NON-CURRENT ASSETS LEARNING OUTCOMES

9. NON-CURRENT ASSETS LEARNING OUTCOMES

At the end of the topic, the student should be able to:

Know and understand the Tangible Assets

 Scrapping of Alienation of Assets  Non-current assets are divided into tangible assets,

intangible assets and other financial assets. Tangible assets (property, plant and equipment) were discussed in the previous topic. In this topic other non-current assets (intangible assets and other financial assets) will

be discussed.

Non-current assets (fixed assets) are acquired with the following purposes in mind:

 The carrying out of operations  In support of operations  To facilitate operations

Non-current assets may be tangible, intangible or financial assets.

9.1 TANGIBLE ASSETS

Tangible non-current assets are assets such as buildings, machinery, vehicles and furniture. They are assets which you can see and touch. They are shown in the statement

of fi a ial positio u de the headi g P ope t , pla t a d e uip e t''.

Because property, plant and equipment become obsolete after several years, they must be written off over their expected economic life. This is usually done by means of a provision referred to as depreciation. The annual amount written off is treated as an expense in the profit and loss account.

The cost price of property, plant and equipment consists of: - The purchase price, including all expenses incurred in getting the asset to the premises - All the installation costs including, for example, the wages of the businesses own technical personnel

- Any other expenses incurred in getting the asset operational

The cost price will remain constant throughout the life of the asset and is referred to as the historical cost price.

Financing costs on loans raised to acquire the asset are not included in the cost price of the asset. The same applies to maintenance costs.

Depreciation

The systematic allocation of a depreciable amount of an asset over its useful life. Three methods of calculating depreciation:

 straight line method  reducing/diminishing balance method  sum of year digits method

Depreciable amount - Cost of an asset, or another amount that replaces the cost of an asset less residual value. Residual value - The value of an asset which may remain at the end of its useful life. Useful life - A period during which an asset is expected to be used by the business.

Book Value/Carrying Amount - Cost of an asset less accumulated depreciation.

For the purpose of this course we will only focus on first two methods. We emphasized the point that these two methods simply provide an alternative way of allocating the total depreciation charge over several accounting periods.

The total depreciation charge using either method will be the same over the total useful economic life of the asset.

To illustrate the reducing balance depreciation method, we have calculated the depreciation charge for the following asset:

Example

A business purchases a new machine for R75, 000 on 1 January 2003. It is estimated that the machine will have a residual value of R10, 000 and a useful economic life of five years. The business decides to calculate annual A business purchases a new machine for R75, 000 on 1 January 2003. It is estimated that the machine will have a residual value of R10, 000 and a useful economic life of five years. The business decides to calculate annual

Reducing balance depreciation method

Using the reducing balance depreciation method, the calculation of the annual depreciation charge is as follows:

31 R December

Original machine cost 75,000 2003

Depreciation in 2003 (40% cost) 30,000 Written down value at 31 December 2003

Depreciation in 2004 (40% of WDV @ 31 2004

18,000 December 2003)

Written down value at 31 December 2004 27,000

Depreciation in 2005 (40% of WDV @ 31 2005

10,800 December 2004)

Written down value at 31 December 2005 16,200

Depreciation in 2006 (40% of WDV @ 31 2006

6,480 December 2005)

Written down value at 31 December 2006 9,720

Depreciation in 2007 (40% of WDV @ 31 2007

3,888 December 2006)

Written down value at 31 December 2007 5,832

The reducing balance method can result in significant differences in the annual depreciation charge, depending on the "percentage" of written-down value that is used to calculate the charge .In the example above, the total amount charged to depreciation in the first three years of owning the machine (2003- 2005) was R58, 800 (compared with R39, 000 if a straight line depreciation method has been used).

Example

A business purchases a new machine for R75, 000 on 1 January 2003. It is estimated that the machine will have a residual value of R10, 000 and a useful economic life of five years. The business has an accounting year end of 31 December.

