Deegan Afa 7e Sm Ch05

INSTRUCTORS MANUAL TO:

Chapter 5

Depreciation of property, plant and equipment

5.1No. Depreciation is an allocation of the cost (or revalued amount) of an asset, less its residual amount, over the period in which the benefits of its use are expected to arise. The market value or fair value of an asset may rise, yet if the approach to measurement being used is based on historical cost (or historical cost adjusted for asset revaluations), then depreciation will still need to be recognised. However, it should be acknowledged that if market-value accounting is employed with any gains or loss in valuation going to profit or loss, then depreciation might not be recognised. When assets are marked-to-market, any gain or loss on the value of an asset would be taken to profit or loss in the period in which the change in market value occurs. However, when assets are revalued to fair value, with the initial increase going to revaluation surplus (in accordance with AASB 116), there will still be a need to depreciate assets. If non-current assets are revaluated in accordance with AASB 116 then the gain is recorded as an increase in the revaluation surplus account, rather than being included in profit or loss (however, the amount recorded in the revaluation surplus is recognised within other comprehensive income).5.2The useful life of a depreciable asset is the period of time over which it is expected that the asset will generate economic benefits or, from a production output basis, the total units that are expected to be obtained from the asset. Specifically, AASB 116 Property, Plant and Equipment defines useful life as follows:

Useful life is:

(a)the period over which an asset is expected to be available for use by an entity; or

(b)the number of production or similar units expected to be obtained from the asset by an entity.

In further discussing the useful life of an asset, paragraph 57 of AASB 116 states:

The useful life of an asset is defined in terms of the assets expected utility to the entity. The asset management policy of the entity may involve the disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the asset. Therefore, the useful life of an asset may be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets.

In determining useful life, consideration needs to be given to the physical, commercial and technological life of the asset in question. Legal factors also may need to be considered. For example, a lease may restrict the use of a particular asset to a certain finite period of time. To the extent that such a restriction is the constraining factor, then this would form the basis for determining the assets useful life. As paragraph 56 of AASB 116 states:

The future economic benefits embodied in an asset are consumed by an entity principally through its use. However, other factors, such as technical or commercial obsolescence and wear and tear while an asset remains idle, often result in the diminution of the economic benefits that might have been obtained from the asset. Consequently, all the following factors are considered in determining the useful life of an asset:

(a)expected usage of the asset. Usage is assessed by reference to the assets expected capacity or physical output.

(b)expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle.

(c)technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset.

(d)legal or similar limits on the use of the asset, such as the expiry dates of related leases.

5.3Depreciation acts to reduce profits (or increase losses) as reported in the statement of comprehensive income, and acts to reduce the assets as recorded in the statement of financial position.

5.4Cost of the asset for depreciation purposes:

Initial cost$110 000

Installation20 000

Modification 10 000

Total$140 000

(a)Sum-of-digits method

The sum-of-years-digits can be determined by using the formula: n(n + 1)/2 = 21

Yearly depreciation can be calculated using the following table. As the table indicates, the sum-of-years-digits method results in higher depreciation expenses being recognised in the earlier years.YearDepreciation

16/21 x ($140 000 $15 000) = $35 714

25/21 x ($140 000 $15 000) = $29 762

34/21 x ($140 000 $15 000) =$23 810

43/21 x ($140 000 $15 000) = $17 857

52/21 x ($140 000 $15 000) = $11 905

61/21 x ($140 000 $15 000) = $5952

$125 000

The entry in Year 1 would therefore be:

DrDepreciation expense35 714

CrAccumulated depreciation35 714

The entry in Year 2 would be:



(b)Declining-balance method

The percentage to be applied to the opening written down value of the asset is determined by: 1 the nth root of (salvage value/cost), where n = the life of the asset= 1.0 0.68917 = 0.31083

In this case n = 6.YearDepreciation

10.31083 x (140 000 ) =43 516

20.31083 x (140 000 43516) =29 990

30.31083 x (140 000 73506) =20 668

40.31083 x (140 000 94 174) =14 244

50.31083 x (140 000 108 418) =9817

60.31083 x (140 000 118 235) = 6765

Total depreciation125 000

Estimated residual value 15 000

Initial cost140 000







(c) Straight-line depreciation method

Yearly depreciation = ($140 000 $15 000) ( 6 = $20 833

The entry at the end of Year 1 would be:



The entries in Years 2 to 6 would be the same as the above entry.

