FA1 Chapter 3 Eng
FA1 Chapter 3 Eng
FA1 Chapter 3 Eng
Notes to teachers
1
Sometimes the differentiation between capital expenditure and revenue expenditure is not very clear. Students should master the definition of capital expenditure first. Any expenditure that fails to meet the definition of capital expenditure should be classified as revenue expenditure. Some students may have the misconception that depreciation is equivalent to a drop in the market value of an asset or the wearing out of an asset. Teachers must clarify the true meaning of depreciation in accounting, even though it may seem a bit abstract for most students. The term depreciation is applicable to tangible non-current assets only. For intangible non-current assets such as patents, the systematic write-off of the cost is known as amortisation. The matching concept may help students understand the accounting rationale behind the treatment of depreciation. But it is not necessary at this stage. It is not difficult for most students to understand the various depreciation methods. However, when a new asset is acquired or an old asset is disposed of during a year, the calculation will become much more complicated, especially when the reducing-balance method is used. In such situations, students must pay attention to the date of the acquisition/disposal. In recent years, minor changes have been made in making accounting entries for annual depreciation. A nominal account called depreciation expense/charges or simply depreciation is now usually opened in the general ledger, while the contra-asset account provision for depreciation is now called accumulated depreciation. Teachers can refer to Chapter 13 of Frank Woods Financial Accounting 2 for the actual meaning of provisions. The accounting entries for the disposal of a non-current asset can be simplified as follows: Dr Accumulated depreciation Dr Cash/Bank/Debtor Cr Non-current asset Cr Profit and loss (when there is a profit generated from the disposal) provided that the entries are made at the year end. The above presentation of entries is generally acceptable in public exams. Note that the term net book value is now more commonly called carrying amount.
3 4 5
7 8
Q1
Capital expenditure is expenditure that generates long-term benefits (i.e., benefits which will last for a number of periods) for an entity.
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Examples include: Purchase price of an office premise Cost of building an extension to an existing factory Cost of upgrading an existing computer system Freight and installation cost of a newly purchased machine Revenue expenditure is expenditure that generates short-term benefits only. It is usually spent on the day-to-day operations of an entity and provides benefits that will be consumed in the period in which it is incurred. Examples include: Office rent Wages and salaries Petrol for a delivery van Capital expenditure should not be wholly written off as an expense in the period in which it is incurred. Instead, it should be expensed over a number of periods. Revenue expenditure should be wholly written off as an expense in the period in which it is incurred. (a) This payment was made to improve an existing non-current asset (car); therefore, it is a capital expenditure. (b) This payment was for car maintenance; therefore it is a revenue expenditure. The systematic allocation of the cost of a tangible non-current asset over its useful life is known as depreciation. Under the matching concept, the expenses recognised in each accounting period have to be matched with the revenues or benefits that they generate in the same period. A non-current asset provides long-term benefits and therefore its cost should not be wholly recognised as an expense in the period of acquisition. Instead, it should be allocated over its useful life. The amount allocated to each accounting period (as depreciation charges) should be matched with the amount of benefits generated in that period (which usually refers to the usage of the asset during that period). (a) Straight-line method: Year ended 31 March 2010 2011 2012 2013 (b) Reducing-balance method: Annual depreciation rate = 45% Year ended 31 March 2010 2011 2012 2013 Depreciation charged for the year $3,600 $1,980 $1,089 $599 Depreciation charged for the year $1,520 $1,520 $1,520 $1,520
Q2 Q3
Q4
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Q5 Q6
Depreciation charged for the year $12,000 $12,000 $8,000 $4,800 $3,200
(a) $103,000 (excluding the annual vehicle licence fee of $4,000 and the annual insurance premium of $3,000). The annual vehicle licence fee is just like the annual insurance premium. Both are running expenses and not a cost of the asset. Only costs that are necessary to bring the asset to the location and condition for its intended use should be capitalised. (b) Depreciation charged for the year ended 31 December 2013 = [$103,000 (1 40%)3] 40% = $8,899
General Ledger Depreciation: Lorries
2009 Dec 31 2010 Dec 31 2011 Dec 31 Accumulated depreciation Accumulated depreciation Accumulated depreciation $ 2009 8,000 Dec 31 2010 4,000 Dec 31 2011 2,000 Dec 31 Profit and loss Profit and loss Profit and loss $ 8,000 4,000 2,000
Q7
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Q8
According to the consistency principle, a firm should keep using the same accounting policy or method for similar items. A change is allowed only if it can give a more accurate view of a business. To achieve consistency, the same depreciation method and policy should be applied to all non-current assets in the same class. Changing methods or policies without a good reason would lead to the reporting of misleading results.
