Accounting for non-current assets

Welcome to Accounting for Non-Current Assets!

In this chapter, we are going to explore how businesses handle the "big stuff"—the assets they buy to use for a long time, like delivery vans, machinery, and office buildings. These aren't just everyday purchases; they are investments in the future of the business. Understanding how to record their cost, their wear-and-tear (depreciation), and what happens when we sell them is a vital skill for any accountant. Don't worry if it seems like a lot of numbers at first—we'll break it down step-by-step!

1. Capital and Revenue Expenditure

Before we can record an asset, we need to know what kind of "spending" it is. Not all money spent is treated the same way in the books.

Capital Expenditure

This is money spent on buying or improving non-current assets. It results in a long-term benefit (more than one year).
Example: Buying a new van, or adding a specialized hydraulic lift to an existing van.

Revenue Expenditure

This is money spent on the day-to-day running of the business or maintaining an asset in its current state.
Example: Buying petrol for the van, paying for insurance, or a routine oil change.

Capital and Revenue Income

Capital Income comes from selling a non-current asset (like selling that old van). Revenue Income is the money earned from normal trading (like the fees charged for deliveries).

Why Does the Distinction Matter?

If you get these mixed up, your profit will be wrong!
- If you treat Capital Expenditure as Revenue: Your expenses look too high, so your profit is understated, and your assets look too low.
- If you treat Revenue Expenditure as Capital: Your expenses look too low, so your profit is overstated, and your assets look too high.

Quick Tip: Think of it this way—if the spending makes the asset "better" than it was when you first got it, it’s Capital. If it just keeps it "working," it’s Revenue.

Key Takeaway: Always check if the spending adds long-term value (Capital) or just keeps things running (Revenue).

2. Depreciation: The Cost of Using Assets

Non-current assets (except most land) don't last forever. They wear out, break down, or become old-fashioned. In accounting, we spread the cost of the asset over the years we use it. This is called Depreciation.

Why do assets depreciate?

1. Physical Deterioration: Wear and tear from use.
2. Economic Factors: Becoming "obsolete" (like an old computer that is too slow for new software).
3. Time: Some assets have a legal time limit, like a 10-year lease on a building.
4. Depletion: Using up natural resources (like a mine or a well).

The Accounting Concepts Behind Depreciation

- Matching/Accruals: We match the cost of the asset against the income it helps us earn each year.
- Prudence: We ensure assets are not "overvalued" on the Statement of Financial Position.

Did you know? Land usually does not depreciate because it has an "infinite" life—it doesn't wear out!

3. How to Calculate Depreciation

There are two main methods you need to master for your exam:

Method 1: Straight-Line Method

The asset loses the same amount of value every year. It is best for assets that provide equal benefit over time, like a building lease.

Formula:
\( Annual\ Depreciation = \frac{Cost - Estimated\ Residual\ Value}{Expected\ Useful\ Life} \)

Example: A machine costs \$10,000, has a residual value (scrap value) of \$1,000, and will last 3 years.
\( (\$10,000 - \$1,000) / 3 = \$3,000\ per\ year. \)

Method 2: Reducing Balance Method

The asset loses more value in the early years and less in the later years. This is common for cars and computers. We apply a percentage to the Net Book Value (NBV), which is the Cost minus any depreciation already taken.

Formula:
\( Annual\ Depreciation = Net\ Book\ Value \times \% \)
\( (Where\ NBV = Cost - Accumulated\ Depreciation) \)

Common Mistake: For the Reducing Balance method, never subtract the residual value before calculating. Just use the NBV!

Key Takeaway: Straight-line = same amount every year. Reducing Balance = percentage of the current (lower) value each year.

4. Revaluation of Assets

Sometimes, an asset (like a building) might actually increase in value. Under the Revaluation Model, we adjust the asset's value in our books to reflect its current market value.

When an asset is revalued upwards:
1. Increase the Asset Account.
2. Remove any Accumulated Depreciation that was already recorded.
3. The "gain" goes into a Revaluation Reserve (part of Equity).

5. Recording Asset Transactions (Ledger Accounts)

You will often be asked to prepare T-accounts. Here is the standard "pathway" for a non-current asset:

The Asset Account (At Cost)

- Debit: When you buy an asset or revalue it upwards.
- Credit: When you sell/dispose of the asset (transferring the original cost to the Disposal account).

The Provision for Depreciation Account

This is where we "collect" the depreciation over the years. It is a credit-balance account.
- Credit: Every year-end when we calculate the annual depreciation charge.
- Debit: When we sell the asset (transferring the total depreciation to the Disposal account).

The Disposal Account

This is a temporary account used to calculate the Profit or Loss on Disposal.
- Debit side: The original Cost of the asset.
- Credit side: The Accumulated Depreciation up to the date of sale.
- Credit side: The Cash/Bank received from the sale (or the Part-Exchange allowance).

Calculating Profit/Loss:
If the Credit side is bigger = Profit.
If the Debit side is bigger = Loss.

Memory Aid: Use "CRAP" for Disposals!
Cost (Debit Disposal)
Remove Depreciation (Credit Disposal)
Amount Received/Cash (Credit Disposal)
Profit or Loss (The balance)

Key Takeaway: The Disposal account is just a "bin" where we put the cost, the old depreciation, and the cash received to see what's left over.

6. Financial Statement Presentation

Where do these numbers go at the end of the year?

Statement of Profit or Loss (Income Statement)

- The Annual Depreciation Charge for the year is listed as an Expense.
- Any Loss on Disposal is an Expense.
- Any Profit on Disposal is Other Income.

Statement of Financial Position (Balance Sheet)

- Non-current assets are shown at their Net Book Value (NBV).
- The format is usually: Cost - Accumulated Depreciation = NBV.
- If an asset was revalued, the Revaluation Reserve appears in the Equity section.

Quick Review Box:
- Cost: What you paid for it (plus installation/delivery).
- Accumulated Depreciation: Total "wear and tear" from all previous years.
- Net Book Value: The value of the asset right now in the books.

Don't worry if this seems tricky at first! Practice drawing the T-accounts for Disposals—that is usually where students find the most success once they've mastered the pattern.