Straight line depreciation method

Using the straight line depreciation method, the calculation of the annual depreciation charge is as follows:

Dpn = (C- R)/ N

Where: Dpn = Annual straight-line depreciation charge

C = Cost of the asset R = Residual value of the asset N = Useful economic life of the asset (years) So the calculation is: Dpn = (R75, 000 - R10, 000) / 5 Dpn = R13, 000 In the accounts of the business a depreciation charge of R13, 000 will be expensed in the profit and loss account for each of the five years of the asset's useful economic life.

In the annual balance sheet, the machine would be shown at its original cost less the total accumulated depreciation for the asset to date.

Example of how this would be disclosed in the accounts

At the end of the third year of ownership of the machine, the financial accounts of the business would include the following items in relation to the machine:

In the Profit and Loss Account:

Depreciation of Machinery - Charge: R13, 000

In the Balance Sheet at 31 December 2005:

Machine at Cost

Less: Accumulated Depreciation

Machine at net book value 36,000

The figure for accumulated depreciation of R39, 000 at 31 December 2005 represents three years' worth of depreciation at R13, 000 per year. The cost of the machine (R75, 000) less the accumulated depreciation charged on the machine (R39, 000) is known as the "written-down value" ("WDV") or "net book value" ("NBV").

It should be noted that WDV or NBV is simply an accounting value that is the result of a decision about which method is used to calculate depreciation. It does not necessarily mean that the machine is actually worth more or less than the WDV or NBV.

Pro rata depreciation:

When an asset is sold before the end of its expected life span and during the financial year, the pro rata depreciation for the period from the beginning of the financial year up to the date of sale must be taken into account as part of the accumulated depreciation. For example, if you sell an asset on 30 September and the financial year end is 31 December, the asset has been in use for 9 months. If the percentage for a full year is 20%, the pro rata depreciation in this case would be 9/12 x 20% for the last year.

9.2 SCRAPPING OF ALIENATION OF ASSETS

An enterprise may dispose of an asset in various ways, such as:  Demolish the asset

 Sell it outright  Trade it in as a partial payment on the purchase of a new asset

Relevant entries must be recorded, irrespective of the manner in which the asset was disposed. This encompasses the following:

 The recording of the sale of the asset.  The updating of interim depreciation for the part of the year which has

elapsed since the last financial year.  The removal of both the cost of and the accumulated depreciation on the assets from the books.  The determination and recording of any profit or loss with the demolition or alienation of the asset.

9.3 SCRAPPING AN ASSET WITHOUT ALIENATION

Should an asset no longer be economically serviceable, sold or traded in but simply disposed of as scrap or dismantled, the actual recording process would depend on whether the asset (at that time) was already written off in full. There will be no loss when the asset is scrapped, if this was the case. A loss may arise if the asset was not written off. In such a case the loss will be transferred to the profit and loss account at the end of the financial period.

9.4 SALE OF AN ASSET

The procedure for recording the sale of an asset subject to depreciation is very similar to that described above, except the receipt of cash or another asset at the same time of sale must be recorded. The asset can be sold at a profit or a loss, or without making either. If an asset is sold for more than the carrying value or amount, a profit is made. If it is sold for less than the carrying amount, the enterprise suffers a loss.

The following six (6) steps should be followed when dealing with the disposal of an asset:

1. Record the depreciation of the current period up until the date of disposal (general journal): Debit: Depreciation Credit: Accumulated depreciation

Now calculate the total accumulated depreciation of the disposed asset.

2. Transfer the total accumulated depreciation of the disposed asset to the realization account (general journal): Debit: Accumulated depreciation Credit: Realisation account

3. Transfer the cost price of the disposed asset to the realisation account (general journal): Debit: Realisation account Credit: The particular asset account (Vehicles, Equipment, etc.)

4. Record the amount earned on the realisation (note that the realisation account is credited in all three cases):

4.1 Sold for cash (CRJ): Debit: Bank Credit: Realisation account

4.2 Sold on credit (general journal): Debit: Debtor (and Debtors control account) Credit: Realisation account

4.3 Asset traded in (general journal): Debit: The asset account (as part of the cost price of the new asset) Credit: Realisation account

5. Determine the profit or loss on the disposed asset:

5.1 If the total of the debit side of the realisation account is bigger than that of the credit side, the asset was disposed of at a loss.

