Changing Asset Values (Copy)

1.3.2 Changing Asset Values – Cheat Sheet

Key Concepts

1. Capital Income:
   • Definition: Income from the sale of long-term assets or capital raised.
   • Examples: Sale of machinery, property, loans, or share capital.
   • Effect on Accounts: Recorded in the balance sheet, does not directly affect profit/loss unless there’s a gain or loss on disposal.
2. Capital Expenditure:
   • Definition: Money spent to acquire or improve non-current assets.
   • Examples: Purchase of machinery, property, or vehicles.
   • Effect on Accounts: Recorded as an asset on the balance sheet and depreciated over time.
3. Revenue Income:
   • Definition: Income from normal business operations.
   • Examples: Sales revenue, interest income, rent.
   • Effect on Accounts: Recorded in the income statement, contributes to profit.
4. Revenue Expenditure:
   • Definition: Day-to-day operating expenses.
   • Examples: Salaries, rent, utilities, repairs.
   • Effect on Accounts: Recorded in the income statement, reduces profit.

Depreciation Methods

1. Straight-Line Method:
   • Formula:

     Annual Depreciation = (Cost of Asset - Residual Value) / Useful Life
     

   • Example:
     • Cost of asset: 10,000
     • Residual value: 1,000
     • Useful life: 5 years

     Annual Depreciation = (10,000 - 1,000) / 5 = 1,800 per year
     

2. Reducing Balance Method:
   • Formula:

     Depreciation Expense = Book Value at Start of Year * Depreciation Rate
     

   • Example:
     • Initial cost of asset: 10,000
     • Depreciation rate: 20%

     First Year Depreciation = 10,000 * 20% = 2,000
     

     • Year 2 Depreciation: New book value is 10,000 – 2,000 = 8,000

     Year 2 Depreciation = 8,000 * 20% = 1,600
     

Measuring Non-Current Assets

1. Cost Model:
   • Formula:

     Carrying Value = Cost of Asset - Accumulated Depreciation
     

   • Example:
     If a machine costs 10,000 and accumulated depreciation is 4,000:

     Carrying Value = 10,000 - 4,000 = 6,000
     

2. Revaluation Model:
   • Non-current assets are carried at fair market value, adjusted periodically.
   • Revaluation Surplus: Any increase in value is recorded under equity.
   • Revaluation Loss: Any decrease is first applied to the revaluation surplus, then to profit/loss if the surplus is exhausted.
   • Example: A building originally purchased for 100,000 is revalued to 120,000:

     Revaluation Surplus = 120,000 - 100,000 = 20,000
     

Ledger Accounts and Journal Entries

1. Acquisition of Non-Current Assets:
   • Journal Entry:

     Debit: Asset (e.g., Machinery) 10,000
     Credit: Cash/Bank 10,000
     

2. Revaluation of Non-Current Assets:
   • Journal Entry for Increase in Value:

     Debit: Asset (e.g., Building) 20,000
     Credit: Revaluation Surplus 20,000
     

3. Depreciation Entry:
   • Journal Entry for Depreciation:

     Debit: Depreciation Expense (Income Statement) 1,800
     Credit: Accumulated Depreciation (Balance Sheet) 1,800
     

4. Disposal of Non-Current Assets:
   • Journal Entry for Disposal:
     • If the asset is sold:

       Debit: Cash/Bank 5,000
       Debit: Accumulated Depreciation 3,000
       Credit: Asset (Machinery) 10,000
       

     • Profit/Loss on Disposal:
       • Profit: If sale proceeds exceed book value:

         Debit: Profit on Sale (Income) 2,000
         

       • Loss: If sale proceeds are less than book value:

         Debit: Loss on Sale (Expense) 2,000
         

Profit or Loss on Disposal

• Formula:

  Profit or Loss on Disposal = Sale Proceeds - Book Value of the Asset
  

  • Book Value = Cost of Asset – Accumulated Depreciation

Recording Depreciation in Financial Statements

1. Statement of Profit or Loss:
   • Depreciation is recorded as an expense, reducing the profit for the period.
2. Statement of Financial Position:
   • The carrying value of non-current assets is shown as Cost – Accumulated Depreciation.
   • Revalued assets are shown at their fair value.

Summary

• Capital Income: Income from asset sales or long-term capital.
• Capital Expenditure: Spending on non-current assets (depreciated over time).
• Revenue Income: Income from core operations.
• Revenue Expenditure: Day-to-day operating expenses, expensed immediately.
• Depreciation Methods: Straight-Line (equal depreciation) and Reducing Balance (higher depreciation in early years).
• Asset Measurement: Cost Model (historical cost) or Revaluation Model (fair market value).
• Proper journal entries ensure accurate recording of asset acquisition, depreciation, revaluation, and disposal, leading to reliable financial statements.