ACC60104

Introduction to Accounting
Lecture 6:
Plant Assets and
Depreciation

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 Objectives…
* Define and identify the characteristics of plant assets.
* Distinguish between capital expenditure and revenue
expenditure.
* Explain the effect on financial statements if capital expenditure is
wrongly treated as revenue expenditure (expenses) and vice-
versa.
* Explaindepreciation and why depreciation is provided on long-
term assets.
* Compute depreciation using both the straight-line and double-
declining-balance (reducing balance) methods.
* Identifythe steps in recording the disposal of an asset through
sale or trade-in.
 Learning Objective 1

Characteristics of plant assets

 Plant Assets- Long Lived Assets
Plant Assets Depreciation

Definition of Plant Characteristics of

Assets Plant Assets
* not specifically bought for *held for use in business
resale but to be used in the *full cost includes several
production or distribution of expenditures
those goods normally sold in
the business. *last several years
* durable
and normally kept for *can be sold or traded in
more than one year.
* expected to generate revenue
over a number of future years.
 Learning Objective 2
Measuring the cost of a plant asset

Types of Plant Assets

Land
Land Buildings
improvements

Machinery & Furniture &

equipment fixtures
 Land
Costs include
Purchase price
Brokerage fees
Survey and legal fees
Property taxes in arrears
Title transfer
Costs of clearing and removing unwanted buildings
* NOT depreciated
 Buildings

Cost includes:
Purchase price
Architectural fees
Contractor charges
Materials, labor, and overhead
 Machinery and Equipment

Cost includes:
Purchase price (less any discounts)
Transportation charges
Insurance while in transit
Sales tax
Installation costs
Cost of testing before asset is used
 Furniture and Fixtures
Cost includes:
Purchase price (less any discounts)
Shipping charges
Costs to assemble
 Plant Asset Spending

Capital Expenditures Operating Expenditure

Debited to an asset Debited to an expense
account account
Increase asset’s capacity Maintain asset in working
of efficiency order
or
Extend useful life
 Capital Expenditure (Capex)

*involves the cost of purchasing plant assets and/or

adding value to plant assets.
*purchase (cost) price of asset
*legal expenses
*extensions and improvements to enhance asset
*delivery charges and installation expenses
*shown as long-term assets in the Balance Sheet.
Operating Expenditure / Expenses (Opex)

*involves expenses not spent on increasing the

value of plant assets, but on running the
business on a day to day basis
*example:
*repair and maintenance of plant assets
*shown as an expense in the Statement
of Comprehensive Income
 Learning Objective 3
Accounting for depreciation

What is Depreciation???
折旧 ; Depresiasi; 감가 상각 ; 減価償却費

RM40,000 cost

10-years life
 Depreciation
*matches expense against revenue generated during the period
using the asset.
*needs to be charged to the Statement of Comprehensive
Income each year as an Expense.

Depreciation is NOT:
A PROCESS OF VALUATION
 Depreciation

What is Depreciation?
It is an accounting method of allocating the cost of
a tangible asset over its useful life.
Businesses depreciate long-term assets for both tax
and accounting purposes.
For tax purposes, businesses deduct the cost of the
tangible assets they purchase as business expenses;
by depreciating these assets in accordance with each
country’s rules about how and when
the deduction may be taken.
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 Depreciation

Buildings, machinery, equipment, furniture,

fixtures, computers, and motor vehicles are
examples of assets that may last for more
than one year, but will not last indefinitely.
During each accounting period (year,
quarter, month, etc.) a portion of the cost of
the assets is being used up & that portion is
reported as Depreciation Expense in
SOCI.

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 Depreciation
In effect depreciation is the transfer of a
portion of the asset's cost from the
balance sheet to the income statement
during each year of the asset's life.
Depreciation is often a difficult concept as it
does not represent real cash flow.
Depreciation is an accounting convention
that allows a company to write-off the value
of an asset over time, but it is considered a
non-cash transaction (no cash is paid to any
external parties).

