CHAPTER
FIXED AND INTANGIBLE ASSETS

Chapter 5 deals with non-current assets and depreciation. It looks at what non currents are, depreciation and how it is provided and eventually leading to disposal. The non-current asset register is also discussed. Additionally the chapter covers the basics of research and development costs and goodwill.

Topics:

• Non-current assets – what are they?
• Depreciation
• Methods of depreciation
• Accounting for depreciation
• The disposal of non-current assets
• The non-current asset register
• ISA 38 - Intangible assets

NON-CURRENT ASSETS

OR FIXED ASSETS

DEFINITION

• A non-current asset is one bought by the business not for resale but to be used in the business to help generate income over a number of years.
• Non-current assets are divided into tangible and intangible assets.

NON CURRENT ASSETS

Tangible non-current assets include:

1. Land

2. Buildings

3. Fixtures and fittings

4. Motor vehicles

Intangible non-current assets include:

1. Goodwill

2. Patents

3. Trade marks

4. Intellectual Property

CURRENT ASSETS

These are assets that are temporal in nature. They change in value with time, and examples includes:

1. Inventory

2. Receivables

3. Cash in bank and

4. Cash in hand

DEPRECIATION

IAS 16 which deals with property, plant and equipment defines depreciation as:

“the allocation of the depreciable amount of an asset over its estimated useful life.”

KEY TERMS

Depreciable assets are assets which:

1. are expected to be used during more than one accounting period.

2. have a limited useful life and

3. are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes.

Useful life is either:

1. the period over which a depreciable asset is expected to be used by the enterprise or

2. the number of production or similar units expected to be obtained from the asset by the enterprise.

Depreciable amount of a depreciable asset is the historical cost or other amount substituted for historical cost in the financial statements, less the estimated residual value.

Residual value, sometimes called scrap value. This is the estimated value of an asset at the end of its life. Residual value is not depreciable.

DEPRECIATION EXAMPLE

Example 2: Equipment costing K80 000 000 which has an expected life of five years with K3 000 000 residual value will be depreciated as:

Cost	K80 000 000
Residual value	(K3 000 000)

K77 000 000 is depreciable amount over 5

Years

CAUSES OF DEPRECIATION

1. Wear and tear

2. Natural causes

3. Obsolescence

4. Inadequacy

5. Depletion

METHODS OF DEPRECIATION

There are many different methods of depreciation. The following are selected for your study:

1. Straight line

2. Reducing balance method

3. Sum of digits

4. Revaluation method

Straight Line Method

In this method the depreciable amount is charged equally from one accounting period to the other over the expected useful life of the asset. It is assumed that the business will enjoy equal benefits from the use of the assets throughout its life.

• Annual depreciation = Cost of an asset – residual value
• Over the expected useful life of the asset

Example 1: Straight line method

A machine was bought on 1 January 20X4 at a cost of K800 000. The machine is expected to be used over a period of 5 years with no residual value.

Annual depreciation would be:

• Depreciation = (K800 000 – 0)
• 5 years expected life
• = k160 000 per annum

Reducing Balance Method

This method assumes that the business will benefit more from the use of the asset in earlier years than later years.

Example: Reducing Balance Method

Machine was bought at a cost of K150 000. Depreciation is to be charged at the rate of 20% per annum. Calculate depreciation for the first 3 years.

SOLUTION

			K
Year 1	20% x 150 000
	(30 000)	Depreciation
Year 2	20% x 120 000		N.B.V
	(24 000)	Depreciation
Year 3	20% x 96 000		N.B.V
	(19 200)	Depreciation
	76 800

Sum of the Digits Method

This method is very similar to reducing balance method. Depreciation is also charged more in earlier years than later year.

• What is referred to as sum of digits are the SUM years the asset will be in use i.e. estimated life.

