LECTURE NOTE ACCOUNTING FOR NON- CURRENT ASSETS

Introduction
This topic is aimed at equipping the learners with the knowledge to enable them to account for non-
current assets
Learning outcomes
At the end of the lesson the learners should be able to:
1. Explain the meaning of non-current assets
2. Identify different types of non-current assets
3. Describe various methods of computing for depreciation
4. Prepare ledger accounts to record transactions related to non- current assets
5. Prepare extracts from financial statements to record non-current assets issue
DEPRECIATION, PROVISIONS AND RESERVES
DEPRECIATION
Concept of depreciation
The concept of depreciation refers to the process of allocating the initial or restated input valuation
(cost or other basis) or fixed assets to the several periods expected t benefit from their acquisition
and use. The main emphasis of the depreciation process is generally on the computation of the
periodic charges to expense or cost of the product to be matched with the revenue s reported in
each period.
Depreciation is a permanent, continuing and gradual shrinkage in the book value of a fixed asset.
According to international accounting standard committee” depreciation is the allocation of
the depreciable amount of an asset over its estimated useful life. “Depreciation for the accounting
period is charged to income either directly or indirectly”
These definitions contain certain terms which are explained below:
a) Depreciable assets
These are assets which:-
i) Are expected to be used during more than one accounting period and
ii) Have a limited life
iii) Are held by an enterprise for use in the production or supply of goods and services
for rental to others, or for administrative purpose and not for the purpose of sale in
the ordinary course of business.
b) Useful life
This is either:-
i. The period over which a depreciable asset is expected to be used by the enterprise; or

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ii. The number of production of similar units expected to be obtained from the use of the asset
by the enterprise.
The useful life of a depreciable asset is shorter that its physical life and is:-
i) Predetermined by legal or contractual limits such as the expiry dates of related lease
ii) Directly governed by extraction or consumption
iii) Dependent on the extent of use and physical deterioration on account of wear and tear
which again depends on operational factors such as, the number of swifts for which
the asset is to be used, repairs and maintenance policy of the enterprise, etc and
iv) Reduced by obsolescence arising from such factors as technological changes,
improvement in production methods, changes in market demand for the product or
service, output of the asset or legal or other restrictions.
Determination of the useful life of a depreciable asset is a matter of estimation and is normally
based on various factors including experience with similar types of assets.
Any addition or extension to an existing asset which is of capital nature and which becomes
an integral part of the existing asset is depreciated over the remaining useful life of that asset.
c) Depreciable Amount
The amount of depreciable asset is its historical cost, or other amount substituted for
historical cost in financial statements, less the estimated residual value.
d) Residual Value
Determination of residual value of an asset is normally a difficult matter. If such value is
considered insignificant, it is normally regarded as nil. On the contrary, if the residual value
is likely to be significant, it is estimated at the time acquisition/installation, or at the time of
subsequent revaluation of the asset.
CAUSES OF DEPRECIATION
The following are the main causes of depreciation:
i. Physical Deterioration
It is caused mainly from wear and tear when the asset is in use and from erosion, rust, rot
and decay from being exposed to wind, rain, sun and other elements of nature.
ii. Economic Factors
These may be said to be those that cause the asset to be put out of use even though it is in
good physical condition. These arise due to obsolescence and inadequacy. Obsolescence

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 means the process of becoming obsolesced or out of date. Old machinery though in good
physical condition may be rendered obsolete by the introduction of a new model which
produces more that the machinery. Inadequacy refers to the termination of the use of an
asset because of growth and changes in the size of the firm. But obsolescence and inadequacy
do not necessarily mean that the asset is scrapped. It is merely put out of use by the firm
iii. Time factors
There are certain assets with a fixed period of legal such as lease, patents and copyrights.
For instance, a lease can be entered into for any period while patents legal life is for some
years but on certain grounds this can be extended. Provision for the consumption of these
assets is called amorlisation rather than depreciation.
iv. Depletion
Some assets are of wasting character perhaps due to the extraction of raw materials from
them. These materials are then used by the firm to make something else or are sold in their
raw state to other firms. Natural resources such as mines, quarries and oil wells come under
this heading. To provide for the consumption of an asset of a wasting character provision for
depletion.
DEPRECIATION ACCOUNTING
Depreciation accounting is system of accounting which aims to distribute the cost of other basic
value of tangible capital assets less salvage (if any), over the estimated useful life of the unit in a
systematic and rational manner. Depreciation for the year is the portion of the total charge under
such system that is allocated to the year.
The main objective of depreciation accounting is to absorb the cost of using the asset to different
accounting periods in such a way that profit and loss account may give true figure of profit or loss
made by the business.
NEED FOR PROVIDING DEPRECIATION
The need for depreciation arises because of the following reasons:-
a) To know the true profits
Depreciation must be deducted out of the income earned from the used assets in order to
calculate true net profit or loss.
b) To show true financial position