5.5Both terms essentially mean the same thing: the allocation of the cost (or revalued amount) less any accumulated impairments losses of an asset, less its expected residual amount, over the expected useful life of the asset. Amortisation is typically the term used for the allocation process in relation to intangible non-current assets or leased assets, whereas depreciation refers to the allocation process in relation to tangible non-current assets that are not the subject of a lease.

5.6A number of judgments would be required. Firstly we would need to determine the cost, or revalued amount of the respective assets. We would then need to determine any expected residual amount for the asset as at the end of its useful life. Such information would then provide us with the depreciable base of the respective assets.

We would then need to determine whether the assets would be subject to periodic depreciation/amortisation. If, for example, the assets were to be accounted for by use of mark-to-market then no depreciation would be recognised. For example, AASB 140 Investment Properties allows investment properties to be measured at fair value with any changes going to profit or loss, rather than requiring periodic depreciation.

If the assets were to be depreciated we would then need to determine respective useful lives. The useful lives might be based upon time, or perhaps tied to other factors, such as production output. If the asset is considered to have an indefinite life, then no depreciation might be recognised. Rather, the asset might be subject to annual impairment testing.

Once we have determined the depreciable base and the useful lives of the respective assets, and we believe that the asset does not have an indefinite life, then we need to determine the method of apportionment of the cost, or revalued amount, over the assets useful lives. For example, we might use the straight-line method or a declining-balance approach. The choice to be made in how depreciation is to be applied should reflect, as far as possible, the underlying economic reality. For example, if we believe that the economic benefits to be generated by the asset will be received fairly uniformly over the life of the asset then we might use straight-line depreciation. However, if we believe that the benefits are to be generated more so in the early years, then a depreciation method that provides for greater depreciation in the early years, such as sum-of-digits, may be more appropriate.5.7We depreciate assets over their expected useful lives. The expected useful lives of assets should be determined after taking into account expected maintenance schedules. If the maintenance programs are such that they are likely to extend the useful lives of the assets beyond what might otherwise be expected then there would be a case for using a revised (extended) useful life for the assets, and this in itself will lead to a reduction in depreciation expenses. The periodic maintenance shall be treated as an expense as incurred except to the extent that the expenditure improves the asset beyond its original character. The increased depreciation charges can only be justified if the accountants expectations about useful lives can be substantiated.

5.8Land and buildings must be accounted for separately. As the life of the building is limited due to such factors as wear and tear or technical or commercial obsolescence, it needs to be depreciated. The total package of land and building may increase in fair value, but typically such an increase is due to the increase in the value of the land. Even when the value of the land is adjusted upwards, this increase is typically not treated as income (unless market value accounting has been employed), but is transferred to a reserve (revaluation surplus), which is part of shareholders funds (equity). The increase in the revaluation surplus is shown as an increase in other comprehensive income. In explaining the requirement to separately depreciate buildings, paragraph 58 of AASB 116 states:

Land and buildings are separable assets and are accounted for separately, even when they are acquired together. With some exceptions, such as quarries and sites used for landfill, land has an unlimited useful life and therefore is not depreciated. Buildings have a limited useful life and therefore are depreciable assets. An increase in the value of the land on which a building stands does not affect the determination of the depreciable amount of the building.

5.9

The physical life of the asset:18 years

The commercial life of the asset:6 years

Legal life of lease:15 years

Given the above information, the firm would probably use a period of depreciation of 6yearsthe shorter of the physical, commercial, and legal lives.

5.10Ideally, management will use that depreciation method which most objectively allocates the depreciable amount of an asset (AASB 116 defines depreciable amount as the cost of an asset, or other amount substituted for cost, less its residual value) over the periods in which the benefits of the asset will arise, with those periods that receive greater benefits being allocated a larger proportion of depreciation. According to paragraph 60 of AASB 116:The depreciation method used shall reflect the pattern in which the assets future economic benefits are expected to be consumed by the entity.