SUM OF THE DIGITS

If the life of an asset is 5 years then the sum of digits will be:

• Year 1
• +

• Year 2

• +

• Year 3

• +

• Year 4

• +

• Year 5

• 15 is the sum of digits

SUM OF THE DIGITS

Since depreciation is more in the first year than later years, each year depreciation charge will be:

Year 1	5/15 x depreciable amount
Year 2	4/15 x depreciable amount
Year 3	4/15 x depreciable amount
Year 4	2/15 x depreciable amount
Year 5	1/15 x depreciable amount

Example: Sum of digits method

Ever green purchased a non-current asset for K600 000 on 1 January 20X4. The useful life of the asset is 5 years after which it will have a residual value of K30,000. The depreciation charge every year will be:

• Depreciable amount is K600 000 – K30 000 = K570 000

Revaluation Method

Revaluation means giving a new value to an asset which could be gains or losses.

• When the market value of a non-current asset falls below its net book value, and the fall in value is expected to be permanent, the asset should be written down to its new market value.
• Revaluation Methods are:
1. Increase in value of asset
2. Change in Depreciation Method

REVALUATION METHODS

Increase in value of asset

Due to inflation, the market value of certain non-current assets go up, especially land and buildings. A business is not obliged to revalue non-current assets in its balance sheet.

However in order to give a ‘true and fair view’ the business may decide to revalue the asset upwards. Depreciation would then be charged on the new revalued amount.

Change in Depreciation

It is allowed to change the depreciation method if it is discovered that a wrong method was adopted initially, and is not true and fair, or if there is a change in the pattern of consumption of economic benefits from the non current asset.

Every year end a business will normally review its accounts and this is the time such a discovery may be made.

Changes should be necessary and not done at will otherwise comparison will be difficult because of inconsistency.

Disposal Account

The non current assets might be sold off at some stage before even their useful life is over. Reasons for selling or disposal may include:

1. Inadequacy – where an asset fails to meet increased demand for a product

2. Obsolescence etc

• Double entry when an asset is disposed of.

Step 1:

Debit – Disposal account with value of asset usually at

Credit – Asset account cost

Step 2:

Debit – Allowance for depreciation account with accumulated

Credit – Disposal account depreciation at the time of sale

Note: The two steps in disposal account reveals the net book value of the asset.

Step 3:

Debit – Receivable account (if sale is on credit) or

Debit – cash book (if sale is on cash or by cheque Credit – Disposal account

Credit – with sale price of the asset

Step 4:

The balancing figure in disposal account will be profit or loss on disposal.

If balancing figure is on debit of disposal account, a profit has been achieved.

If balancing figure on disposal account is on credit side, then a loss is recorded.

Examples: Disposal of non-current asset

Green Grass purchased a van on 1 January 20X5 for K100 000. He estimated that its resale value on 31 December 20Y0 after six years use would be K40 000 and depreciated it on a straight line basis. He sold it on 30 June 20X7 for K55 000.

EXAMPLE

The amount to be charged as depreciation each year is

• Cost – residual value
• Estimated economic life:
  (K100 000 – K40 000) / 6 years = K10 000 per annum

Note:

o Green Grass owned the asset for two years and six months, thus the total depreciation charged since acquisition is K10 000 x 2¹/₂ years = K25 000.

o This means that the net book value at the date of disposal was K100 000 – K25 000 = K75 000.

o Since the sale proceeds amounted to K55 000, a loss on disposal of

o K55 000 – K75 000 = K20 000 has been made.

o

Ledger accounting on disposal.