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 Depreciation
Factors in computing depreciation

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 Depreciation
Yearly Depn & Accumulated Depn
Yearly – for 1 yr only. Accumulated – total sum of yrs.
FYr FYr FYr FYr
2017 2018 2019 2020

1,000 1,000 1,000 1,000

1,000

2,000

3,000

4,000
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 Depreciation
*Many non current assets have a limited
economic life. Their useful life decreases
over time
*Depreciation is an expense charged against
the revenue that the asset generates for the
business
*Accumulated depreciation is the aggregate of
the depreciation expenses at a given point in
time made in respect to a particular asset
*The entry for depreciation
Dr Depreciation expense
Cr Accumulated depreciation
*The depreciation expense account will be
closed off to profit and loss summary.
 *Depreciation
ASSET ACCOUNT

Initial cost

CONTRA ASSET ACCOUNT EXPENSE ACCOUNT

Accumulated Depreciation Depreciation Expense

Adjusting entry Adjusting entry

Credit Debit
cost used up &
allocated to current
period
 Unadjusted Trial Balance
(extract)
Account debit credit
Accumulated depreciation 400
Office furniture 2000

Above shown is as per last year, then for this

year we do the following:

Calculation of depreciation : 2000 x 10/100

= 200
Accumulated depreciation = 400+200=$600
 General Journal (extract)
Particulars debit credit

Depreciation-
office furniture 200
Accumulated depreciation 200
(Balance day adjustment)

Statement of Income for the year ended

30 June (extract)

Expenses
Depreciation-office furniture 200
 Statement of Balance Sheet as at
30 June (extract)

Non – Current Assets

Office Furniture 2000
Less Accumulated
Depreciation 600 1400
 Depreciation Methods

Double
-Declining
Straight Line Units-of-
(or Reducing
Method Production
Balance
Method)
 Straight-Line Method

- same amount is depreciated each year

1 #
(Cost – residual value) 12
Life

Depreciation expense
 Advantages and Disadvantages

*Advantages
*easy to understand and calculate.
*may be suitable where asset utilisation is the
same each year.

*Disadvantage
*may not give an accurate measure of loss in value
or reduction in useful life.
Double-Declining (or Reducing Balance)
Method
Accelerated method
Writes off more depreciation near the start of an asset’s
life
Residual value is not in formula
Ignored until last year
 Double-Declining-Balance Method
Every year:

(Cost – Accumulated 2 #
depreciation) Life 12
Book value

Depreciation expense

Decreases over the asset’s life

 Advantages and Disadvantages

*Advantage
*useful when asset loses most of its value during
early years.

*Disadvantage
*More difficult to calculate.
 Units-Of-Production Method

The units of production method of depreciation is based on

an asset's usage, activity, or parts produced instead of the
passage of time.

Under the units of production method, depreciation during a

given year will be very high when many units are produced,
and it will be very low when only a few units are produced.
 Units-Of-Production Method
There is no specific formula but usually calculate according to
the extent that the asset is being used.
Example
PQ Pte Ltd’s gravel pit operation builds a conveyor system to
extract gravel from a gravel pit at a cost of $400,000. PQ
expects to use the conveyor to extract 1,000,000 tons of
gravel, which results in a depreciation rate of $0.40 per ton
($400,000 cost/1,000,000 tons). During the first quarter of
activity, PQ extracts 10,000 tons of gravel, which results in the
following depreciation expense:
= $0.40 depreciation cost per ton x 10,000 tons of gravel
= $4,000 depreciation expense
 Advantages and Disadvantages

*Advantage
*- reflect more closely actual depreciation of assets
with different levels of activity
- matches more accurately cost with revenue
- relates depreciation to activity of the asset
*Disadvantage
*- if a depreciable asset has no activity, there won’t
be any depreciation expensed regardless that
machinery losing value making this accounting
method unacceptable
- cannot be applied to all depreciable assets equally
- calculations can be complex if perform them
manually
Which Method is Best for Matching?

Double-declining
Straight-line
balance
• for assets that • for assets that
generate revenue produce more
over time revenue in their
early years
 Book Value (sometimes NBV)

Increases over
time

Cost Accumulated Book value

Depreciation
Decreases over
time
 Example

At the beginning of 2016, Air Asia purchased a used airplane

at a cost of $40,000,000. Air Asia expects the plane to remain
useful for eight years (5,000,000 miles) and to have a
residual value of $5,000,000. Air Asia expects the plane to be
flown 1,200,000 miles the first year and 1,400,000 miles the
second year.

