equipment 2) You add costs that directly attributable to bringing in the asset into working condition.

Question 6

Give an example of PPE initial investment?

Answer 6

E.g. printer worth £500, put you pay for electrican which costs £100 to fix all the wires, this is a directly attributable cost, so this is added onto SOFP as £600

Question 7

What happens with you repair the PPE where does this value go ( PPE - subsequent measurement)?

Answer 7

If you have rountine repairs or maintence costs, these are put as expenses on the income statement, e.g. company transporting goods and you have multiple trucks, some trucks have punctured typres, and you have to do maintence that goes to expenses.

Question 8

But what happens if you do something that extends the uselife of PPE?

Answer 8

It is added onto the cost of the asset on the (SOFP) e.g. the same truck, and you replace a very old motor in a truck that extends its useful life by 3 years, so if truck is worth £7000 and you spend £200 replacing the motor, this means the value of the PPE becomes £7,200.

Question 9

What are 2 ways to measure PPE after initial measurement ( so after use)

Answer 9

1) Cost model 2) The revaluation model

Question 10

What is the cost model ( a way of measuring PPE after initial measurement?

Answer 10

Original cost -any accumulated depreciation - impairments you might have.

Question 11

What is an impairment?

Answer 11

Reduction in the value of the asset, for some reason the value of the asset has fallen.

Question 12

What is the Revaluation model?

Answer 12

Every year you will revalue the asset and ask is the asset, the same value as it originally was. So Revalue cost - any accumulated depreciation - accumulated impairment losses?

Question 13

What is the difference between Impairment and accumulated deprecation?

Answer 13

TBA?

Question 14

So what is the big difference between Cost model and revaluation model?

Answer 14

The difference is that in the cost model you take the historic cost but in revaluation model you take the fair value ( or revalue the asset every year, taking the revalue amount)

Question 15

Give an example of Cost model vs revaluation?

Answer 15

TBA

Question 16

So previously we have said that depreciation affects what two accounts?

Answer 16

Depreciation expense and accumulated depreciation

Question 17

What is the defintion of depreication again?

Answer 17

loss of value of Asset due to use or passage of time.

Question 18

What is Accumlated depreciation again?

Answer 18

how much has the lose in value been over the past years e.g. if you brought an asset 10 years ago, how much has the depreciation been over the last 10 years, each year.

Question 19

What is a Net book value of an asset?

Answer 19

Cost of an asset - Accumulated deprecation

Question 20

When calculating depreciation what 4 factors do you have to consider?

Answer 20

1) The cost( of fair value) of an asset ( beginning)
2) The uselife life of an asset 3
3) The residual value of an asset
4) The deprecation method

Question 21

What does useful life of an asset mean?

Answer 21

How long will the asset be useful to us ( estimation), it isn’t just necessarily the physical life, it is time period for which it is actually useful, for example a computer can be okay for 7 years, but it is actually useable for 3 or 4 years, because after it becomes slow, and not useable, so the useful economic life is 3 or 4 years not 7.

Question 22

What does the residual value of an asset mean?

Answer 22

What is the value of an asset, if you are going to sell it at the end of the uselife ( it is an estimate)

Question 23

How would you calculate depreciable amount using residual value e.g. a car £10,000 after 6 years, you can sell for £2000?

Answer 23

Depriecable amount = inital cost - Residual value.

Question 24

What is are the 2 types of depreciation methods?

Answer 24

Straight line method Reducing balance method.

Question 25

What is the straight line method?

Answer 25

Constant charge over the life of an asset e.g. in previous example the depreciable amount for the car was 8000 and spread over 6 years so depreciation each year is = 8000/6. This method gives an answer to guy the depreciable amount of £8000 is spread evenly over 6 years.

Question 26

What is the Reducing balance method?

Answer 26

Decreasing charge over the life of an asset ( the asset losses have a larger value at the beginning rather than the end.

Question 27

Are firms free to choose what method they use?