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 For the purpose of reflecting true financial position, it is necessary that depreciation must be
deducted from the assets and then at such reduced value these may be shown in the balance
sheet. If depreciation is not deducted from the fixed assets their values will be overstated.
c) To make provision for replacement of assets
If depreciation is not provided the profits of the concern will be overstated and can be
distributed to shareholders as dividend. After the end of the working lie of the asset, there
will be no provision or funds at the disposal of the concern and has to borrow for purchasing
new assets.
Basic factors taken into consideration while calculating depreciation expenses:
i. The total cost of the asset including all freights, insurance and installation charges
ii. The scrap value at the end of its life.
iii. Estimated number of years of its usefulness.
METHODS OF RECORDING DEPRECIATION
1. When a provision for depreciation account is not maintained
Under this method the amount of depreciation is charged to the depreciation account and
credited to the assets account. The asset appears in the balance sheet at written down value.
The depreciation account being a nominal account is transferred to profit and loss account. The
following journal entries are passed to give effect to the depreciation
a. For providing depreciation
Dr Depreciation a/c xx
Cr asset a/c xx
b. For transfer of depreciation to profit and loss a/c
Dr profit and loss a/c xx
Cr depreciation a/c xx
c. When additional asset is purchased during the year
Dr Asset a/c xx
Cr bank a/c xx
d. When the asset is sold, it i8s desirable to calculate its book value after charging the
current periods depreciation and this value is to be compared with the realizable value in
order to calculate the profit or loss on the sale of an asset. The entries will be:
i) When the asset is sold

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 Dr bank a/c xx
Cr asset a/c xx
ii) For the depreciation of the current year
Dr Depreciation a/c xx
Cr assets a/c xx
iii) For loss on sale of asset
Dr profit and loss a/c xx
Cr assets a/c xx
Note: Reverse entry will be passed if there is profit on the sale of asset.
2. WHEN A PROVISION FOR DEPRECIATION ACCOUNT IS MAINTAINED
The following journal entries are passed under this method
i) For providing depreciation out of profit and loss account
Dr profit and loss a/c xx
Cr provision for depreciation a/c xx
ii) On sale of an asset
 Dr provision for depreciation a/c xx
Cr asset a/c xx
 Dr bank a/c xx
Cr assets a/c xx
 For profit
Dr Asset a/c xx
Cr profit and loss a/c xx
 For loss
Dr profit and loss a/c xx
Cr asset a/c xx
Methods of Depreciation
The following are the main methods of providing depreciation:

Methods of Depreciation
a) Straight-line method (using equation)
Straight-line method of depreciation is based on the cost of an asset that is
then depreciated, by the same amount, over the estimated useful life of the asset.
Cost – Estimated Disposal Value
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 Depreciation per annum =
Expected useful life
Example 1:
ABC Ltd. bought a machine at a cost of sh.80,000. The machine has an
expected useful life of 5 years and at the end of the 5th year, it can be sold for
sh.10,000.
Depreciation per annum =
a) Straight-line method (continues)

Depreciation for 5 years would be:

Cost Annual Provision for NBV
depreciation depreciation
Date of 80000 80000
purchase
End of year 1 80000 14000 14000 66000
End of year 2 80000 14000 28000 52000
End of year 3 80000 14000 42000 38000
End of year 4 80000 14000 56000 24000
End of year 5 80000 14000 70000 10000

The depreciation expense can also be calculated by writing off a fixed percentage
of cost of the asset.

a) Straight-line method (using fixed percentage of cost of asset)

The depreciation expense can also be calculated by writing off a fixed percentage
of cost of the asset.

Example 2:
ABC Ltd. bought a machine at a cost of sh.80,000. The depreciation is to be
charged at a 20% per annum on cost.

Depreciation per annum = sh.80,000 x 20%

= sh.16,000 per year
b) Reducing balance method
Depreciation is calculated on a fixed percentage on the Diminishing
Balance of the Asset (the NBV). This results in a higher depreciation charge in the
earlier years of the asset’s estimated useful life.
Example 3: A machine costs sh.50,000 is to be depreciated at
15% on Reducing Balance Method.

