Week 04 Student - 3pp

7/31/2019 Week 04 Student - 3pp

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Accounting Transactions and Analysis

Week 4: Lecture 7

Property, Plant and Equipment (PPE)

Weekly Roadmap Week 4

LectureAttendance

Readings andResearch Assignment

TutorialPreparation

Questions,

MultipleChoice &Exercises

Problems, CaseStudies &Projects

Content

Key Content

Property, Plant &Equipment (PPE)

Accounting inContext

Potter, Libby,Libby & Short.

Chapter 8

Financial Reports& Research

Access the financialReports for CountryRoad and Pacific

Reading

SupplementaryStudy Notes forWeek 4

Accounting InContext Potter

Chapter 8Pages 428-497


Chapter 8Pages 428-497

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Definition of CostDefinition of Fair Value

DepreciationStraight LineReducing balanceUnits of Production

Disposal / Scrapping ofPPE

Sale of AssetSale of Asset methodCarrying amountmethod

Revaluation of PPE

Posting Lectures:All completed lectureslides will be posted onthe LMS at theconclusion of the lectureplus 1 day.

Pages 428-497

KeyTermsPage 469

Additional

Readings

Inventory Note

Super Cheap AutoLtd Annual Report2007Note 13Page 1106

JB Hi-Fi Ltd AnnualReport 2007Note 16Page 1037

BrandsCreate WorkingPapers of allcalculations

CountryRoad20092008

20072006

Pacific Brands2009200820072006


Ratios Profitability,Efficiency & Liquidity

Tutorial Week 4All tutorialQuestions

Posting TutorialSolutions:

Solutions to alltutorial questionswill be posted onthe LMS after alltutorials for thatweek have beencompleted.

QuestionsPage 469-470QuestionsQs. 7,8,9,10 & 12

Multiple Choice

Pages 470Questions1-10

ExercisesPages 473-481ExercisesE8-1,E-2,E84,E8-8,E8-9 &E8-14

ProblemsPages 481Problems8-3, 8-5,8-6 &8-7

AlternativeProblems

Pages 487-491Students choice

Case & ProjectsPage 492Case StudyCP8-1,CP8-3&CP8-8

PPE & Valuation

Objectives

At the end of this lecture you should be able to

Calculate depreciation of assets using:

Straight line

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Units of production / use

Reducing balance

Account for a change in the depreciation method /

calculation during the life of an asset

Record the entries when an asset is scrapped


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PPE & Valuation

PPE and Valuation PPE is an account that involves significant risk

Typically PPE has significant $ values attached to it

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The cost of an asset (ARA)

Depreciation

An assets fair value

Depreciation

PPE and Depreciation (Recall from ARA)

Depreciation defined

The allocation of the cost of a non-current asset over its

estimated useful life

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Important points:

Depreciation is not a cash flow!

Depreciation is an estimate of the decline in future benefit,NOT the decline in value!

Depreciation Methods

Straight line (ARA)

Units of production / units of use

Depreciation

Cost Estimated residual valueLife

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u

Recall from ARA the entry to record

depreciation:

DR Depreciation of PPE ExpCR Accumulated depreciation of PPE -A


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Depreciation

Depreciation Methods Units of production / units of use

used for assets where output can be measured

determines a rateof de reciation erunit ofout utb

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dividing depreciable cost by the total output expected

over the life of the asset:

Units of Production Depreciation rate

Cost estimated residual value

Estimated useful life in units

Depn per unit of output =

Depreciation


Units of production / use

the depreciation expense in any period is then calculated

b :

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Depreciation

expense for

the period

=

Depreciationrate per unit(calculated onprevious slide)

xActual units of

output forthe period

Depreciation


Reducing balance method

a constant depreciation rate is applied to the carrying

amount of the asset

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as each year passes the assets carrying amount reduces

and the amount of depreciation charged in subsequent

years diminishes

rule-of-thumb: RB rate = 1.5 x SL rate

depreciation is therefore charged at an accelerated rate

since a greater allocation occurs in the early part of the

assets life


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Depreciation

Case Study TW Lecture Illustration On 1 January 2005 Tarrant Woods purchased a

computer system as follows: Cost $8,000

Useful life ears) 10

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Useful life (machine hours) 15,600

Hours used 1 January 2005 to 30 June 2005 780

Hours used 1 July 2005 to 30 June 2006 1,800

Hours used 1 July 2006 to 30 June 2007 1,650

Residual value disposal costs $200

Calculate the depreciation to 30 June over each of thenext three years under each method

Depreciation

Case Study TW Lecture Illustration

(1) Straight line method:

Y/E 30 June 2005:

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Y/E 30 June 2006:

Y/E 30 June 2007 (and each subsequent year):

Depreciation


(2) Units of production method:

Rate =

12

Y/E 30 June 2005:

Y/E 30 June 2006:

Y/E 30 June 2007:

Note that in 2005 SL and UOP depreciation expense are the same. Why?