As we read in Chapter 3, however, there may be various agreements to which the firm is a party and which, in part, are tied to accounting numbers. Hence, considerations such as debt agreements, management compensation plans and political costs may motivate managers to prefer to adopt particular depreciation methods in preference to others. In periods in which the firm considers that it is under political scrutiny because of its apparent high profits, it may elect to use those methods that reduce profits and the associated political costs. At other times it may be motivated to adopt depreciation methods that increase reported profits (perhaps by assuming a longer useful life for the depreciable assets). Of course, such predictions assume that managers will put self-interest ahead of objectivity. This will not always be the case. Whatever the managers incentives, the auditor will be responsible for determining whether the accounting policies adopted by an organisation, including the depreciation policies, are fair and reasonable and in accordance with generally accepted accounting practices.

5.11The profit (or loss) on the disposal of a non-current asset is determined by subtracting the carrying amount of the asset (AASB 116 defines the carrying amount as the amount at which an asset is recognised after deducting any accumulated depreciation and accumulated impairment losses) from the fair value of the consideration received from the disposal of the asset. As paragraph 71 of AASB 116 states:

The gain or loss arising from the derecognition of an item of property, plant and equipment shall be determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item.

AASB 116 requires that the profit on disposal of property, plant and equipment be treated as a gain, and not as revenue (with gains and losses both being components of income). Specifically, paragraph 68 of AASB 116 states:

The gain or loss arising from the derecognition of an item of property, plant and equipment shall be included in profit or loss when the item is derecognised (unless AASB 117 requires otherwise on a sale and leaseback). Gains shall not be classified as revenue.

5.12We must calculate the written-down value of the machinery on 1 July 2014, which is the date of disposal and which is 3 years after the asset was acquired.

The sum-of-digits is determined as: n(n + 1)/2 = 6(7)/2 = 21

Year

1($90 000 $10 000) x 6/21 =$22 857

2($90 000 $10 000) x 5/21 =$19 048

3($90 000 $10 000) x 4/21 =$15 238

Accumulated depreciation at the end of year 3$57 143

The written-down value of the machinery as at 1 July 2014 was $32 857, which is $90 000 less $57 143. The acquisition cost of the motor vehicle would be recorded at its fair value of $20 000. Hence, the accounting entry to recognise the asset exchange would be:

DrMotor vehicle20 000

DrLoss on disposal of machinery12 857

DrAccumulated depreciation57 143

CrMachinery90 000

5.13Consistent with AASB 116, the bases for allocating the depreciable amount (which is the historical cost of a depreciable asset, or other revalued amount substituted for historical costs, in the financial statements, less in either case the net amount expected to be recovered on disposal of the asset at the end of its useful life) ought to be appropriate to the nature of the respective assets and their expected use. The basis chosen is that which best reflects the underlying physical, technical, commercial and, where appropriate, legal facts. Once a basis of depreciation has been chosen, it should be applied consistently from financial year to financial year. As paragraphs 60, 61 and 62 of AASB 116 state:

60.The depreciation method used shall reflect the pattern in which the assets future economic benefits are expected to be consumed by the entity.

61.The depreciation method applied to an asset shall be reviewed at least at the end of each annual reporting period and, if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern. Such a change shall be accounted for as a change in an accounting estimate in accordance with AASB 108.

62.A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method. Straight-line depreciation results in a constant charge over the useful life if the assets residual value does not change. The diminishing balance method results in a decreasing charge over the useful life. The units of production method results in a charge based on the expected use or output. The entity selects the method that most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. That method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits.

5.14Pursuant to paragraph 73 of AASB 116, the financial statements should disclose the following information in relation to each class of property, plant and equipment:

the measurement bases used for determining the gross carrying amount

the depreciation methods used

the useful lives or the depreciation rates used

the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period depreciation expense

the aggregate amount of depreciation allocated, whether recognised as an expense or as part of the carrying amounts of other assets during the financial year

a reconciliation of the carrying amount at the beginning and end of the period.Where there are changes in the depreciation expense from year to year due to such factors as reassessments of useful lives, or where depreciation methods are changed, AASB 116 also requires additional disclosures to those listed above.

5.15AASB 116 requires that depreciation methods must be reviewed at least annually and, if there has been a change in the expected pattern of consumption or loss of future economic benefits, the method applied must be changed to reflect the changed pattern. Paragraph 61 of AASB 116 states:The depreciation method applied to an asset shall be reviewed at least at the end of each annual reporting period and, if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern. Such a change shall be accounted for as a change in an accounting estimate in accordance with AASB 108.