Answer 27

Yes

Question 28

Using straight line method calculate the Annual depreciable amount? Cost of a machine is $40,000, the estimated residual value is 1,024, with an estimated uselife of 4 years

Answer 28

Depricable amount = initial cost - residual value / Useful economic life 40,000 - 1,024/4 = 9744

Question 29

For reducing balance how would you find the Annual amount part 1?

Answer 29

First step would would have to find the deprieciable rate but this is given in exam The rate is 60%

Question 30

For reducing balance how would you find the Annual amount part 2?

Answer 30

So we know each year it reduces by 60% Cost = £40,000 Year 1 depreication charge is ( 60% of 40000) = 24000 NBV = £16000 Year 2 depreication is ( 60% of 16000) = 9600 NBV = £6400 Year 3 depreication is ( 60% of £6400) = £3840 NBV = £2560 Year 4 deprieication is ( 60% of 2560 ) = 1536 NBV = 1024 ( You do 4 years as the question has a useful life of 4 years)

Question 31

So if you use straight line or reducing balance, the total depreication over the years will be what?

Answer 31

The same, on a year to year basis it might differ but total depreciation over the life of an asset has to be the same.

Question 32

Show a diagram using straight line and reducing balance to show annual depreication for the previous example for the 4 years?

Answer 32

Question 33

What they must do when choosing the depreication methods?

Answer 33

They must however apply it constantly, unless there is a change in the expected pattern of economic beneift e.g. when the newspaper companies realise that they have a lot more compeitiors coming from online and the uselife of the printer will not be too much, because they do not need to print that much, so they have to reduce uselife life of certain assets, to sell it quickly, so assumption changes.

Question 34

What do entities usually select from influence of the industry when selecting depricaiton method?

Answer 34

They usually select the method used by industry for comparability.

Question 35

What is the double entry for depreication expense again?

Answer 35

DR Depreication expense ( + expense) Cr Accumlated depriceation ( - Asset)

Question 36

Now here there is an example of a change in assumption? An asset which costs £1,000 was estimated to have a useful life of 10 years and residual value £200. After two years, the useful life was revised to 4 remaining years. The revised depreciation using the straight line method would be:

Answer 36

Inital cost - residual value / Uselife life = Deprication expense 1000-200/10 = £80 Depriecation expense was £80 per year ( in year one accumlated depreication is £80. Year 1 1000- 80 = 920 NBV = 920 Year 2 1000- 160 = £840 Now the change of assumption has happened so Yout take the NBV you year 2 then calculate from there so 840-200/4 = 160 accumluated depreication Year 3 840 -( accumlated + 160) = 680 Year 4 you do 840 - 320 ( accumlated) = 520 or 1000 - 480 = 520

Question 37

What is there a huge amount of when calculating depreciation?

Answer 37

Huge amount of subjectiviity ( managerial discretion is required)

Question 38

What is a main disadvantage of Depriecation?

Answer 38

Firms could use this as a measure to manipulate profits, profits increase by reducing expenses so, so to do this they would lower depreciation expense e.g. you can say an asset has a useful life for 10 years but in reality it is 3. You can also change residual value, to a high value so the depreicable amount reduces.

Question 39

Can firms change deprication methods during the years?

Answer 39

Yes they can but they have to write an explanation for doing so.

Question 40

So, so far what have we learnt?

Answer 40

We have learnt PPE, how to measure inital value, then we looked how to calculate the depreciation.

Question 41

What is PPE disposal?

Answer 41

When you sell a non current asset?

Question 42

To make it very clear when you sell a non-current asset what doesn't it give you?

Answer 42

SALE REVENUE

Question 43

What does disposal or selling a non current asset give?

Answer 43

It gives rise to gains or losses.

Question 44

To calculate whether you have gained or made a loss what do you do?

Answer 44

Gains / loss on diposal of PPE = Net disposal proceeds ( Cash received ) - Carrying value or NBV ( cost or revaluation amount - Accumlulated depriecation.