o	Dr	Van account (at cost)			Cr
o
o	20x5	K			K
o	1^st Jan. bank	100 000	31 Dec.	Balance c/d 100 000
o		______			______
o		100 000			100 000
o	20x6
o	1^st Jan. Balance b/d	100 000	31 Dec.	Balance c/d 100 000
o		______			______
o		100 000			100 000
o	20x7
o	1^st Jan. Balance b/d	100 000	30 June	Disposal	100 000
o		______			______
o		100 000			100 000
o
o
o	Dr	Allowance for Depreciation			Cr
o					K
o		K		20x5
o	31 Dec. Balance c/d/ 10 000		31 Dec. Inc. Statement 10 000
o				(Depreciation)
o		______			______
o		10 000			10 000
o	20x6
o	31 Dec. Balance c/d/ 10 000		1 Jan. Balance b/d 10 000
o			31 Dec. Inc. Statement 10 000
o				(Depreciation)
o		______			______
o		20 000			20 000
o	20x7
o	30 June Disposal 25 000		1 Jan. Balance b/d 20 000
o			30 June Inc. Statement 5000
o				(Depreciation)
o		25 000			25 000
o
o
o
o	Dr	Disposal Account			Cr
o
o	20x7	K	20x7		K
o
o	30 June Van at Cost	100 000	30 June Allow for Depreciation		25 000
o			30 June Bank		55 000
o			Loss (to inc. state)		20 000
o		______			______
o		100 000			100 000
o
o
o

Non-Current Asset Register

This register will contain the following information for each non-current asset.

i. - the date of purchase

ii. - the name and address of supplier

iii. - the cost of the asset

iv. - the estimated useful economic life of the asset

v. - the estimated residual or resale value of the asset at the end of its useful life

vi. - a description of the asset

vii. - a code number for easy identification

viii. - the method of accumulated depreciation to be used

ix. - the accumulated depreciation of the asset

x. - details of disposal of the asset

xi. - the location of the asset within the organization

xii. - the extent to which it is being used

xiii. - the repairs carried out and how much they cost

xiv. - the expiry dates of any licenses permitting the organization to use it.

RETIREMENTS AND DISPOSALS

When an asset is permanently withdrawn from use, or sold or scrapped, and no future economic benefits are expected from its disposal, it should be withdrawn from the balance sheet.

• Gains or losses are the difference between the estimated net disposal proceeds and the carrying amount of the asset.
• They should be recognized as income or expense in the income statement.

RESEARCH AND DEVELOPMENT COSTS (IAS 38)

• An intangible asset is an identifiable non monetary asset without physical substance. The asset must be:

a) Controlled by the entity as a result of event in the past.

b) Something from which the entity expects future economic benefits to them.

RESEARCH

• This is an investigation undertaken in order to discover new facts or get additional information.
• Research could be used for new or improved products, processes and methods.

DIVISION OF RESEARCH

1. PURE OR BASIC RESEARCH

This is research carried out to advance knowledge without specific objectives.

2. APPLIED RESEARCH

This utilizes pure research to attain specific objectives. Research used to extend knowledge of problems in industry, health, education, etc.

3. DEVELOPMENT

This is making use of the results of research to produce or develop new or existing products or services.

CONDITIONS OF CAPITALIZATION

(i) The project is technically feasible.

(ii) The enterprise intends to complete the project and use or market the product.

(iii) The enterprise has the ability to use or sell the asset.

(iv) There is either an external market for the asset or an internal use for it.

(v) The company has the financial resources to complete the project.

(vi) The related costs can be measured reliably.

AMORTISATION

• Capitalized development costs can be carried forward until the product being developed is ready for production.
• At this point it must be amortized over the expected commercial life of the product.

CHAPTER SUMMARY

i. Non-current assets are acquired not for resale but to be used in organization to help generate income over a period of more than one year.

ii. Non-current assets are depreciated over a period of their estimated life span

iii. Depreciation is the allocation of the cost of the asset over its economic life

iv. Depreciation is a non-cash expense and it is charged to income statement.

v. The straight line method of depreciation assumes that the asset will be used evenly throughout its life and therefore some amount is charged to income statement from one year to the next.

vi. Reducing balance method assumes that the asset will be used more in its earlier years than later years, thus the depreciation amount will be reducing with time.

vii. Non-current assets may be sold off before their life span expires. A disposal account is opened to determine whether a profit or loss has been made on disposal.

viii. It is also important that an organization keeps a non-current asset register for control purposes.