Where there has been a change in depreciation method, additional disclosures about the nature and reason for the change and the financial effects of the change since the beginning of the financial year are required.

5.16Calculating the depreciation expense:

Component cost ResidualUseful life Depreciation

$value($) (years) expense ($)

Airframe 6 600 000 150 00015 years 430 000

Engines 4 800 000 nil20 000 hours 700 800*

Interior fixtures and fittings 600 000 nil5 years120 000

12 000 000

1 250 800* $4 800 000 20 000 x 2 920 = $700 800

Journal entry

30 June 2014

Dr Depreciation expense 1 250 800

Cr Accumulated depreciationairframe

430 000

Cr Accumulated depreciationengines

700 800

Cr Accumulated depreciationinterior fixtures and fittings

120 000

5.17The carrying amount of the machinery would be $140 000. If the item has been depreciated for the period, but the carrying amount exceeds the recoverable amount of the asset, then an impairment loss shall be recognised. As we know, the recoverable amount is determined as the greater of the fair value less costs to sell and its value in use. Hence, a number of issues need to be considered. No impairment loss needs to be recognised simply because fair value is less than carrying value if the value in use is greater than or equal to the carrying amount. The other point is that in determining fair value we need to consider what amount would be attributed to the asset if there was an exchange between knowledgeable, willing parties in an arms length transactionwe cannot simply respond to what the managing director considers might be a fair value. We need information on how he came to this conclusion.

If it is decided that the recoverable amount of the asset is $110 000 then an impairment loss of $30 000 would be recognised, rather than recognising another $30 000 in depreciation as the managing director had wished.

Challenging questions5.18Depreciation is an allocation process rather than a valuation process. An asset might actually be appreciating in value, yet depreciation would still need to be recognised. The depreciation might be based on the cost of an asset, or it might be based on fair value if asset revaluations are being undertaken. As paragraph 6 of AASB 116 states:

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.5.19Original cost2011$100 000

Expected residual$10 000

Depreciable base$90 000

Depreciation per year given expected life of 10 years$9000

Carrying value at 30 June 2013 (after two years accumulated depreciation)$82 000

Revised residual$14 000

Revised depreciable base as at 1 July 2014$68 000

Depreciation per year with remaining life of 11 years $6 182

Hence, depreciation expenses for 2011, 2013 and 2014 are $9000, $9000 and $6182 respectively.

5.20At issue in this question is how to treat the replacement roof and the expected demolition costs. The general rule is that if we repair an asset to its former state then the repair is treated as an expense when incurred. However, if the asset has some work done to it which extends its useful life then such expenditure can be capitalised. In this question we will capitalise the roof repairs given that the work extended the life of the building such that it would last for 25 years from the end of the 2014 financial year. The work undertaken represented an improvement.

In relation to the expected demolition costs, paragraph 16 of AASB 116 states:

The cost of an item of property, plant and equipment comprises:

(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates;

(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management; and

(c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.

Therefore, in determining depreciation expense, we need to include the cost of the future demolition in our calculations.

Original cost in 2010

(assuming completed at the beginning of 2010 financial year) $960 000

Expected residual$nil

Expected demolition cost$100 000

Depreciable base$1 060 000

Depreciation per year given expected life of 25 years$42 400

Carrying value at 30 June 2014 (with five years accumulated depreciation)$848 000

New roof$200 000

Revised depreciable base as at 1 July 2014$1 048 000

Depreciation per year with remaining life of 25 years $41 920

Hence, depreciation expenses for 2013, 2014 and 2015 are $42 400, $41 920 and $41 920 respectively.

5.21In this question we need to consider whether the cost of the attachment should be included as part of the cost of the fin-making machine, or whether it should be accounted for, and depreciated, separately. Because the attachment has a separate identity and can be used in conjunction with other assets if required then it would be appropriate to depreciate the asset separately. Because the attachment will not become an integral part of the machine, both the machine and the attachment can be depreciated over different useful lives.