A1 A2
Under the straight-line method, the cost of a non-current asset is allocated evenly as depreciation over its estimated useful life. The amount of depreciation charged in each period is constant and is calculated as follows: (Cost Estimated residual value) Estimated useful life Under the reducing-balance method, the cost of a non-current asset is allocated as depreciation at a diminishing rate over its estimated useful life. This means that the depreciation expense gets smaller each period. The amount of depreciation charged in each period is diminishing and is calculated as follows: (Cost Depreciation already charged) Fixed depreciation rate The depreciation charged for 2013 (final year) should still be $1,000. If the difference is very significant, prior year adjustments of depreciation charges and profits may be required. This means the business has to adjust the results of its previous years as a result of the significant difference between estimated depreciation and actual depreciation. (a) Straight-line method. Under this method, the amount of depreciation charged in each period is constant and therefore the depreciation only needs to be calculated once. (b) Reducing-balance method. Under this method, a larger amount of depreciation is charged in early years and a smaller amount is charged in later years. It is often said that repairs and maintenance of non-current assets in the early years of use will be far lower than in later years. Therefore, this method can help even out the annual expenditures on non-current assets. (c) Usage-based method. Under this method, the amount of depreciation charged in each period is based on actual usage during that period, which represents the actual benefits generated by the asset in that period. Yes. Freehold land has an unlimited useful life. To put it simply, freehold land is land that can be held for an indefinite period of time. Therefore, depreciation should not be charged for this type of asset. Expenses for the year will be overstated and the net profit will be understated. The net book value of non-current assets will also be understated. In Exhibit 3.8, the depreciation charged for the year ended 31 December 2010 increased by $500, while the loss on disposal decreased by $500. As a result, total expenses and the net profit for the year remained the same. Furthermore, the net book value of non-current assets (Machine No. 2 only) as at the year end increased as less depreciation was charged in the year of purchase.
A3
A4 A5 A6
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ASSESSMENT
Short Questions
1 2 3X 4 5
(C) and (D) Capital expenditure: b, c, e, g Revenue expenditure: a, d, f, h Capital expenditure: c, e, g, j Revenue expenditure: a, b, d, f, h, i Capital expenditure: (a) $1,500, (b) $500, (c) $23,000, (d) $400, (e) $500 Revenue expenditure: (a) $6,500, (b) $1,500, (c) $2,000, (d) $3,600, (e) $300 (a) Straight-line method
Cost Year 1 Year 2 Year 3 Year 4 Depreciation* Depreciation Depreciation Depreciation 4 $ 12,500 (1,845) 10,655 (1,845) 8,810 (1,845) 6,965 (1,845) 5,120
6X
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( ( ( ( (
$ 40,000 (8,750) 31,250 (8,750) 22,500 (7,000) 15,500 (7,000) 8,500 (3,500) 5,000
) ) ) )
Application Problems
8X
(a) (i) Straight-line method
Machinery
2007 Nov 1 2008 Nov 1 2009 Nov 1 Cash Balance b/f Balance b/f $ 2008 18,000 Oct 31 2009 18,000 Oct 31 2010 18,000 Oct 31 Balance c/f Balance c/f Balance c/f $ 18,000 18,000 18,000
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2010 Nov 1
2010 Nov 1
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(a)
2006 Jan 1 2007 Jan 1 2008 Jan 1 Cash Balance b/f Balance b/f
Motor Vehicles
$ 2006 12,500 Dec 31 2007 12,500 Dec 31 2008 12,500 Dec 31 Balance c/f Balance c/f Balance c/f $ 12,500 12,500 12,500
(b)
2006 Dec 31 2007 Dec 31 2008 Dec 31 Balance c/f Balance c/f Balance c/f
(c)
2006 2007 2008
