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This is a question from the ACCA website:
Division D currently has $2,000,000 of net assets included in its accounting records on 31 December 20X2 and is showing an operating profit of $280,000. No entries have yet been made for depreciation.
However, the accounting records need to be amended for transactions in relation to non-current assets that took place on 30 December 20X2. A machine with net realisable value of $100,000 was sold for $125,000 and replaced with a machine costing $300,000. A full 20% depreciation charge is charged on machinery in the year of purchase, but no charge is made in the year of sale.
The solution is below:
Revised profit = $280,000 + $25,000 (Profit on sale of old machinery) – $60,000 (Depreciation charge on new machinery) = $245,000Revised assets = $2,000,000 – $100,000 (Old machinery) + $300,000 (New machinery) – $300,000 (cash paid for new machinery) ? $60,000 (Depreciation charge on new machinery) + $125,000 (Cash on sale of old machinery) = $1,965,000
ROI = ($245,000/$1,965,000) × 100% = 12.5%
I have few concerns regarding this and ROCE topic in general;
1. Why did the solution deduct the depreciation of the new asset (ONLY) out from the revised assets (capital employed) figure? What happened to the old assets? Arent they depreciating in value too?
2. Generally, do we need to deduct the depreciation figure from the capital employed to arrive at the ROCE figure?
The solution deducts the depreciation of the new asset from the capital employed figure to reflect the current value of the asset after accounting for its depreciation. The old assets, while they do depreciate, are not explicitly deducted in this calculation because the focus is on the new asset’s impact on the capital employed at the start of the year.
Generally, when calculating capital employed, it is common practice to adjust for accumulated depreciation to reflect the true value of the assets. However, if the question does not specify adjustments for economic depreciation or accumulated depreciation for old assets, it may be assumed that the accounting depreciation is already factored into the profit figure, and thus no further adjustment is necessary for the capital employed.
Just to reconfirm, so generally, we do not need to deduct the depreciation from the capital employed figure? (only the profit figures that are usually need to be altered).
But for the question above, it is a special case considering they are highlighting the new asset implication?
Please further clarify this. Thank you.
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