Depreciation of fin-making machine

Original cost of machine acquired in 2012 $20 000

Expected residual$nil

Depreciable base$20 000

Depreciation per fin using a production basis method and expected

production of 2000 units$10 per unit

Carrying value at 1 July 2014

Cost

$20 000

Accumulated depreciation

Depreciation 2012: 400 x $10 $4000

Depreciation 2013: 600 x $10$6000

Depreciation 2014: 500 x $10$5000$15 000

Carrying value$5000

Revised depreciable base: balance of units = 2000 (400 + 600 + 500) + 10001500

Depreciation per fin from the beginning of 2015 financial year $3.33 per unit

Depreciation of attachment

The attachment costs $5000 and is depreciated over 5 years at $1000 per year.

Therefore, total depreciation for 2015 will equal:

Depreciation of machine acquired in 2012: 800 x $3.33 = $2664

Depreciation of attachment:$1000

$3664

5.22Original cost 1 July 2012$3 660 000

Depreciation year ending 30 June 2013 [$3 660 000 x 3000/10 000]$1 098 000

Carrying amount 30 June 2013$2 562 000

Major upgrade undertaken on 1 July 2013$234 600

Carrying amount at 1 July 2013 2 796 600

Depreciation year ending 30 June 2014 [$2 796 600 x 4000/9000]1 242 933

Carrying amount 1 July 20141 553 667

Major upgrade undertaken on 1 July 2014$344 900Carrying amount 1 July 20141 898 567

Depreciation year ending 30 June 2015 [$1 898 567 x 3800/8100]890 686Carrying amount 30 June 20151 007 8811 July 2012

DrPlant3 660 000

CrCash/payables

3 660 000

30 June 2013

DrDepreciation expense1 098 000

CrAccumulated depreciationplant

1 098 000

1 July 2013

DrPlant234 600

CrCash payables

234 600

30 June 2014

DrDepreciation expense1 242 933

CrAccumulated depreciation plant

1 242 933

1 July 2014

DrPlant344 900

CrCash payables

344 900

30 June 2015


CrAccumulated depreciationplant

890 686

5.23(a)Straight-line depreciation

(Cost residual value) useful life = ($65 000 $5000) 6 = $10 000 per year

This method of depreciation would be appropriate when the pattern of benefits derived from the asset are expected to be uniform throughout the assets useful life.

(b)Sum-of-digits depreciation

The asset is expected to be used for six years. We need to sum the digits from one to the assets life, in this case five.

1 + 2 + 3 + 4 + 5 + 6 = 21

Or we could use the formula n(n + 1) 2,

which gives (6 7) 2 = 21

Year depreciation6 21 ($65 000 $5000) = $17 143

5 21 ($65 000 $5000) = $14 286

4 21 ($65 000 $5000) = $11 429

3 21 ($65 000 $5000) = $8571

2 21 ($65 000 $5000) = $5714

1 21 ($65 000 $5000) = $2857

$60 000

Depreciation based on the sum-of-digits method would be appropriate where the economic benefits expected to be derived from the asset will be greater in the early years than the later years.

(c)Declining-balance depreciation

The percentage to be applied to the opening written-down value (or carrying amount) of the asset is determined by using the following formula: percentage = 1 the nth root of (salvage value cost), where n = the life of the asset, which in this case is 6

= 1.0 60.076923

= 1.0 0.652143

= 0.347857

Year CalculationDepreciation

1 0.347857 ($65 000) = $22 611

2 0.347857 ($65 000 22 611) = $14 745

3 0.347857 ($65 000 37 356) = $9616

4 0.347857 ($65 000 46 972) = $6271

5 0.347857 ($65 000 53 243) = $4090

60.347857 ($65 000 57 333) = $2667$60 000

As with the sum-of-digits approach, depreciation based on the declining-balance approach would be appropriate where the economic benefits expected to be derived from the asset will be greater in the early years than the later years.

(d)Units-of-production method

Year CalculationDepreciation

201228 246 x $60 000$6829

201334 246 x $60 000$8293

2014 42 246 x $60 000$10 244

2015 55 246 x $60 000$13 415

2016 68 246 x $60 000$16 585

201719 246 x $60 000$4634

$60 000

The units-of-production method results in a depreciation charge based on the expected use or output of the asset. Depreciation is calculated by taking the actual usage for the year and dividing it by total expected usage and then multiplying it by the depreciable amount

5.24As the new disk drive will only work on the existing computer, it must be depreciated over the remaining useful life of the computer (which is 3.5 years following the acquisition of the high speed disk drive).

