Non-Current Assets

1 Introduction

Non-current assets refer to items such as machinery, equipment, premises and motor vehicles. These assets usually last for several accounting periods. They are not frequently bought and sold (like inventory is) but are used by the business to carry on its operations and to make profits.

You might hear people refer to non-current assets as ‘fixed assets’. Technically this term is out of date, but it is still commonly used informally. Financial statements should use the term ‘non-current assets’

2 Capital and revenue expenditure

Revenue expenditure is expenditure incurred for the purposes of the trade of the business or for maintaining the earning ability of non-current assets. Examples include: wages, rent, repairs, purchases of goods for resale, interest, electricity, fuel. Revenue expenditure is another term for business expenses and will appear on the statement of profit or loss

Capital expenditure is the purchase of non-current assets or expenditure to enhance their earning ability. Examples include: purchase of a computer, purchase of factory machinery, purchase of a leasehold or freehold office, upgrading a computer by adding a larger hard disk. Capital expenditure results in non-current assets and these will appear in the statement of financial position.

3 Depreciation

Although non-current assets last for several accounting periods, most wear out. The only exception is freehold land (ie land that is owned for ever). Cars, machines, office equipment all wear out and will eventually be scrapped or sold for a (usually low) second hand value. Leases gradually ‘wear out’ over the period of a lease.

If you have ever owned a car you will be familiar with the idea that it loses value as it gets older and the term given to this process is depreciation.

For leases, the term amortisation is used instead of depreciation.

When working out profits depreciation should be taken into account. The asset loses value as it is used and losing value is an expense. To get a fair view of profit, the amount of depreciation in each period should be treated as an expense of the period. Note that it is not the purpose of depreciation to value the asset at its net realisable value as it wears out: its purpose is to spread the initial cost less residual value over the asset’s estimated useful life and to match that to income on a time basis.

Usually the rate of depreciation is determined in advance by reference to the asset's estimated useful life.

As time passes, each year more depreciation will be charged. The accumulated depreciation keeps increasing and the net book value of the asset (cost less accumulated depreciation) keeps falling.

4 Methods of depreciation

There are two main methods of depreciation used in financial statements:

• Straight line
  

• Reducing balance
  

Straight line

This is the easiest approach: the asset is written down from cost to residual value over its estimated useful life.

Reducing balance method

Each year’s depreciation is based on the brought forward written down value

Note that most companies have a depreciation policy that charges a full year’s depreciation in the year of acquisition irrespective of when during the year the asset was bought, and no depreciation charged in the year of disposal irrespective of when during the year the asset was disposed of.

Note that there is much estimation in depreciation calculations: useful life, residual value, straight-line or reducing balance method.

5 Choosing a method

The choice is not free: the method should match the way the asset's benefit is actually consumed.

• Straight line suits an asset whose benefit is used up evenly over its life, and one whose running costs do not change much as it ages - a lease or a rented property (where the benefit is literally a fixed number of years), a building, office furniture, a fixture and fitting. It is also the method to use when the useful life is known but the pattern of use is not.

• Reducing balance suits an asset that gives up most of its benefit early, or loses most of its value early, or whose repair costs rise as it ages - a motor vehicle, IT equipment, plant with heavy early use. Because the depreciation charge falls each year while repairs rise, the TOTAL cost of holding the asset is spread more evenly through the statement of profit or loss than straight line would spread it.

Two practical points. Reducing balance never writes an asset down to nil, so it is not used where the asset will have no residual value at all. And whichever method is chosen, consistency requires the business to keep using it for that class of asset.

6 Accounting for non-current assets and depreciation

There are four ‘T’ accounts needed when accounting for non-current assets and depreciation:

1. The non-current asset cost account. This simply holds the cost of non-current assets. It is of vital importance to realise that this is not affected by depreciation; it is an account that simply records the acquisition of non-current assets.
   

2. The accumulated depreciation account (this might sometimes be referred to as the depreciation provision account). The cumulative depreciation is built up in this account.
   

3. The depreciation expense account. Each year’s depreciation expense is posted to this account and then transferred to that year’s statement of profit or loss.
   

4. The non-current assets disposal account. Used to account for the disposal of non-current assets.
   

7 Accounting for non-current assets disposal

On 12 January 2017, the machine is sold for $7,500. To handle this transaction correctly you must ensure that:

1. No trace of the machine’s cost remains in the cost account: if the company no longer has the asset it cannot be recording its cost. The cost is therefore transferred to the disposal account.
   

2. No trace of the machine’s accumulated depreciation remains in the accumulated depreciation account: if the company no longer has the asset it cannot be recording its depreciation. The accumulated depreciation is therefore transferred to the disposal account.
   

3. Cash is debited with the disposal proceeds and credited to the disposal account
   

4. The balance on the disposals account is a profit or loss on disposal.
   

At the start of 2017, the accounts are:

These balances are transferred out of these accounts into the disposals account and the cash credited to the disposals account also:

The Profit on Disposal amount of $1,500 is credited to the statement of profit or loss (usually by reducing the total depreciation charge). The profit arises because the company has disposed of an item of net book value $6,000 (ie $26,000 – 20,000) for $7,500.

8 Scrapping an asset

Scrapping is just a disposal for nil proceeds, and the disposals account handles it in exactly the same way. Because there are no proceeds, the loss on disposal is always equal to the net book value at the date of scrapping.

Illustration. A machine that cost $18,000 has accumulated depreciation of $15,500. It breaks down beyond repair and is scrapped, with nothing received for it.

The loss of $2,500 is the net book value ($18,000 - $15,500) and is charged to the statement of profit or loss, usually alongside the depreciation charge. It arises because the depreciation charged over the asset's life turned out to be too little - the useful life or the residual value was over-estimated.