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Depreciation


(3) Reducing balance method:

SL rate = 780 / 8,000 = 9.75 % => RB rate =

13

Y/E 30 June 2005:

Y/E 30 June 2006:

Y/E 30 June 2007:

Y/E 30 June 2008:

Depreciation

Case Study TW Lecture Illustration So, three methods to choose from which one?

The method that best reflects the assets pattern of use /

contribution to revenue

Clear choice Units of production

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But practicality of measuring output may restrict

choice between SL & RB

If contribution to revenue / pattern of use is constant =>SL

If contribution to revenue / pattern of use is greatest

during early part of assets life => RB

Depreciation


Comment on the useful life (10 yrs) of the

computer

Seems a long time for a computer system

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So why might Tarrant Woods use 10 years?

Recall from ARA

Agency theory / earnings management

Report higher profits in the short term


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Depreciation

Case Study TW Lecture Illustration Are the current useful lives being used by Tarrant

Woods reasonable?

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Assets

u ngsImprovements

Equipment

Fixtures

Land

Estimatedresidual value

Nil Nil Nil Nil N/A

Estimated usefullife

5 40 10 10 N/A

Depreciation rate 20.0% 2.5% 10.0% 10.0% N/A

Depreciation


Currently Tarrant Woods uses straight line

depreciation

What strategies could Tarrant Woods use to alter

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ts eprecat on expense n t e current year

Change methods would need to disclose in notes

Change residual value estimates

Change estimated useful lives

Adjusting PPE

PPE and Depreciation How do you account for changes in the useful life

of an asset? if a company finds that a change is warranted in its

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es ma e o an asse s use u e, we o no c ange epast calculations

the current Carrying Amount (cost less accumulateddepreciation) is treated as the assets cost

subsequent depreciation calculations are based on thisrevised cost


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Adjusting PPE

Case Study TW Lecture Illustration On 31 March 2005 Tarrant Woods purchased a post-

driver (for installing fence posts) as follows:

Cost $12,000

Depreciation method Straight line

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Estimated useful life 4 years

Estimated residual value $2,000

On 30 June 2005 a review of all vineyard assets by

independent valuers Potter Bradley & Associates

determined that the asset was likely to have a useful life

of 10 years and no residual value

To 30 June 2005 depreciation has been recorded based

on the original estimates

Adjusting PPE


The journal entries to account for this change are

as follows:

The General Journal

Date Account and Explanation Post Debit Credit

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Ref

200530 June Accumulated Depreciation

PPE (Post driver)Depreciation write back

(12,000 2,000) / 4 yrs x 3/12

200630 June Depreciation expense

Accumulated depreciation

Record subsequent depreciation=(12,000 625) / 10 = 1137.5 peryear

Adjusting PPE

PPE and Asset Disposals

Eventually, a non-current asset will no longer

serve the needs of the business (i.e. FB used up)

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ever be exhausted?)

At the end of an assets useful life, a business will

generally dispose of the asset by scrapping it,

selling it, or exchanging it


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Adjusting PPE

PPE and Asset Disposals Scrapping an asset

If the asset is fully depreciated with no residual value,

the entry to record its disposal is:

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The General Journal

Date Account and ExplanationPostRef

Debit Credit

Accumulated depreciation - asset $

Asset $

Recording the scrapping of afully depreciated asset

Adjusting PPE

PPE and Asset Disposals

Scrapping an asset

If the asset is not fully depreciated, a loss is recorded to

write off the remaining book value:

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The General Journal

Date Account and Explanation Post

Ref

Debit Credit

Accumulated depreciation - asset $

Loss on scrapping asset (write down) $

Asset $

Recording the scrapping of a partiallydepreciated asset

Adjusting PPE


On 31 May 2005, one of Tarrant Woods tractors

was involved in an industrial accident. Details of

this asset are:

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Cost (Purchased 1/02/05) $30,500

Carrying value $29,483

Estimated useful life 10 yrs

Residual value nil

The asset was uninsured

The asset cannot be repaired

Tarrant Woods ceased depreciat ion at 31 May because the

tractor was no longer operational


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Adjusting PPE


Journal entry:

The General Journal

Date Account and Explanation Post Debit Credit

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Accumulated depreciation - asset

Loss on scrapping asset (write down)

Asset


Adjusting PPE


What if the tractor was insured for $20,000?

The General Journal

Date Account and Explanation PostRef

Debit Credit

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Accumulated depreciation - asset

Bank / Other receivables

Loss on scrapping asset (write down)

Asset


Accounting Transactions and Analysis

ec ure roper y, an an qu pmen(PPE)


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PPE & Valuation

Objectives At the end of this lecture you should be able to

Record entries for the sale of an asset

Sale of asset method

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Carrying amount method

Record entries for asset revaluations

Prepare an appropriately classified property plant and

equipment note

Prepare a reconciliation of movements in property plant

and equipment

Sale of PPE

PPE and Valuation

Sale of Assets

At the end of an assets useful li fe the business may

seek to sell the asset to recoup some of its initial cost

At the date of sale an entry is made for pro-rationed

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depreciation since the last adjustment

The final carrying amount (cost less AD) is compared to

the proceeds of the sale: If proceeds > CA => recognise a profit on sale of asset

If proceeds < CA => recognise a loss on sale of asset

There are two methods to record a sale of asset

Sale of asset method

Carrying amount method

PPE Disclosure

Sale of Asset Example

A business provides the following details relating

to the sale of one of its motor vehicles used by its

executives on Jul 1, 2007:

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Motor vehicles a/c balance $200,000 DR

Accumulated depreciation a/c balance $80,000 CR

The vehicle, which cost $50,000 and had a CA of

$35,000, was sold for $40,000 cash


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PPE Disclosure

Sale of Asset Example What is a profit (or Loss) on sale?