(d)
Motor vehicles at cost Less Accumulated depreciation
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$ 2007 162,000 Dec 31 2008 162,000 Dec 31 162,000 162,000 2009 Jan 1 Dec 31
(b)
2007 Dec 31 2008 Dec 31 2009 Jan 1 Dec 31 Balance c/f Balance c/f
(c)
2009 Jan 1 Machinery
Machinery Disposal
$ 54,000 54,000 2009 Jan 1 " 1 Dec 31 Accumulated depreciation Cash Profit and loss Loss on disposal $ 17,000 24,600 12,400 54,000
(d)
2007 2008 2009
(e)
Machinery at cost Less Accumulated depreciation
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11
(a)
2006 Apr " 1 1 Cash Cash Installation cost Balance b/f Balance b/f
Computers
$ 2007 9,500 Mar 31 500 10,000 2008 10,000 Mar 31 2009 10,000 Mar 31 Balance c/f Balance c/f Computers disposal $ 10,000 10,000 10,000 10,000
(b)
2007 Mar 31 2008 Mar 31 Balance c/f Balance c/f Computers disposal
2009 Mar 31
Computers Disposal
$ 10,000 10,000 2009 Mar 31 " 31 " 31 Accumulated depreciation Cash Profit and loss Loss on disposal $ 4,000 4,250 1,750 10,000
(d)
2007 2008 2009
(e)
Computers at cost Less Accumulated depreciation
12
T Tang Revised Net Profit for the year ended 31 December 2008
Net profit before corrections Add Purchases overstated Loan interest overstated Less Motor repairs understated Revised net profit (i) (iii) (ii) $ 3,110 5,000 $ 28,910 8,110 37,020 (290) 36,730
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13X
S Pang Corrected Net Profit for the year ended 30 June 2009
Net profit before corrections Add Motor expenses overstated Less Repairs to fixtures understated Loan interest understated Corrected net profit (iii) (i) (ii) $ 750 540 $ 77,270 3,790 81,060 (1,290) 79,770
14X (a)
Gross profit as per accounts Add Purchases overstated Less Carriage inwards understated Purchases understated Corrected gross profit
(b)
Net profit as per accounts Add Motor expenses overstated Purchases overstated Less Carriage inwards understated Rent understated Purchases understated Corrected net profit
(23,150) 210,410
(c)
Non-current assets as per accounts Add Vans understated Machinery understated Less Fixtures overstated Buildings overstated Office equipment Corrected non-current assets
(23,150) 380,250
(d)
Current assets as per accounts* * No amendments are required.
15
36
(a) The straight-line method is being used for machinery. The reducing-balance method is being used for fixtures. (b) Machinery: $48,000 $16,000 $16,000 = $16,000 Depreciation rate for fixtures is 25% per annum. Fixtures: $20,250 $5,063 $3,797 = $11,390 (c) Machinery: $80,000 $20,000 $15,000 $11,250 $8,438 = $25,312
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16X (a) The straight-line method is being used for office equipment. The reducing balance method with a rate
of 33 1 % is being used for fixtures. 3 (B) 1,900 (H) 2,500 (Y) 2,000
17X (a) As the cost of running the van is likely to be the same each year, then the straight-line method should
be used.
= $16,400
(b) For a machine that will incur few repairs in the first year and increasing amounts in subsequent years, the reducing-balance method should be used as this would help even out the expenses incurred on the machine. Of the three figures shown, 33 1 % will bring the net book value at disposal nearest to the amount to 3 be received. Proof:
Depreciation rate Cost Year 1 Depreciation Year 2 Depreciation Year 3 Depreciation Year 4 Depreciation Net book value at disposal 50% $ 72,000 (36,000) 36,000 (18,000) 18,000 (9,000) 9,000 (4,500) 4,500 33 3 % $ 72,000 (24,000) 48,000 (16,000) 32,000 (10,667) 21,333 (7,111) 14,222
1
20% $ 72,000 (14,400) 57,600 (11,520) 46,080 (9,216) 36,864 (7,373) 29,491
18
(a) Depreciation is that part of the cost of a tangible non-current asset consumed during its period of use by the firm. Depreciation must be charged to the profit and loss account of the firm because it represents the cost of using its tangible non-current assets.