5.2 If the total of the credit side of the realisation account is bigger than that of the debit side, the asset was disposed of at a profit.

6. Transfer the profit or loss to the profit or loss account on disposal of that type of asset (general journal):

6.1 Profit: Debit: Realisation account Credit: Profit on disposal of ... account

6.2 Loss: Debit: Loss on disposal of ... account Credit: Realisation account

Sale of an asset more than the carrying amount

A motor vehicle purchased by an enterprise several years ago for R60000 is sold on 31 December 19.6 for a cash price of R12000. On that date the accumulated depreciation amounted to R50000.

The profit or loss on the sale of the asset is the difference between the carrying amount of the asset and the selling price received for it:

Cost price of the asset R60000 Accumulated depreciation R50000

Carrying amount R10000 Selling Price R12000

Profit on sale of asset R 2 000

Journal Entries Debit Credit

Bank 12000 Motor vehicle realisation account 12 000 Receipt of selling price

Motor vehicle realisation account 60000 Motor vehicle account 60 000 Transfer of original cost price of vehicle sold to the realisation account

Accumulated depreciation motor vehicles 50000 Motor vehicle realisation account 50 000 Transfer of accumulated depreciation on vehicle sold to

the realisation account

Motor vehicle realisation account 2000 Profit on sale of motor vehicle 2 000 Transfer of profit on sale of asset

Sale of an asset for less than carrying amount

An enterprise owns ten delivery vehicles, all bought on 1 March 19.2 at R80000 each. The annual depreciation provided is 20% per year on the original cost price. On 28 February 19.5 one of the vehicles is sold for R25000 cash.

Journal entries Debit Credit

Bank 25000 Vehicle realisation account 25000 Receipt of selling price

Vehicle realisation account 80000 Delivery vehicles account 80000 Transfer of cost price of delivery vehicle sold on

28 February 19.5

Accumulated depreciation: Delivery vehicles 48000 Vehicle realisation account 48000 Transfer of accumulated depreciation to

28 February 19.5 on vehicle sold

Loss on sale of non-current assets 7000 Vehicle realisation account 7000 Transfer of loss on vehicle sold

Calculations

The total accumulated depreciation on ten delivery vehicles on 28 February

19.5 are calculated as follows: 20% per annum for 3 years on R800000 (cost price) =

R480000 Accumulated depreciation on one vehicle (1/10* R480000) = R 48000 Loss on sale: Cost price of vehicle

R80000 Accumulated depreciation to date of sale

R48000 Carrying Amount

R32000 Sale price R25000

Loss on sale R 7000

9.5 TRADING IN OF ASSETS

It is general practice to trade-in an old asset when acquiring a new one (usually of the same type). The trade-in value allowed by the seller is deducted from the selling price of the new asset and the purchaser pays, or undertakes to pay, the balance owing. As with the sale of an asset, trading in an old asset can give rise to either a profit or a loss, depending on whether the trade-in value is higher or lower than the carrying amount.

A new machine is purchased for R10000. An old machine which cost R6000 and with depreciation amounting to R5000 is traded in on the new machine. A trade-in value of R1400 is received and the balance of the purchase price of the new machine is paid in cash.

Journal Entries Debit Credit

Machinery 10000 Creditor 10000 New machine purchased

Creditor 10000 Machinery 1400 Bank 8600 Settlement of purchase price by trading in machine Y and cash payment

Accumulated depreciation 5000 Machinery 5000 Transfer of accumulated depreciation on machine Y on trade in:

Machinery 400 Profit & loss 400 Recording profit on trade in of machine

9.6 OTHER NON-CURRENT ASSETS

Intangible Assets

….ide tifia le, o -monetary assets without physical substance held for use in the production or supply of goods or services, for rental to others or for

administrative purposes, which are controlled by an entity as a result of past events, and from which future economic benefits are expected to flow to the entity.

