Tangible non-current assets

Welcome to Tangible Non-Current Assets!

Hello there! Today, we are diving into one of the most important parts of financial accounting: Tangible Non-Current Assets (NCAs). Think of these as the "heavy lifters" of a business—the buildings, delivery vans, and machinery that help a company generate income over a long period.

Don't worry if this seems a bit technical at first. We’re going to break it down into bite-sized pieces, using real-life examples to make everything crystal clear. By the end of these notes, you'll know how to record these assets from the day they are bought until the day they are sold.

1. What is a Tangible Non-Current Asset?

In simple terms, a tangible asset is something you can touch (like a computer or a machine). A non-current asset is an asset retained for long-term use within the business rather than for immediate resale or consumption.

The "Big Three" Criteria:
1. It has physical substance.
2. It is held for use in the business (to produce goods, provide services, or for administrative purposes).
3. It is expected to be used for more than one accounting period (usually 12 months or longer).

Example: If a car dealership buys a van to deliver parts to customers, that van is a Non-Current Asset. However, if they buy a van specifically to sell it to a customer next week, that van is Inventory (a current asset).

Quick Review Box:

Non-Current Asset: Long-term use. Example: A pizza oven in a restaurant.
Current Asset: Short-term use or held for sale. Example: The flour and cheese used to make pizza.

2. Initial Measurement: How much is it worth?

When an asset is acquired, it is recorded initially at Cost under IAS 16 Property, Plant and Equipment. Cost includes the purchase price plus all costs directly attributable to bringing the asset to the working condition and location necessary for its intended use.

Included in Cost (Capital Expenditure):
- Purchase price (less trade discounts).
- Delivery, freight, and handling costs.
- Site preparation, installation, and assembly costs.
- Professional fees directly incurred (e.g., legal fees or architect fees).
- Testing costs to ensure proper functioning (net of any proceeds from selling items produced during testing).

Excluded from Cost (Revenue Expenditure):
- Routine maintenance, servicing, and repairs (e.g., an oil change for a van).
- Ongoing insurance for the asset.
- Staff training costs on how to operate the machine.
- General administration overheads.

Did you know? If you incorrectly capitalise a repair expense as part of an asset's cost, profits and assets will be overstated in that period. This is a common error to watch out for in your exam!

3. The Non-Current Asset Register

Every business must keep track of its physical assets. A non-current asset register is an internal record maintained outside the main ledger that lists detailed information for each individual non-current asset owned.

Purpose of the Register:
- Helps maintain physical and internal control over company assets.
- Records details such as asset description, serial/identification number, location, date of purchase, original cost, depreciation method and rate, accumulated depreciation, carrying amount, and disposal date.
- Enables periodic physical checks (reconciliation of physical assets against the register and the general ledger balances) to detect theft, damage, or unrecorded disposals.

4. Depreciation: Sharing the Cost

Imagine you buy a delivery van for \$20,000 and expect it to last 4 years. It would not reflect reality to record a \$20,000 expense in Year 1 and \$0 in Years 2, 3, and 4. Instead, we allocate the depreciable amount over its useful life. This is called Depreciation.

Depreciation follows the accrual concept: we match the cost of the asset against the revenue it helps generate over its useful life.

Method A: Straight Line Method

The asset depreciates by the same constant amount each year.

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

Note: Residual value is the estimated net amount the entity expects to obtain from disposal at the end of its useful life.

Method B: Diminishing (Reducing) Balance Method

Under this method, a fixed percentage is applied to the carrying amount (cost less accumulated depreciation) at the start of each period.

Formula:
\( \text{Annual Depreciation} = \text{Percentage (\%)} \times \text{Carrying Amount} \)

Common Mistake to Avoid:

When using the reducing balance method, DO NOT deduct residual value before applying the percentage rate. Residual value is deducted only when calculating straight-line depreciation.

Recording Depreciation:
Debit Depreciation expense (Profit or loss)
Credit Accumulated depreciation (Statement of financial position)

5. Revaluation of Assets

Under IAS 16, an entity may choose the revaluation model instead of the cost model. If an asset is revalued, its carrying amount is adjusted to its fair value at the date of revaluation.

Accounting Entries for an Upward Revaluation:
1. Restate the gross carrying amount (cost) to the new valuation: Debit Asset account.
2. Eliminate any existing accumulated depreciation against the asset: Debit Accumulated depreciation.
3. Credit the revaluation increase to Revaluation surplus (reported in other comprehensive income and held within equity in the statement of financial position).

Depreciation on Revalued Assets:
Subsequent depreciation is calculated on the revalued amount over the remaining useful life. An entity may make an annual reserves transfer from the revaluation surplus to retained earnings for the "excess depreciation" (the difference between depreciation on the revalued amount and depreciation on historical cost).

6. Disposals and Part-Exchange

When an asset is sold or retired from use, its cost and accumulated depreciation must be removed from the general ledger accounts, and any resulting gain or loss is recognised in profit or loss.

Gain or Loss on Disposal Formula:
\( \text{Gain or Loss} = \text{Net Disposal Proceeds} - \text{Carrying Amount at Date of Disposal} \)

The Disposal Account Procedure:
1. Transfer Cost: Debit Disposal account, Credit Asset at cost account.
2. Transfer Accumulated Depreciation: Debit Accumulated depreciation account, Credit Disposal account.
3. Record Proceeds Received: Debit Cash/Bank (or Receivables), Credit Disposal account.
4. Balance the Disposal Account: A net credit balance represents a profit on disposal (Credit Profit or loss). A net debit balance represents a loss on disposal (Debit Profit or loss).

Part-Exchange Allowance

Businesses often acquire a new asset by trading in an old one and paying the remaining balance in cash. The dealer grants a part-exchange allowance for the old asset.

In this situation, the part-exchange allowance acts as the disposal proceeds of the old asset and contributes toward the purchase cost of the new asset:

Recording the Old Asset Disposal in a Part Exchange:
- Debit Disposal account with original cost of old asset; Credit Old asset account.
- Debit Accumulated depreciation with depreciation on old asset; Credit Disposal account.
- Debit New asset account with part-exchange allowance; Credit Disposal account.
- Debit New asset account with balance paid; Credit Cash/Bank (or Payables).
- The balance on the disposal account is the gain or loss on the part-exchanged asset.

7. Summary and Final Tips

Here is a quick checklist of the key points to remember for your ACCA FA exam:

• Initial Cost: Only include costs directly necessary to bring the asset into working condition.
• Asset Register: Detailed internal record for physical verification and internal control.
• Depreciation: Straight line spreads cost evenly; reducing balance applies a percentage to carrying amount.
• Revaluation Surplus: Gains go to other comprehensive income and equity, not regular operating profit.
• Part Exchange: The allowance counts as disposal proceeds for the old asset and part of the cost of the new asset.