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(b) (i)
2007 Jan 1 2008 Jan 1 2009 Jan 1 Cash ($48,000 3) Balance b/f Balance b/f
Lorries
$ 2007 144,000 Dec 31 2008 144,000 Dec 31 144,000 144,000 2009 Jan 1 Dec 31 Balance c/f Balance c/f Lorries disposal Balance c/f $ 144,000 144,000 48,000 96,000 144,000
(ii)
2007 Dec 31 2008 Dec 31 2009 Jan 1 Dec 31 Balance c/f Balance c/f Lorries disposal (W2) Balance c/f
Depreciation for the 3 lorries per year = $9,000 3 = $27,000 (W2) (iii)
2009 Jan 1 Lorries
19X (a)
2007 Jan 1 2008 Jan Oct 1 1 Bank Balance b/f Bank
Machinery
$ 2007 6,400 Dec 31 6,400 7,200 13,600 2008 Dec 31 Balance c/f Balance c/f $ 6,400 13,600 13,600
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(b)
2007 Jan Jul 2008 Jan Dec 1 1 1 1 Bank Bank Balance b/f Bank
Fixtures
$ 1,000 2,000 3,000 3,000 500 3,500 2007 Dec 31 2008 Dec 31 Balance c/f Balance c/f $ 3,000 3,000 3,500 3,500
(c)
2007 ec 31 2008 Dec 31 Balance c/f Balance c/f
Balance b/f 800 Depreciation {[($6,400 $800) + $7,200] 121 %} 1,600 2 2,400
(d)
2007 Machinery at cost Less Accumulated depreciation Fixtures at cost Less Accumulated depreciation 2008 Machinery at cost Less Accumulated depreciation Fixtures at cost Less Accumulated depreciation
11,200 2,880
20
(a)
2007 Jan Jul 2008 Jan Apr 2009 Jan " 1 1 1 1 1 1 Bank (No. 1) Bank (No. 2) Balance b/f Bank (No. 3) Balance b/f Bank (No. 4)
Machinery
$ 24,000 27,000 51,000 51,000 30,000 81,000 81,000 28,000 109,000 2007 Dec 31 2008 Dec 31 2009 Jan 1 Dec 31 Balance c/f Balance c/f Machinery disposal (No. 1) Balance c/f $ 51,000 51,000 81,000 81,000 24,000 85,000 109,000
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(b)
2007 Dec 31 2008 Dec 31 2009 Jan 1 Dec 31 Balance c/f Balance c/f
2009: On machine sold (No. 1) : (2007) $4,800 + (2008) $4,800 = $9,600. On machines kept: (No. 2) $5,400 + (No. 3) $6,000 + (No. 4) $5,600 ($28,000 20%). Total = $17,000.
The Journal
Date 2009 Jan Details 1 Accumulated depreciation: Machinery Cash Machinery disposal Machinery 31 Profit and loss Loss on disposal Machinery disposal Dr $ 9,600 12,950 1,450 1,450 1,450 Cr $
(c)
24,000
Dec
(d)
Machinery at cost Less Accumulated depreciation
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21X
Motor vehicles Reducing-balance 25% $ 40,000 ($160,000 25%) 30,000 [($160,000 $40,000) 25%]
Straight-line $
Machinery Reducing-balance 20% $ 15,000 ($75,000 20%) 21,000 {[($75,000 $15,000) + $45,000] 20%} 16,800 [($75,000 + $45,000 $15,000 $21,000) 20%]
2006
Reducing-balance $40,000 + $15,000 = $55,000 $30,000 + $21,000 = $51,000 $52,500 + $16,800 = $69,300
Straight-line $40,000 + $12,500 = $52,500 $40,000 + $20,000 = $60,000 $70,000 + $20,000 = $90,000
(9,000) 129,490
(20,700) 106,440
22X (a)
Computer No. 1 Computer No. 2 Computer No. 3 Computer No. 4 Computer No. 5
Depreciation per year 2005 2006 2007 $ $ $ 6,500 6,500 6,500 7,000 7,000 7,000 9,600 9,600 8,500 13,500 23,100 31,600
2008 Total $ $ 6,500 32,500 7,000 28,000 9,600 28,800 8,500 17,000 31,600 106,300
(b)
Date 2009 Jan Details
The Journal
Dr $ 28,800 16,250 2,950 2,950 2,950 Cr $
1 Accumulated depreciation: Computers ($9,600 3) Cash Computer disposals Computers 31 Profit and loss Loss on disposal Computer disposals
48,000
Dec
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23X (a)
Physical deterioration Economic factors: obsolescence and inadequacy Depletion (ii) Obsolescence