Initial cost of computer$50 000

Hardware modifications$40 000

$90 000

Depreciation = $90 000 ( useful life of 5 years$18 000

High-speed disk drive$20 000

Depreciation = $20000 ( remaining useful life of computer = $20 000 ( 3.5 years $5714

Total depreciation expenses$23 714

5.25(a)($29 000 $7000)/7 = $3143 per year.

(b)The sum-of-digits is determined as: n(n + 1)/2 = 28

Year

1($29 000 $7000) x 7/28 =$5500

2($29 000 $7000) x 6/28 =$4714

3($29 000 $7000) x 5/28 =$3929

(c)If we use a specified percentage, 33 per cent in this case, we perhaps may elect to apply the percentage to the cost, less the salvage value, or instead to the total cost of the asset.

If we apply the percentage to the cost alone, then we would need to discontinue depreciating when we reach the salvage value. Whatever approach is adopted, it should reflect the underlying economic reality.

Applied to cost

Year

129 000 x 0.33 =9570

2(29 000 9570) x 0.33 =6412

3(29 000 15 982) x 0.33 =4296

Applied to cost less salvage value

Year

122 000 x 0.33 =7260

2(22 000 7260) x 0.33 =4864

3(22 000 12 124) =3259

(d)Year

1($29 000 $7000) x 6000/35 000 =$3771

2($29 000 $7000) x 7000/35 000 =$4400

2($29 000 $7000) x 5500/35 000 =$3457

5.26For an asset with a useful life of six years the sum-of-digits depreciation is:

n(n + 1) 2 = 6 7 2 = 21

First year depreciation 30 June 2012 = 6 21 $250 000 $71 429

Second year depreciation 30 June 2013 = 5 21 $250 000$59 524

Third year depreciation 30 June 2014 = 4 21 $250 000 $47 619Total accumulated depreciation at 30 June 2014$178 572Therefore the carrying amount of the asset is $71 428, made up of the historical cost of $250000 less the accumulated depreciation of $178 572.

Calculation of the present value of the consideration receivable:

$60 000 in 1 year discounted at 6% = $60 000 x 0.9434 = $56 604

$50 000 in 2 years discounted at 6 % = $50 000 0.8900 = $44 500

$101 104

The journal entry at the date of the disposal is:

1 July 2014

Dr Loan receivable 101 104

Dr Accumulated depreciationmachinery 178 572

Cr Machinery

250 000

Cr Gain on sale of machinery

29 676

At the end of the financial year, the increase in the value of the loan receivable must be recognised. It will be calculated as:$101 104 6% = $6 066.

30 June 2015

Dr Loan receivable 6066

Cr Interest revenue

6066

DrCash at bank60 000

CrLoan receivable

60 000

Again, at the end of the second year, the increase in the value of the receivable must be recognised, and then the receipt of cash must be accounted for. The interest revenue to be recognised equals (101 104 + 6066 60 000) 6% = 2830

30 June 2016

Dr Loan receivable2830

Cr Interest revenue

2830

Dr Cash at Bank 50 000

Cr Loan receivable

50 0005.27With limited exceptions (such as in relation to investment properties that are not accounted for in accordance with the cost modelsee AASB 140), all buildings are considered to be depreciable. As the buildings will have a limited useful life, depreciation is required to be recognised. The fact that the land may increase in value should not be used as a reason not to depreciate the building. Land and buildings are separate classes of assets, and should be accounted for separately.