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 Cost Annual depreciation Pro for NBV
depre
Date of 50000 0 - 50000
purchase
End of 1st yr 50000 50,000 x 15% = 7,500 7,500 42,500

End of 2nd yr 50000 42,500 x 15% = 6,375 13,875 36,125

End of 3rd yr 50000 36,125 x 15% = 5,419 19,294 30,706

End of 4th yr 50000 30,706 x 15% = 4,606 23,900 26,100

End of 5th yr 50000 26,100 x 15% = 3,915 27,815 22,185

b) Reducing balance method

Advantages of using reducing balance method:

1) Appropriate for assets which lose value quickly in the early year.
2) Appropriate for assets which become outdated/obsolete

Disadvantages:
1) Asset is never completed written off
2) For assets which have a short life, the percentage used to calculate
depreciation is very large.

Double entry records for depreciation and the disposal of fixed assets
The ledger accounting entries for depreciation:

Step 1:
Dr Depreciation Expense (Profit and Loss)
Cr Provision for Depreciation (Balance Sheet)
Step 2:
Dr Profit and Loss
Cr Depreciation Expense

The Disposal of an Asset

Reason for accounting entries:
Upon the sale of an asset, we will want to delete it from our accounts. This
means that the cost of that asset needs to be taken out of the asset account. In
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addition, the depreciation of the asset which has been sold will have to be taken out
from the provision for depreciation. Finally, the profit and loss on sale, if any, will
have to be calculated.

The Disposal of an Asset: The accounting entries needed

On the sale of a fixed asset, for instance machinery, the following entries are
needed:

A) Transfer the cost price of the asset sold to an assets disposal

account:
Dr Machinery disposals A/C
Cr Machinery A/C

B) Transfer the depreciation already charged to the assets disposals

account:
Dr Provision for Depreciation A/C
Cr Machinery disposals A/C

C) For remittance received on disposal:

Dr Cash A/C
Cr Machinery disposals A/C

D) Transfer difference to the profit and loss account. If the machinery

disposals account shows a credit balance, it is a profit on sale:
Dr Machinery disposals A/C
Cr Profit and loss A/C

If the machinery disposals account shows a debit balance, it is a

loss on sale:
Dr Profit and loss A/C
Cr Machinery disposals A/C
Example 4:
In a business with financial years ended 31 December, a machine is bought
for sh.2,000 on 1 January 2005. It is to be depreciated at the rate of 20% using the
reducing balance method.
The company has decided to sell the machine for sh.1,070 on 2 January
2008.

Required:
Show the following ledger accounts for the year ended 31 December 2008:
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 i) Machinery A/C ii) Cash A/C
iii) Provision for Machinery A/C
iv) Disposals on Machinery A/C

Example 5:
In a business with financial years ended 31 December, a machine is bought
for sh.2,000 on 1 January 2005. It is to be depreciated at the rate of 20% using the
reducing balance method.
The company has decided to sell the machine for sh.950 on 2 January 2008.

Required:
Show the following ledger accounts for the year ended 31 December 2008:
i) Machinery A/C ii) Cash A/C
iii) Provision for Machinery A/C
iv) Disposals on Machinery A/C

Exercise 1

The financial year of Ndesh Ltd. ends on 31 December. On 1 January 2002, the
following balances are in its Ledger Accounts that relate to fixed assets:

Fixed Assets at cost sh.

Machinery 650,000
Equipments 320,000

Provision for depreciation sh.

Machinery 140,000
Equipments 72,000

The company adopts the following policies for the depreciation of its assets:
i) The reducing balance method of depreciation is used to depreciate the
machinery. A rate of 10% per annum is used.
ii) The straight-line method of depreciation is used to depreciation the
equipments at a rate of 10% per annum.
iii) When fixed assets are purchased in the first half of a financial year, a
full year’s depreciation is charged. When fixed assets are purchased in the second
half of a financial year, a half-year’s depreciation is charged.
v) Depreciation is not charged on assets in the year in which they are
sold.

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During the year 2002, the following transactions took place in relation to the
company’s fixed assets:

Purchases on credit:
10 February Machinery sh.50,000
29 September Equipments sh.6,000

Sales
On 15 August, a machine was sold for sh.14,000 and the proceeds were received
by cheque. The machine had been purchased on 12 October 2002 for sh.15,000.
Required:
Prepare the following Ledger Accounts for the year ended 31 December 2002:
i) Machinery
ii) Equipment
iii) Provision for depreciation of machinery
iv) Provision for depreciation of equipment
v) Disposals on machinery

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