Lorries
Balance b/f Cash (No. 3) Cash (No. 3) Balance b/f Cash (No. 4) Cash (No. 5) Balance b/f Kam Motors (No. 6) Lorries disposal Trade-in allowance (No. 2) $ 68,000 48,000 6,000 122,000 122,000 30,000 28,000 180,000 2008 Dec 31 Balance c/f $ 122,000
(iii) Depletion
Lorries disposal (No. 3) ($48,000 + $6,000) Balance c/f Lorries disposal (No. 2) Balance c/f
122,000
176,000
(ii)
2008 Dec 31 2009 Jul 16 Dec 31 2010 Nov 5 Dec 31 Balance c/f Lorries disposal (No. 3) Balance c/f Lorries disposal (No. 2) Balance c/f
26,250
24,063
26,750 94,063
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Proof: Total $94,063 Sold (No. 2) $20,813 Sold (No. 3) $13,500 = $59,750, which is the balance in the accumulated depreciation account. (iii)
2009 Jul 16 2010 Nov 5 Dec 31 Lorries (No. 3)
Lorries Disposal
$ 54,000 54,000 36,000 3,463 39,463 2009 Jul 16 " 16 Dec 31 2010 Nov 5 " 5 Accumulated depreciation Bank Profit and loss Loss on disposal Accumulated depreciation Lorries Trade-in allowance (No. 2) $ 13,500 35,680 4,820 54,000 20,813 18,650 39,463
(iv)
Lorries at cost Less Accumulated depreciation
24X
Stephen Kwan Income Statement for the year ended 31 March 2009
Sales Less Cost of goods sold: Inventory as at 1 April 2008 Add Purchases Less Inventory as at 31 March 2009 Gross profit Add Other revenues: Discounts received Interest revenue Less Expenses: Sundry expenses Rent and rates ($12,000 $1,000) Insurance Wages and salaries ($29,750 + $2,750) Discounts allowed Bad debts Allowance for doubtful accounts [($46,130 $1,130) 5% $1,500] 6 Depreciation: Office equipment [($7,500 10%) + ($2,500 10% )] 12 Motor vehicles ($20,000 20%) Net profit $ 40,000 122,500 162,500 (42,500) 3,000 4,380 1,620 11,000 3,250 32,500 4,750 1,130 750 875 4,000 $ 182,500
120,000 62,500
7,380 69,880
(59,875) 10,005
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25,125
45,000 (2,250)
93,130
(59,500)
25
(a)
Sales Less Returns inwards Less Cost of goods sold: Inventory as at 1 July 2008 Add Purchases Less Returns outwards Add Carriage inwards Less Inventory as at 30 June 2009 Gross profit Less Expenses: Carriage outwards Wages and salaries Rent and rates ($16,000 $4,000) Lighting and heating Vehicle running costs Repairs and maintenance Telephone expenses ($13,800 + $1,875) General office expenses Depreciation: Motor vehicles [($21,250 $8,500) 40%] Machinery ($15,000 25%) Furniture and fittings ($10,000 25%) Allowance for doubtful accounts ($65,500 3%) Net loss
(333,300) 197,950
(211,890) (13,940)
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(b)
Non-current assets Machinery Furniture and fittings Motor vehicles Current assets Inventory Accounts receivable Less Allowance for doubtful accounts Prepayments Bank Cash Less Current liabilities Accounts payable Accruals Net current assets Financed by: Capital as at 1 July 2008 Less Net loss for the year Drawings
26
(a) (i)
2006 Apr 1 2007 Jan Aug 2008 Jan 1 1 1 Bank Balance b/f Bank Balance b/f
(ii)
2006 Dec 31 2007 Dec 31 2008 Dec 1 " 31 Balance c/f Balance c/f
$ 129,600
Balance b/f Depreciation [($864,000 20%) + ($345,600 5 20% )] 12 Balance b/f Depreciation [($864,000 + $345,600 $129,600) 20%]
129,600
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(iii)
2008 Dec 1 Plant and machinery