These types of assets do not have a physical nature; rather, it is classified as an asset because of the rights and advantages it has for the owner. The value of this type of asset is often determined by the general business factors as an asset may have an uncertain existence. Examples are patents, copyrights, research costs of uncompleted projects, trademarks and trade names If an asset is purchased, the purchase price and all its costs relating to the purchase, such as legal costs, constitute the cost price of the asset.

Sometimes an asset is not purchased from an outsider, but the enterprise itself undertakes the development of the project. In this case the cost is more difficult to mention and all costs incurred during the development must be recorded correctly.

Financial Assets

Cash investments

Every entity tries to invest its available cash in the most profitable way; that is the entity tries to:

 obtain the highest yield, or  earn the best return on its investment

Although cash investments may not always be the most profitable type of investment, entities often have cash temporarily available which they want to invest for a relatively short period.

The cash may be required on a specific future date.

These investments may be in the form of savings accounts, call deposits or fixed deposits. This kind of investment usually yields interest at a fixed rate or a rate that does not change often.

Investments in shares

A popular form of investment is the purchase of shares in a company. The

i est e t etu o sha es is alled di ide ds''.

Dividends earned on investments in shares differ from interest in that interest is usually earned at a fixed rate while dividends are received only if the company which issued the shares declares a dividend. The rate at which dividends are to be paid out is decided on annually. The accounting procedure is basically the same as for interest.

As regards the extent of dividends declared, you should note that dividends are shown either as a percentage of the nominal value of the shares or as cents per share.

Recording of an Investment

The following transactions peculiar to investments must be recorded:  The acquisition of the investment

 Income earned from the investment  The sale of the investment

As in the case of non-current assets, the cost concept should be applied and the acquisition of the investment be recorded at cost. The cost price will

i lude all e pe ses i u ed i the a uisitio , su h as the p i e, oke s fees and commission.

Example

On 1 July 2008 Char Limited buys 1000 ordinary shares in Babsa Limited at 2800 cents per share and pays R500 in oke s fees. During the year Babsa Limited declared a dividend of 100 cents per share. In January 2009 Char Limited decides to sell its shares, as it now seems as if the growth possibilities of the shares are not very good. The shares are sold for 2700 cents per share.

The Journal entries are as follows:

DR 2008

CR

Investment in Babsa Limited

July 1 Bank 28500 Purchase of 1000 shares at 2800 cents

per share plus brokers fees of R500 2008

Bank

Dec 31 Dividends Received 1000 Receipt of dividends of 100 cents

2009 Bank

Jan 15 Loss on sale of shares

Investment in Babsa Limited 28500 Sale of 1000 shares in Babsa Limited at 2700 cents per share

Investment in Associated Enterprises

An associate is an incorporated or unincorporated enterprise in which an investor holds long term equity and which he is able to influence significantly, but which is not a subsidiary or joint enterprise of the investor. If the investor holds directly or indirectly more than 20% of the voting power of an enterprise, it is assumed that the investor has significant influence unless the contrary is clearly proven. This type of investment is made purely from an investment point of view and to promote the business activities of the investor. Two examples are an investment in an enterprise which provides essential raw

ate ials, o i a e te p ise hi h a kets the i esto s p odu t. I the ase of an investment in an associate company, the investor should disclose its

share of the net profit of the associated firm in the year in which it is earned. This is known as equity reporting or equity method and in essence means that the investment is valued on the basis of cost price, plus the portion of the profit or loss of the associated enterprise.

Example

On 2 January 19.8 INF Ltd buys 30% of the ordinary shares in Logo Ltd for R250000. Logo Ltd made a profit of R750000 during 19.8 and declared a total dividend of R100000.

The following entries were made in the books of INF Ltd:

Dec 31 Investment in Logo Limited

Bank 250000 Purchase of 30% equity in Logo

Limited Bank

Income from investment 225000 Dec 31 Recording portion of net profit of

associated company for the year(30% * R750000)

Bank

Dividends received 30000 Dec 31 Dividend received from Logo

Limited

Disclosure of Investments in the Financial Statements

Investments are shown separately between non-current and current assets in the Statement of Financial Position (Balance Sheet), since they are made outside the enterprise and have a distinctive character. If, however the investments are speculative or short term, they must be shown as current assets.