Accounting #6 - Non-Current Assets and Depreciation

[samvara]

OMG half way through already, we skipped up two flights of stairs to use a lecture theatre that was cooler - UWA is powersaving and spending that energy on the labs *g* the temperature was pretty decent for me.

Group exercise #2 results were 90% which was awesome. Test #2 was 70% / 75% and review tells me I fall to pieces when faced with questions in the form 'if W changes will X, Y & Z...' a) increase, increase and decrease b) increase, decrease and decrease c) etc. I want to blame it on dyslexia and that does make it harder but it's also not understanding the relationships well enough to be able to make a sensible call.

What is Depreciation? (Hehe, wikipedia says Not to be confused with Deprecation.) The best I can do in simple language is say it's an accounting trick used to spread the cost of something over the entire time you use it. In non-simple language it's 'the process of allocating the net acquisition cost of a non-current asset to the particular periods that relate to the use of that asset.'

• It does not represent the value (rise or fall) of the asset despite looking suspiciously similar.

Why do we do it?

• So we can watch our assets being consumed (burn, baby, burn)
• NOT so we can maintain business capacity although that seems to be a side-affect
• NOT so we can match expense to revenue on balance sheet although that also seems to be a side-affect

How do Aussies do it? Handy guides may be found in the below sources:

• IAS 16 Property, plant and equipment
• AASB 116 Property, plant and equipment: Depreciation is 'an expense recognised systematically for the purpose of allocating the depreciable amount of a depreciable asset over its useful life.'

Break for 15 mins to snack and talk about Organisational Behaviour. It looks like I got lucky doing it last year, the assessment structure has changed and people seem stressed about it. Have offered my (dubious) study notes for moral support.

Things to think about:

• Total acquisition costs - wah, have to factor in such things as shipping, taxes, licensing/registration, essential setup costs, installation, tuning etc.
  • At acquisition - '...all reasonable and necessary expenditure incurred to place the asset in position and condition for use'
  • After acquisition - '...all expenditures which enhance the future economic benefits of the asset beyond those initially expected and or extend the useful life of the asset'
• Disposal value; predicting of
• Useful life, predicting of
• Choice of depreciation method

What if we get it wrong?

• See Worldcom:Accounting Scandals where CEO Bernard Ebbers and friends reported expenses as assets to the tune of an estimated $11 billion. Oops.

Break to work on an example in small groups: Total acquisition costs exercise - am loudest person :( We decided to capitalise upgrading the floor for new, heavier machinery, capitalise a contractor tuning said machinery and capitalise something else I cannot remember.

Vocabulary: Capitalise = use depreciation rather than treat as expense in current year.

Useful life; predicting of: can measure:

• Potential physical life
• Potential technical life
• Expected commercial life
• Legal life (i.e. patent, copyright)

Depreciation methods

• Straight line method: Buy car worth $50,000, estimated useful life 4 years, worth $10,000 on resale (Residual Value). Maths is (Cost - Residual Value)/Useful life = (50,000 - 10,000)/4 = 10,000. Depreciate at $10,000 per year.

Year	Opening Balance	Depreciation Expense	Closing Balance
1	50,000	10,000	40,000
2	40,000	10,000	30,000
3	30,000	10,000	20,000
4	20,000	10,000	10,000
Total Depreciation		40,000

  

• Declining Balance Method (aka Reducing Balance Method or Accelerated Method): Buy car worth $50,000, estimated useful life 4 years, worth $10,000 on resale. Maths is work out depreciation rate (4 years = 25% per annum). Introduce fudge factor of 1.5 or 2 depending on how enthusiastic you want to be, this example uses 1.5. Rate = 25% x 1.5 = 37.5%. Take 37.5% in year 1 = 37.5% of 50,000 = 18,750 and keep doing that to the reduced balance each year.

Year	Opening Balance	Depreciation Expense	Closing Balance
1	50,000	18,750	31,250
2	31,250	11,719	19,531
3	19,531	7,324	12,207
4	12,207	4,578	7,629
Total Depreciation		42,371

 

• Unit based: Aware of existence but we didn't cover the maths in class.

Comparison of methods: Outcome is very similar but spread during life is different

• Straight line: $40,000
  • Simple and convenient
  • Higher earnings in earlier years
• Reducing: $42,371
  • More complex
  • Lower earnings in earlier years

Break to do a group exercise and do maths - compare two identical companies who use different methods to measure depreciation and who capitalised/expensed renovations differently. How to choose between them? Only difference is accounting methods despite different predicted profits.

What is the written-down (aka carrying value or book value)? (I'd be more bitter about this if one of my other loves Chemistry didn't measure temperature in Celcius, Farenheight, Kelvin and Clunks.)

• '... cost of the non-current asset less the total depreciation to date.' Yes, you can revalue assets and frequently do in which case written-down value is valuation minus depreciation to date.

Implications for accounting policies: when comparing entities be aware of their choice of depreciation policies. Or hire an analyst you trust :p See Woolworths 2008 Financial Report page 79 for their somewhat non-detailed policy.

Intangible assets are divided into

• Identifiable - patents, mastheads, trademarks. If purchased, record at cost. Depreciate (except we use a special word 'amortise') if expected to have a finite life, check annually for impairment if indefinite life.

NB: If developed internally by entity no way of measuring value, can't count them.

• Unidentifiable - goodwill, market penetration, effective advertising, good labour relations. If purchased, record at cost, not amortised, check annually for impairment.

NB: If developed internally as above.

Fled home playing v. loud music and danced with the woofer.