(b) The reasons for charging depreciation on plant and machinery are: 1 Physical deterioration: wear and tear; rust, rot and decay 2 Economic factors: obsolescence and inadequacy
Machinery
Bank Machinery W Bank Machinery X Balance b/f Bank Machinery Y Balance b/f Bank Machinery Z $ 2007 28,000 Sept 30 33,600 61,600 Balance c/f Balance c/f Machinery disposal W Balance c/f $ 61,600
61,600 100,800
(ii)
2007 Sept 30 2008 Sept 30 2008 Oct 11 2009 Sept 30 Balance c/f Balance c/f Machinery disposal W ($28,000 25% 2) Balance c/f
11,200
29,400 65,800
(iii)
2008 Oct 5 2009 Sept 30 Machinery Profit and loss Profit on disposal
Machinery Disposal
$ 28,000 4,900 32,900 2008 Oct " 5 5 Machinery accumulated depreciation Bank $ 14,000 18,900 32,900
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(iv)
2007 Sept 30 2008 Sept 1 Balance c/f Balance c/f Balance c/f
2009 Sept 30
Workings: (W1) $14,000 25% = $3,500 (W2) {[($14,000 $3,500) 25%] + ($21,000 25%)} = $7,875 (W3) {[($14,000 $3,500 $2,625) 25%] + [($21,000 $5,250) 25%] + ($28,035 25%)} = $12,915
(b) (i) Under the reducing-balance method, a fixed percentage for depreciation is deducted from the
cost in the first year. In the second and later years the same percentage is applied to the reduced balance.
(ii) The straight-line method is sometimes also called the fixed instalment method. Under this method, the useful life is estimated (in years). The depreciable cost (i.e., cost estimated residual value) is then divided by the estimated useful life to give the annual depreciation charge.
Photocopiers
Balance b/f (W1) $ 2009 52,000 Mar 31 Balance c/f $ 52,000
(ii)
2009 Mar 31 Balance c/f
Cost of the photocopier = $50,000 + $2,000 = $52,000 Depreciation for the year ended 31 March:
2007 2008 $52,000 150,000 2,500,000 $52,000 600,000 2,500,000 $52,000 575,000 2,500,000 $52,000 250,000 2,500,000 $ 3,120 12,480 11,960 27,560 5,200 32,760
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(b)
Date 2009 Sept " " Details 30 Photocopier disposals Photocopiers
The Journal
Dr $ 52,000 32,760 32,760 64,000 12,000 52,000 Cr $ 52,000
30 Accumulated depreciation: Photocopiers (W2) Photocopier disposals 30 Photocopiers Photocopier disposals (trade-in allowance) Bank
(c)
Cost Less Accumulated depreciation Net book value Less Trade-in allowance Loss on disposal
(d) The units-of-output method matches the annual depreciation with the economic benefits (in terms of output produced) that are expected to be derived from the use of an asset each year. However, it may not be applicable to assets for which it is difficult to measure the units of output produced (e.g., furniture and fixtures).
Machines Account
$ 2004 400,000 Jun 30 600,000 1,000,000 1,000,000 540,000 1,540,000 Balance c/d $ 1,000,000
(b)
2004 Jun 30 2005 Jun 1 " 30 Balance c/d
240,000 240,000
Profit and loss 332,000 11 {[($400,000 $160,000) 40% ] 12 + [($600,000 $80,000) 40%] 2 + ($540,000 40% )} 12 572,000
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(c)
2005 Jun 1 Machine (No. 1)
(ii)
2005 May 5 Dec 31 2006 Sept 20 Dec 31
(iii)
2005 May 5 Plant and machinery
(b) The purpose of providing depreciation is to apply the matching principle to fixed assets. The benefits arising from the use of fixed assets are spread over the periods of their useful lives in the business so that the costs incurred in using the fixed assets can be matched with the benefits.
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