If the business is paid something for the scrap - $400 for the metal, say - the $400 is credited to the disposals account as proceeds and the loss falls to $2,100.

9 Accounting for part exchange (or trade-in) of non-current assets

A business owns a delivery van that cost $25,000 some years ago. The accumulated depreciation on the van is $15,000. The van is traded in for a new one. There was a trade–in allowance of $13,000 on the old van and the balance of $22,000 was paid in cash.

To treat this correctly you have to:

1. For the old asset, remove the cost and accumulated depreciation by transferring these to the disposals account.
   

2. Understand that a trade in allowance of $13,000 is equivalent to sale proceeds of $13,000 (though not received in cash). The trade-in allowance will be posted to the disposals account.
   

3. Understand that the new van’s cost is $35,000 ie the trade-in value of $13,000 plus the cash paid of $22,000.

10 The non-current assets register

In its nominal ledger, a business will typically have accounts for the cost of: premises, vehicles, office equipment and machinery. There will also be accounts for the accumulated depreciation for each class of non-current asset.

Every time a new item is bought, its cost will be debited to the appropriate cost account. For example, if a piece of office equipment is bought, its cost will be debited to the office equipment account. The cost accounts therefore keep track of the total cost of each type of non-current asset and similarly the accumulated depreciation accounts keep track of the total accumulated depreciation of each type of asset.

However, more detailed information is also required. For example, when an asset is sold its depreciation to date has to be transferred to the disposals account, so records are needed of how much depreciation attaches to each individual asset. Similarly, if an asset is fully written down to zero net book value, no more depreciation should be applied to it or NBV will become negative. Therefore, depreciation cannot simply be calculated as, for example, 25% of the balance on a fixed asset cost account, because some of the assets in that figure might have been fully depreciated.

The more detailed information needed is recorded in a non-current asset register; this is a memorandum record and is not part of the double entry system

The situation is rather similar to that of the total receivables account (receivables control account) and the receivables ledger. The total receivables account holds the total summary information, but the receivables ledger holds details about each customer and exactly what is owed by whom.

The non-current assets register has a page for each non-current asset. Typically it will list out:

11 Preparing the register

Knowing the columns is not enough - the study guide asks you to prepare the register. In practice it is one line (or one page) per asset, written up as each event happens.

Illustration. A business's office equipment register at 31 December 2013 shows one asset. During 2014: on 1 April a printer costing $1,800 is bought for cash, authorised by the office manager on requisition R/214; and on 1 July the old laptop (cost $2,400, accumulated depreciation to 31/12/2013 $1,200) is part-exchanged for a new one, with a trade-in allowance of $900 and $1,700 paid in cash. Office equipment is depreciated at 25% straight line, a full year in the year of purchase and none in the year of disposal.

Note the new laptop's cost of $2,600 - the $900 trade-in allowance plus the $1,700 paid in cash - and that the old laptop's cost and accumulated depreciation drop out of the totals on disposal. Its loss on disposal is $1,200 - $900 = $300.

12 Reconciling the register to the general ledger

The register is a memorandum record, exactly like the receivables ledger, so the same discipline applies: the totals of the register must agree with the balances on the cost and accumulated depreciation accounts in the general ledger. The totals above - cost $4,400 and accumulated depreciation $1,100 - are what the Office equipment cost account and the Office equipment accumulated depreciation account should show.

Where they do not agree, the usual causes are:

• an asset bought and posted to the ledger but never entered on the register, or entered on the register but expensed as a repair in the ledger;

• a disposal recorded in the ledger but not removed from the register, or removed from the register but still in the ledger;

• the wrong rate or the wrong method applied to one asset on the register;

• an asset on the register that no longer physically exists - lost, stolen or scrapped without anyone telling the accounts department;

• a part exchange where only the cash paid was capitalised, so the new asset is on the register at too low a cost.

Resolving them follows the same rule as a control account reconciliation: find out which record is wrong, correct that one, and put through a journal if the correction touches the general ledger. Assets that no longer exist are written out of both records through the disposals account, giving a loss equal to their net book value.

13 The purchase and disposal of non-current assets

The purchase of non-current assets will often begin with an employee raising a purchase requisition, for example for a new printer, which is then authorised by a manager or by the company accountant. When the invoice is received, someone needs to ensure that the asset has been received and that it is working properly. These payments are handled in a similar way to purchases of goods and raw materials.

Non-current asset purchase is often very closely monitored because every asset bought removes cash from the business. Once a non-current asset has been bought, the transaction is difficult to reverse without incurring large losses on disposal. A successful company hoping to expand can find that it has spent so much on buying non-current assets that it then has difficulty paying its rent, wages and interest on loans.

The disposal of non-current assets should also be carefully controlled. Apart from the asset being potentially valuable, its disposal could damage the company’s ability to make profits.

Major acquisitions and disposals would normally be approved at board level.

Regular physical inspection of non-current assets should be carried out to ensure that the assets still exist, still work and that they are still used. If assets are no longer in use they should be written down to nil book value because if a non-current asset is of no use, it can’t really still be regarded as an asset with any value.

It is very important that the purchase of non-current assets is correctly recorded. Possible material errors are:

1. The purchase is treated as revenue expenditure rather than capital expenditure. That would mean that all of the cost of the non-current asset is expensed in the year of acquisition rather than its cost being spread over the life of the asset through the depreciation mechanism. Profits would therefore be understated in that year and overstated in subsequent years.
   

2. Revenue expenditure is treated as capital expenditure. This would cause profits to be overstated because instead of being expensed in the period of purchase, the expense is spread and the expenditure is treated as the acquisition of an asset.
   

3. Posting the acquisition to the wrong non-current asset account. This could lead to incorrect depreciation rates being used.