Question 45

Suppose we bought a vehicle at the beginning of 2007 On 1-Jan-2007: Cost of the vehicle: £41,000, Estimated useful life: 4 years, Estimated residual value at the end of its useful life: £1,000 Caluclate annual depreication

Answer 45

As you are not given percentage you know you have to use straight line method so: Depreciation=Initial value – Residual Value/ Useful Economic Life =(41,000 –1,000)/4 = 10,000

Question 46

Suppose we bought a vehicle at the beginning of 2007 On 1-Jan-2007: Cost of the vehicle: £41,000, Estimated useful life: 4 years, Estimated residual value at the end of its useful life: £1,000. Now suppose the vehicle was sold on 31 December 2008 for £27,000, Calculate gains or losses on dispoal

Answer 46

We know from previous depreciation per year is £10000 you can see there is 2 years, difference so Year 1 £41000 ( Equip cost) - 10000 ( Accumlated depreication = 31000 ( NBV of PPE) Year 2 £41000 ( Equip cost) - 20000 ( Accumlated depreication) = 21000 ( NBV ofo PPE) Gains or losses on disposal on PPE = Cash received – (Cost of PPE – Accumulated Depreciation) Cash received 27000 - (£41000- 20000) ( this 20000 is accumlated depreication for 2 years. =£6000 --- This goes on the income statement.

Question 47

How would £6000 be presented on the income statement?

Answer 47

Below operating incomee, you would have interest expense then below that you have Gains or losses at disposal £6000.

Question 48

Now that you have worked out gains or losses of PPE disposal what do you to the income statement and statement of financial position?

Answer 48

1) Remove the cost of the disposed asset from total PPE on SOFP. 2) Remove the accumlated depreciation of disposed asset from accumlated depreciation on SOFP 3) The gains/ losses on disposal of asset is calucated and entered in the income statement.

Question 49

Suppose we bought a vehicle at the beginning of 2007 On 1-Jan-2007: Cost of the vehicle: £41,000, Estimated useful life: 4 years, Estimated residual value at the end of its useful life: £1,000. Now suppose the vehicle was sold on 31 December 2008 for £27,000, Now how do make changes on the income statmenet and SOFP?

Answer 49

Write-off the cost 1. Dr Disposal account ( -) 41,000 Cr Non-current asset (cost) (-)Asset) 41,000 Write-off the accumulated depreciation 2. Dr Accumulated Depreciation (- C.Asset) 20,000 Cr Disposal account (+) 20,000 Proceeds from sale 3. Dr Cash (+ Asset) 27,000 Cr Disposal account (- ) 27,000 Move from disposal a/c to gains or loss on disposal 4. Dr Disposal Account 6000 Cr Gains on disposal 6000

Question 50

With this find Accumlated depreication, Gains/ losses of disposal and how does it affect income statement and SOFP?

Answer 50

So you know that depreication happened for 4 years, 2012,2013,2014,2015 not 2016. Accumlated depriecation using straight line = cost of inital which is 560 10% of 560 = 56 ( quick way to find accumlated depreciation over the 4 years is times by 4) 56 x4 = accumlated depreciation = 224 So the NBV as @ 2016 = 335 Now to find GAIN/ loss = Proceeds - NBV ( inital cost - Accumlated depreciation = 1-336 = Loss (£335) Now you sold £560 worth of equipment so reduce it from cost from SOFP : e.g. Inv 3700 PPE cost 2560 - 560 = 2000 Acc. Dep 947 - 224 = 723 ( reduce accumlated depreciation) I/S Sales COS Gross profit . . . Operating profit Interest Gains/losses ( 335)

Question 51

What would be the double entries for the previous example

Answer 51

Dr disposal account 560 Cr equipment 560 Dr accumulated depreciation 224 Cr disposal account 224 Dr Cash £1 Cr disposal account £1 Dr Loss on disposal 335 Cr disposal account 335

Question 52

What does PPE revaluation mean?

Answer 52

What happens when the value of PPE or non- current asset increases of decreases.

Question 53

What are 2 basis of valuation?

Answer 53

Historic cost = Historic cost - Accumlated deprication = Net book value. Fair value At the end of the year, experts of accountants invite people to value an asset, asking themselves can this still be the same price as it was on financial statement or has it increased or decreased.

Question 54

What happens if the value of a non- current asset increases, using fair value valuation?

