ACCT1101 Chap.10 Non-current Assets and Depreciation Methods
Non-current Assets and Depreciation Methods
Property, plant and equipment is initially recorded at cost, and cost is read widely: anything the business had to spend to get hold of the asset, get it where it will be used, and get it into a state where it can be used. A machine's cost is therefore its purchase price plus transport plus installation, not the invoice figure alone.
This is the single most reliably tested detail in the topic because it is so easy to skip.
After acquisition the asset is commonly carried at cost while depreciation is recognised periodically. Two figures are then reported: cost, which never changes, and the carrying amount, which is cost less accumulated depreciation.
Depreciation is not a valuation exercise; it is the systematic allocation of the asset's depreciable amount, being cost less residual value, across its useful life.
Three inputs must be settled before any method can be applied: cost, useful life, being the estimated time over which the asset will be used, and residual value, being what the asset is estimated to be worth at the end of that life.
Two of those three are estimates, which is why depreciation is a judgement rather than a fact.
The course teaches three methods. Straight line divides the depreciable amount by the useful life, giving an equal charge each year. Diminishing balance applies a rate to the reducing carrying amount, loading more expense into the early years on the assumption that some assets are more productive when new.
Units of production ignores time altogether and charges by actual use, dividing the depreciable amount by total expected output to get a rate per unit, then multiplying by the units used in the period. Because the three methods produce different expense in any given year, the choice changes reported profit and reported asset values, and should reflect how the asset's benefits are actually consumed.
What this chapter covers
- 01
What belongs inside the cost of an item of property, plant and equipment
- 02
Cost against carrying amount, and which of the two changes
- 03
Depreciable amount, useful life and residual value as three separate inputs
- 04
Straight line and the constant annual charge
- 05
Diminishing balance and the front loaded pattern
- 06
Units of production and the rate per unit of output
- 07
Choosing a method, and what the choice does to reported profit
One asset, three methods, three different answers
- +1Establish cost before anything else. Transport and fitting are both necessary to bring the van into the condition and location for use, so cost is $58,000 plus $1,400 plus $2,600, which is $62,000. The depreciable amount is $62,000 less the $12,000 residual, which is $50,000.
- +1Straight line divides the depreciable amount by the useful life in years. $50,000 over five years gives $10,000 per year, and it will be $10,000 in every one of the five years.
- +1Diminishing balance applies the rate to the carrying amount, which in year one is the full cost. Thirty per cent of $62,000 gives $18,600. Note that this method starts from cost rather than from the depreciable amount, and year two would apply the same rate to $43,400.
- +1Units of production works from output. The rate per kilometre is the depreciable amount over total expected units, so $50,000 over 240,000 kilometres gives $0.2083 per kilometre. Multiplied by 62,000 kilometres travelled, first year depreciation is $12,917 to the nearest dollar.
Key terms
- Cost
- Everything the business had to spend to obtain an asset and get it ready and in place for use.
- Carrying amount
- Cost less accumulated depreciation, being the value at which the asset is reported at balance date.
- Depreciable amount
- Cost less residual value, being the total that will be allocated across the asset's useful life.
- Useful life
- The estimated period over which the entity expects to use the asset, which may be shorter than its physical life.
- Residual value
- The estimated amount the asset is expected to be worth when it is disposed of at the end of its useful life.
Non-current Assets and Depreciation Methods FAQ
Why are delivery and installation added to the asset rather than expensed?
Because the asset is not usable until they have happened, so those costs are part of getting the asset into the condition and location necessary for use. Treating them as expenses would understate the asset and overstate expenses in the year of purchase, then understate depreciation in every later year. The test to apply is whether the cost was necessary to make the asset ready.
How do two businesses with identical vans report different profits?
Through the estimates and the method. Useful life and residual value are both estimates, and the three methods spread the depreciable amount differently across the years. A business using diminishing balance reports a much larger expense early and a smaller one late than a business using straight line on the same van, with both reporting the same total across the asset's whole life.
When is units of production the right choice?
When the benefits are consumed by use rather than by time, so that a year of heavy operation genuinely wears the asset more than a quiet one. Vehicles measured in kilometres and machinery measured in production hours or units produced are the standard examples. Its distinguishing feature is that useful life in years plays no part in the calculation.
What happens when a depreciable asset is sold?
The asset is removed at cost and its accumulated depreciation is removed with it, while cash comes in for the proceeds. If the proceeds exceed the carrying amount there is a gain, recognised as income; if they fall short there is a loss, recognised as an expense. Selling an asset at exactly its residual value at the end of its useful life produces neither.
Does depreciation set money aside to replace the asset?
No. It is an allocation of a cost already incurred, and no cash moves when it is recognised, which is why it never appears on the statement of cash flows. A business that wants funds available for replacement has to manage that separately; the depreciation charge on its own guarantees nothing about the bank balance.
Exam move
Build one depreciation schedule by hand before you do anything else: cost, residual value, depreciable amount, annual expense, accumulated depreciation and carrying amount, across the full useful life.
Doing it once for straight line and once for diminishing balance fixes the difference between them permanently, because you will see the carrying amount converging on residual value from two different directions.
Then drill the cost step alone. Write ten short purchase scenarios that each include one cost that does belong in the asset and one that does not, and practise separating them.
The later arithmetic is easy, but every figure in it descends from a cost you either got right or did not.
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