5.28(a)S/LCostDepn rateDepnCarrying amt

Year 1120 00025%30 00090 000

Year 2120 00025%30 00060 000

Year 3 if kept120 00025%30 00030 000

Year 4 if kept120 00025%30 0000

30.6.13Dr Depreciation expense$30 000

Cr Accumulated depreciation$30 000

Being depreciation charge for year

30.6.14DrDepreciation expense$30 000

CrAccumulated depreciation$30 000


01.07.14Dr Accumulated depreciation$60 000

Cr Printing machine$120 000

Dr Loss on disposal$10 000

Dr Bank$50 000

Being sale of asset for $50 000

(b)Decl-balOpen CADepn rateDepnCarrying amt

Year 1120 00040%48 00072 000

Year 272 00040%28 80043 200

Year 3 if kept43 20040%17 28025 920

Year 4 if kept25 920remainder25 9200









Dr Gain on disposal$6800

Dr Bank$50 000


(c)SOYDCostDepn rateDepnCarrying amt

Year 1120 0000.448 00072 000

Year 2120 0000.336 00036 000

Year 3 if kept120 0000.224 00012 000

Year 4 if kept120 0000.112 0000









Cr Gain on disposal$14 000

Dr Bank$50 000


(d)ProductionCostHoursDepnCarrying amt

Year 1120 000300030 00090 000

Year 2120 000340034 00056 000









Dr Loss on disposal$6 000

Dr Bank$50 000


5.29Original depreciation

Depreciation expense = $800 000/20 years = $40 000 per annum




Carrying amount

Cost$800 000

Accumulated depreciation to 30.6.12 (5 x $40 000) 200 000

Carrying amount 30.6.12$600 000

Change of estimated useful life 30.6.13

Carrying amount brought forward prior to depreciation for y/e 30.6.12$600 000

Remaining useful life including the current year16 years

Annual depreciation charge, to be applied in y/e 30.6.13$37 500




Carrying amount

Cost$800 000

Accumulated depreciation to 30.6.013 (5 x $40 000 + $37 500) 237 500





Carrying amount

Cost$800 000

Accumulated depreciation to 30.6.14 (5 x $40 000 + 2 x $37 500) 275 000


5.30Austar changed its policy relating to the depreciation of installation costs. Installation costs would be considered to be an intangible asset. It depreciates the costs over 5 years, rather than the former policy of 3 years. This can be justified to the extent that the useful life of the assets associated with the installation costs can reasonably be assessed as being 5 years. Austar would have incurred installation costs on the assumption that the costs would generate subsequent economic benefits in the form of income streams from customers. To justify using 5 years as the period for amortising the installation costs Austar must believe that each customer will, on average, stay with the organisation for at least 5 years. Should this expectation change then subsequent changes would need to be made to adjust the depreciation expense to be charged each period.

5.31A major issue raised in the article is that councils are basing their depreciation charges on historical cost rather than on fair values. There is also criticism made of councils on the basis that their spending on infrastructure is very low and that the spending is less than the annual depreciation charges. There is a perception that current use of council infrastructure will have to be funded by future ratepayers.

This is a common criticism of depreciating assets on the basis of historical costs. The yearly depreciation charge might have little correspondence with the actual decline in fair value of an asset, particularly if the costs of the assets are increasing rapidly across time. Because organisations might distribute their profits, they might find that they have insufficient funds on hand to replace assets when the requirement to replace assets subsequently becomes necessary. This risk would be less if the periodic depreciation charges were based on up-to-date fair values. Nevertheless, AASB116 provides organisations with a choice between recording assets at historical cost, or on the basis of fair values (through asset revaluations).

In terms of why the council would prefer to value their assets at historical costs we obviously cannot be certain. What we do know is that recording assets on the basis of historical cost will lead to lower depreciation and greater profits on ultimate sale of assets. Higher profits might be something that council officers prefer, particularly perhaps if they are on some form of bonus relating to council profitability. Further, the adoption of historical costs will also lead to improvement in a variety of financial performance indicators, such as return on assets (given the lower asset base).

5.32 If the company distributes all its profits in the form of dividends then to ensure that the company is not effectively going backwards we need to consider whether the expenses actually reflect the real decline in the value of assets being used. If depreciation is being based on historical cost then it does not actually reflect the actual value of the aeroplane being consumed. For example if the same aeroplane had a current replacement cost of $110 million then recognising depreciation on the basis of a cost of $75 million means in effect that we are overstating real profits, and effectively paying out more in dividends than we should. This problem would be alleviated to some extent if revaluations were undertaken as the depreciation would then be based on the higher depreciable amount, meaning profits would be less and dividend payments would be reduced.Solutions Manual t/a Australian Financial Accounting 7e by Craig Deegan

Copyright 2012 McGraw-Hill Australia Pty Ltd

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