Required:
1. Compute second-year (2017) depreciation expense on the
plane using the following methods:
a. Straight-line
b. Double-declining-balance
c. Units-of-production
 Example – Depreciation - SL

Straight- = (Cost − Residual value) / Useful life

line
(Year 1 & …)
  = ($40,000,000 ̶ $5,000,000) / 8 years

  = $4,375,000 per year

 Example – Depreciation - DDB

Double-declining- = (Cost – Accumulated depreciation)

balance × 2 × (1 / Useful life)
(Year 1)

  = ($40,000,000 ̶ $0) × 2 × (1/ 8 years)

  = $10,000,000 in year 1
 Example – Depreciation - DDB

Double-declining- = (Cost – Accumulated depreciation)

balance × 2 × (1 / Useful life)
(Year 2)

  = ($40,000,000 ̶ $10,000,000) × 2 ×
(1/ 8 years)

  = $7,500,000 in year 2
 Example – Depreciation - UoP

Depreciation = (Cost – Residual value) / Useful life

per unit in units
  = ($40,000,000 ̶ $5,000,000) / 5,000,000
miles
  = $7 per mile
     
Units-of- = Depreciation per unit × Current year usage
production
(Year 1)  = $7 per mile × 1,200,000 miles
  = $8,400,000 in year 1
 Example – Depreciation - UoP

Units-of- = Depreciation per unit × Current

production year usage
(Year 2)

  = $7 per mile × 1,400,000 miles

  = $9,800,000 in year 2
Changes in Useful Life or Residual Value

Considered a change in estimate

Businesses must report on the reason and
effect of the change
Remaining asset book value is depreciated
over the remaining life
 Fully Depreciated Assets

Asset has reached the end of its estimated life

If still useful, a company will continue to use it
Report book value on balance sheet
Record no more depreciation
Asset never reported below residual value
 Learning Objective 4
Record the disposal of an asset by sale or
trade
Disposing of a Plant Asset
*Company can:
* Sell the asset for cash
* Scrap the asset for no cash
* Trade the asset for another asset
* Non-like property exchange
* Like-kind exchange
 Disposal of Asset
The disposal of a non-current (fixed) asset
*Upon the sale of a fixed asset we would want to remove
it from our ledger accounts.
*Cost of asset need to be removed AND
*Accumulated depreciation of the asset sold will have
to be taken out of the accumulated depreciation.
*Finally, the profit and loss on sale if any will have to be
calculated and posted to the Profit and Loss.
*When we charge depreciation , we make a calculated
estimate of the possible end or scrap value at the end of
the life of asset. This may differ from actual sale or
disposal price i.e when we dispose an asset the amount
received for it is usually different from our estimate.

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 Disposal of Asset – journal entries
The disposal of a non-current (fixed) asset
On sale of a fixed asset, like the computer mentioned earlier, the
following entries would be required.
(a) Transfer the cost price of the asset sold to a “Disposals Account”
Debit Disposals Account
Credit Computer Account
(b) Transfer the depreciation already charged to this asset
(acc dep’n) to the disposal account
Debit Acc Depreciation for Computer
Credit Disposals Account
(c ) On receipt of disposal proceeds
Debit Cash (Bank) Account
Credit Disposals Account
(d) Transfer the difference in the Disposal account
(amount needed to balance the disposal a/c)
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 Disposal of Asset – example - gain

The disposal of a non-current (fixed) asset

Activity
A computer was bought on 1 Jan 2014 for Rm2,000.
As at 31 December 2016, the cost of the computer was
Rm2,000 and the accumulated depreciation Rm 976.
On 2 Jan 2017, the computer was sold for Rm1,070 cash.
Required
Show the relevant ledger accounts and the extract of the
Income Statement for the period ended 31 Dec 2017.

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 Disposal of Asset - steps
The disposal of a non-current (fixed) asset
Upon disposal
1.Transfer cost of asset disposed to “Disposals Account”
2.Transfer accumulated depreciation related to asset sold
to disposal account
3.Upon receipt of proceeds, Debit cash (or Bank) and
Credit Disposals Account
4.Balance in disposal account to be transferred to profit
and loss account as either
Profit on disposal
OR
Loss on disposal

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 Disposal of Asset – steps 1, 2
A computer was bought on 1 Jan 2014 for Rm2,000.
As at 31 December 2016, the cost of the computer was Rm2,000 and the
accumulated depreciation Rm 976.
On 2 Jan 2017, the computer was sold for Rm1,070 for cash
Computer - Cost
01-Jan-17 Bal b/f 2,000 02-Jan-17 Disposal 1 2,000

Accumulated Depreciation
02-Jan-17 Disposal 2 976 01-Jan-17 Bal b/f 976

Cash Account
02-Jan-17 Disposal 3 1,070

Disposal Account

02-Jan-17 Cost 1 2,000 02-Jan-17 Acc Dep'n 2 976

Profit on
31-Dec-17
disposal (P&L) 46 02-Jan-17 Cash 3 1,070
2,046 2,046

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 Disposal of Asset – steps 3, 4
Disposal Account