Answer 54

If the value increases you have something called re-evaluation gain, you put it on the SOFP as a revaluation reserve, e.g. value of land at LSE goes up from £100000 to £150000, this increases in value, ( this 50000 belongs to owners, because they have invested into the company £100000 to build that building, so 50000 goes into the equity section. You have a special space called Reevaluation reserve. E.g. Double entry will be Dr land ( + Asset) 50000 Cr Revaluation reserve (+ Equity)

Question 55

What happens if there is an impairement of non- current asset?

Answer 55

This could happen because the asset is suddenly no longer in use and no one will pay cost price. The prudenance princple states that you have to reduce value on balance sheet to its recoverable amount. ( It naturally affects Equity section through retained earnings.

Question 56

What also happens on the income statement due to an impairment of a non- current asset?

Answer 56

You have to show reduction as an expense e.g. Dr Impairment loss expense.

Question 57

What would be the double entry for the following? Computer equipment with a net book value of £50,000 is currently valued at £30,000.

Answer 57

DR impairment loss expense £20000 ( I/S) CR Equipment and Asset £20000 ( BALANCE SHEET WITH ALSO REDUCTION IN Retained Earnings)

Question 58

What is the fundemental thing about Impariment losses?

Answer 58

Impairment losses are recorded in I/S regardless of which method the company uses: historic cost or fair value!

Question 59

What are the flaws with the trial balance?

Answer 59

Where there is a cahs transcation it simply asks what is this cash transcationn for, it doesn't ask if it is for this year or next. If there is no cash transcation the dumb bookkeeping software will not note it down.

Question 60

What is the accountants task when looking at unadjusted trial balances?

Answer 60

The accountants task is to make the accounting year end adjustmenets and prepare the financial statements.

Question 61

What are some of the end of year adjustments accountantns can make?

Answer 61

CoS Depreication Profit or losses on disposal of assets Proviison for bad and doubtful debt Accurals/ prepayments Diviends Taxation charge and liabilitiy

Question 62

Prepare an I/S and SOFP FOR HUGHES LTD 1) 1- Land is non-depreciable and is to be revalued at £280,000 on 31 October 2011.

Answer 62

Value of land on Trial balance is 250000 Reservation reserve on trial balance = 75000 Dr Land ( + Asset) 30000 Cr Reservation reserve 30000 280000 on SOFP as 250000+ 30000 = 280000 75000+30000 = 105000 SOFP revaluation reserve

Question 63

Prepare I/S and Statement of financial position for Hughes LTD 2- The buildings were acquired on 1 November 2000. At that time, their useful life was estimated to be 50 years and it was decided to adopt the straight-line method of depreciation, assuming no residual value. On 1 November 2010, it was determined that the useful economic life of the buildings would end on 31 October 2040. The estimate of the residual value remains unchanged

Answer 63

Buildings at cost were 300000 (T/B) Annual depreciation of buildings = 60,000 NBV = 240000 Depreciation over 30 years (1.11.10-31.10.2040): 240,000-0/30 =£8,000 deprecation per year. NBV of buildings at 31.10.11 £232,000 Dr appreciation expense buildings £8000 CR Accumlated depriecation buildings 8000 Accumlated depreciation is £60000 + 8000 = 68000

Question 64

3- Equipment and vehicles are depreciated at 25% per annum on the reducing balance basis. A full year’s depreciation is charged in the year of acquisition. No depreciation is charged in the year of disposal. In June 2011, a distribution vehicle which had cost £64,000 in February 2007 was sold for £18,000. This amount was debited to the bank account and credited to a disposal account, but no further entries have yet been made with regard to this disposal.