Cost less proceeds = actual cost of benefit In our example: MV cost $50, sold for $40 => benefit actually

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CA = cost less our estimate of benefit used up (i.e.depreciation over the life of the asset)

In our example: AD was $15

So, actual cost of benefit was $10, accounting estimatewas $15 (i.e. $5 too much)

Profit on sale is really an over-provision fordepreciation [Loss on sale is really an under-provision]

PPE & Valuation

PPE and Valuation

PPE & Fair Value

Traditionally accountants have recorded assets at their

cost

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Advantage => reliability

Limitation => relevance (especially for LT assets)

Accountants / preparers have choice when recording /

disclosing PPE:

(1) carrying value; or

(2) fair value

PPE & Valuation

PPE and Valuation

PPE & Fair Value

Fair value is an estimated market value

Ma be determined based on the NPV of future cash

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flows of the asset

Obtained from independent valuer or directors

valuation


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PPE & Valuation

PPE and Valuation

Initial decremental revaluations FV < CA Must adjust regardless of method

Two entries required:

The General Journal

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Debit Credit

Accumulated depreciation $

Asset $

Depreciation writeback

Asset write down $

Asset $

Record the write down of the asset toits fair value

PPE & Valuation

PPE and Valuation

Initial incremental revaluations FV > CA

If cost do nothing, if FV record the following:

The General Journal

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Debit Credit

Accumulated depreciation $

Asset $Depreciation writeback

Asset $

Revaluation reserve $

Record asset at its fair value

Adjusting PPE

Case Study TW Lecture Illustration On 20 June 2005 Tarrant Woods received a firm offer to

buy 50% of its land for $720,000

What should / could Tarrant Woods do?

The General Journal

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Date Account and Explanation Post

Ref

Debit Credit

2005

June 30 Land

Revaluation reserve

Record asset at its estimated (implied)fair value = 720,000 x 2 = 1,440,000.Carrying value was 800,000, thusincrease carrying value by 640,000


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Adjusting PPE


The choice between CA and FV

Write-downs arising from decremental revaluations are an

expense (no choice here)

v

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Gain is not a revenue, but assets and equity

If adopt FV:

profitability ratios move unfavourably (ROE and ROA )

Gearing ratios move favourably (debt ratio )

Mgt could choose depending on which is more important

(or needs to be managed)

Comparison

Case Study TW Lecture Illustration Consider TWs profitable inventory lines

FV > CA can TW incrementally revalue?

Gross Margin AnalysisList

priceStandard

CostGrossMargin

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$ $ $

MC-White Wine sales 9.00 4.95 4.05

MC-Red Wine Sales 10.50 6.00 4.50

MC-Soft Cheese Sales 12.00 7.00 5.00

MC-Hard Cheese Sales 17.00 7.80 9.20

MC-Flavoured Oils 18.00 22.00 (4.00)

MC-Raw Oils 19.00 19.00 0.00

MC-Hot Mustards 20.00 10.00 10.00

MC-Mild Mustards 15.50 17.00 (1.50)

Financial Reporting


Now we record the previous PPE adjustments in

the worksheet in preparation for reporting

inventor in TWs financial statements

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Financial Reporting

Note 3 Profit from Ordinary Activities

2005 2004Profit from ordinary activities before income tax has been determinedafter:

a. Expenses:

Cost of sales 394,695 -

Borrowing costs:

- director related entities - -

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- controlled entities - -

- other persons 270,000 17,581

Total borrowing costs 270,000 17,581

Depreciation of non-current assets:

- Vineyard Assets 87,109 2,031

- Buildings & Improvements 39,207 3,715

- Plant and Equipment 105,693 13,202- Furniture & Fixtures 2,500 52

Total depreciation 234,509 19,000

CommercialExample

Consideration: a business has overvalued

assets

How does this affect any analysis of the business?

TA overstated => Gearing ratios understated

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What are the likely consequences of such an

overvaluation?

Directors have signed off on FSIs this a fraud?Did they know?Should they have known?

Examination

How this area may be examined

In an exam you may be asked to:

Calculate / record depreciation adjustments using

different depreciation methods

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Recor transact ons assocate w t t e sae an

scrapping of assets

Record the effects of incremental / decremental asset

revaluations

Prepare disclosure notes for

Property, Plant and Equipment, and

Depreciation


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Next Week

Whats next? Next week we will examine Liabilities and Equity

and consider any adjusts that may be appropriate

In the next session we will examine how to ad ust

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and disclose liabilities

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Week 04 Student - 3pp

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