02-Jan-17 Cost 1 2,000 02-Jan-17 Acc Dep'n 2 976

Profit on
31-Dec-17
disposal (P&L) 46 02-Jan-17 Cash 3 1,070
2,046 2,046

Profit and Loss Acc (Extract)

31/12/17 Profit on Diposal
of Computer 46

SOCI for the Period ended 31 Dec 2017 [Extract]

Gross Profit XXXX

Add : Profit on disposal of Computer 46

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 Disposal of Asset – example - loss

Consider position and entries if computer was sold at

loss using same example
Activity - Example
A computer was bought on 1 Jan 2014 for Rm2,000.
As at 31 December 2016, the cost of the computer was
Rm2,000 and the accumulated depreciation Rm 976.
On 2 Jan 2017, the computer was sold for Rm950 cash.
Required
Show the relevant ledger accounts and the extract of the
Income Statement for the period ended 31 Dec 2017.

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 Disposal of Asset – steps 1, 2
A computer was bought on 1 Jan 2014 for Rm2,000.
As at 31 December 2016, the cost of the computer was Rm2,000 and the
accumulated depreciation Rm 976.
On 2 Jan 2017, the computer was sold for Rm950 for cash
Computer - Cost
01-Jan-17 Bal b/f 2,000 02-Jan-17 Disposal 1 2,000

Accumulated Depreciation
02-Jan-17 Disposal 2 976 01-Jan-17 Bal b/f 976

Cash Account
02-Jan-17 Disposal 3 950

Disposal Account
02-Jan-17 Cost 1 2,000 02-Jan-17 Acc Depn 2 976
02-Jan-17 Cash 3 950
31-Dec-17 Loss on Disposal 74
2,000 2,000

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 Disposal of Asset – steps 3, 4
Disposal Account
02-Jan-17 Cost 1 2,000 02-Jan-17 Acc Depn 2 976
02-Jan-17 Cash 3 950
31-Dec-17 Loss on Disposal 74
2,000 2,000

Profit and Loss Acc (Extract)

Loss on
31-Dec-17 Disposal of 74

SOCI for the Period ended 31 Dec 2017 [Extract]

Gross Profit XXXX

Less : Loss on disposal of Computer (74)

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 Disposal of Asset – short cut

Simple calculation procedures when it comes to the

Disposal of Fixed Assets: (higher selling price)

Cost of fixed assets xxxx

Accumulated depreciation (xxx)
Net Book Value xxx
Sale Proceeds xxx
Gain or Loss on Disposal of FA xx .

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 Disposal of Asset – short cut -
example
Simple calculation procedures when it comes to the
Disposal of Fixed Assets: (higher selling price)

Cost of fixed assets 100,000

Accumulated depreciation (60,000)
Net Book Value 40,000
Sale Proceeds 45,500
Gain or Loss on Disposal of FA 5,500

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 Disposal of Asset – short cut -
example
Simple calculation procedures when it comes to the
Disposal of Fixed Assets: (lower selling price)

Cost of fixed assets 100,000

Accumulated depreciation (60,000)
Net Book Value 40,000
Sale Proceeds 35,500
Gain or Loss on Disposal of FA 4,500

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Activity - HW
A Company bought a machine for RM16,000. It is expected to be
used for 5 years then sold for Rm1,000.
What is the annual amount of depreciation if the straight line
method is used?
Calculate the profit/(loss) on depreciation if the machine is sold
for Rm10,500 at the end of year 3.
Yrly Depn = RM3,000 Gain on Disposal = RM3,500
Activity - HW
A Company bought a machine for Rm3,200. It is to be depreciated
at 25% per annum using the reducing balance method. What would
be the Net book value of the asset after two years?
Calculate the profit/(loss) on depreciation if the machine is sold
for Rm1,000 at the end of year 2.
NBV = RM1,800 Loss on Disposal = RM800

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 Tutorial Questions, kindly refer our
study guide…
 
Short Exercises Questions: S10-1, S10-2, S10-3,
S10-4, S10-5, S10-6, S10-7, S10-8, S10-9
 
Exercises: E10-17, E10-18, E10-19, E10-20,
E10-22, E10-23 
 
Problems: P10-31A, P10-37B
0102723912 Gregory
01128188585
See you next lecture
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