Answer 64

Do the Q in 3 parts so first we want to calculate deprication for 4 years, to find NBV to calculate whether there was a gain or loss. The reason it is 4 years is that: Feb 2007 31 october 2007, 2008, 2009,2010 Thats 4 years, it was sold on the last year with no depreication. So using reducing balance Y1 25% of 64000 = 16000 Y2 25% of 48000= 12000 Year 3 25% of 36000 = 9000 Year 4 25% of 27000 = 6750 Accumlated depreciation is 43750. NBV of the disposed asset = 64,000 - 43750 = 20230 Gains/ losses = 18000 - 20230 = (2250) = I/S. 1) Remove cost of disposed equipment, (Equipment at cost = 197400 - 64000 = 133400 2) Remove accumlated depriecation from disposed = 105750 - 43750 = 62000 3) Add to income statement 4) You have to find Depereciation for remaining equipment so = 25% of remaining equipment, So NBV of remaining is 133400 - 62000 = 71400 Depreciation of 25% of 71400 = 17850 Dr depreication expense = 17850 Cr accumlated depreciation So on Balance sheet you would do NON CURRENT ASSETS Land Building @ cost Equipment and vechile ( cost) 197,400 - 64000 Accumlated depriecation = 105750 - 43750 + 17500

Question 65

4) The cost of inventory at 31 october 2011 was 92280. Calculate COS.

Answer 65

Inventory at 1st november 2010 It says on trial balance return inwards and outwards, we are looking at inwards so 87520 + 483,230 - ( 12570) - (92280) = 465900 - I/S (92280) = CLOSING INVENTORY

Question 66

Trade receivables include bad debts of £2000 which shoulf be written off. The allowance for doubtful receivables should then be adjusted to 2% of the remaining trade receivables.

Answer 66

TR = 71500 from T/B Dr Bad debt expense 2000 Cr Trade receivables 2000 Tr Rec = 71500 - 2000 = 69500 - SOFP Provision of doubtful debt = 2% of 69500 = 1390 Exisiting provision = 1520 (There has been decrease in provision so you debt provision of doubtful debt.) 1520 - 1390 ( this goes on SOFP) = 130 ( this is called a provision release) Dr provision for doubtful debt 130 Cr Doubtful debt expense = 130.

Question 67

When are taxes paid?

Answer 67

Taxes are paid later, after the finanical year e.g. if financial year ends 31 december 2020, it will be paid e.g. June 2021. The reason is after your financial statements are calculated they create a separate statement for tax. Taxes are a liability and expense

Question 68

6- The company’s tax liability for the year to 31 October 2010 was underestimated by £8,400. The liability for the year to 31 October 2011 is estimated to be £20,000 and falls due on 1 August 2012.

Answer 68

Timeline 31 october 2010 -------------------------------------31 october 2011 Under valuation 8400 Current year tax ( Not paid) ( This wasn't added to last years 20000 ( Not paid) expense, so you add it to this year) DR tax expense 20000 Dr Tax expense 8400 CR tax payable 20000 Cr Taxpayble 8400 So tax expense is 8400 + 20000 = 28400 ( I/S) Tax payable = 8400 + 20000 - 8400 (T/B as on there is a DR payable, you decrease a liability by DR) = 20000

Question 69

7- The loan stock was issued on 1 January 2011. Interest is payable halfyearly on 30 June and 31 December. The interest due on 30 June 2011 was paid on the due date. Accrued interest at 31 October 2011 has not yet been accounted for.

Answer 69

Question 70

How does the I/S look like for the hudges example be careful with the returns inwards

Answer 70

Question 71

How does the SOFP look like for Hudges example

Answer 71

Question 72

Whenever you are calculating using Depreciation using straight line and Reducing balance, what do you have to find?

Answer 72

The net book value

Question 73

Following is the Trial balance. The buildings were acquired on 1 October 2000. At that time, their useful life was estimated to be 50 years and it was decided to adopt the straight-line method of depreciation, assuming no residual value. On 1 October 2010, it was determined that the useful life of the buildings would end on 30 September 2040 (i.e. they only had 30 years life remaining). The estimate of residual value remains unchanged. What is the impact on I/S and SOFP?

Answer 73

From trial balance: Building at cost = 3,600 Depreciation = 720 Building NBV = 3,600 - 720 = 2880 Residual value = 0 Life remaining = 30 Depreciation = 2880 - 0/30 = 96 SOFP Building at cost 3,600 Accumulated depreciation = 720+96 = 816 I/S Depreciation expense = 96 The correct answer is: SOFP Building at cost 3,600 Accumulated depreciation = 816 I/S Depreciation expense = 96