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Semester Fall 2012
Graded Discussion Board
Financial Accounting (MGT101)
Concept to be Tested: “Revaluation of Fixed Assets and Depreciation”
Alloy Manufacturers Limited (AML) is a well-known company working in the automobiles Alloy industry. Mr. Naseer is working as accounts manager at AML and has more than 05 years of relevant experience. His major responsibilities include looking after accounting matters for accounting of fixed assets – incorporation, maintenance, depreciations, revaluation, and disposal etc. as per accounting rules, IASs and other related laws.
a) ALM has been charging depreciation at the rate of 10%-15% from 2001 to 2012 on its all fixed assets. From 2012 onwards, the management has decided to change its depreciation rates from 15%-20%. Balance sheet of AML as at December 31, 2012 has carries the value of inventory and Land at Rs. 850,000 and Rs. 2,000,000 respectively.
As a student of accounting, you are required to suggest that at which rate business should charge depreciation on inventory and land from year 2012 and onwards? Support your answer with logical reasons.
b) From year 2005 onwards, AML has also been bringing forward “Revaluation surplus”. But in year 2012, business incurred a loss on revaluation of its Buildings. You are required to suggest that what will be the accounting treatments of this loss? Support your answer with logical reasons.
Note: Your discussion should not exceed 150 words.
For acquiring the relevant knowledge, do not rely only on handouts but watch the course video lectures and read additional material available online or in any other mode.
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Revaluation of fixed assets
In finance, a revaluation of fixed assets is a technique that may be required to accurately describe the true value of the capital goods a business owns. This should be distinguished from planned depreciation, where the recorded decline in value of an asset is tied to its age.
Fixed assets are held by an enterprise for the purpose of producing goods or rendering services, as opposed to being held for resale in the normal course of business. For example, machines, buildings, patents or licenses can be fixed assets of a business.
The purpose of a revaluation is to bring into the books the fair market value of fixed assets. This may be helpful in order to decide whether to invest in another business. If a company wants to sell one of its assets, it is revalued in preparation for sales negotiations.
Depreciation is defined as an accounting methodology which allows an organization to spread the cost of a fixed asset over the expected useful life of that asset. The cost of the fixed asset immediately comes out of the cash account of the organization and is entered as an asset for the organization. At the end of each period of the useful life of the asset a part of the cost is expensed. This amount is added to the accumulated depreciation for the asset. The net value of the asset on the books of the organization is the asset account less the accumulated depreciation account.
A fixed asset is considered depreciable if it will wear out or become obsolete over a period of years. The period of years is called the life or the useful life of the item. The life that is assigned to an item will depend on industry standards, management standards, and governmental regulations. Generally, depreciable items include buildings, manufacturing equipment, office equipment, and vehicles. Land is not considered a depreciable item as it does not wear out or become obsolete.
Some fixed assets may be expected to have a market value at the end of their useful life. This expected value is called the salvage value. Some organizations set this value on a per asset basis, some use a percentage of the purchase price, some assume that all assets will have zero salvage value, and some use a combination of these methods.
Organizations usually set a price at which a fixed asset is considered depreciable. Any asset purchased at less than the set price is immediately expensed. This eliminates the need to track every waste basket, stapler, hammer, wrench, desk lamp, etc. Some organizations set this as low as $100.00. Other organizations set it at $10,000.00 or more. Once this limit has been set it should be adhered to and should not be reset every year
How to Calculate Depreciation
Depreciation expense is calculated utilizing either a straight line depreciation method or an accelerated depreciation method. The straight line method calculates depreciation by spreading the cost evenly over the life of the fixed asset. Accelerated depreciation methods such as declining balance and sum of years digits calculate depreciation by expensing a large part of the cost at the beginning of the life of the fixed asset.
The required variables for calculating depreciation are the cost and the expected life of the fixed asset. Salvage value may also be considered. Examples of depreciation calculations for both straight line and accelerated methods are provided below.
Straight Line Depreciation Method
The straight line depreciation method divides the cost by the life.
SL = Cost / Life
Example: A desk is purchased for $487.65. The expected life is 5 years. Calculate the annual depreciation as follows:
487.65 / 5 = 97.53
Each year for 5 years $97.53 would be expensed.
What if there is a salvage value?
Declining Balance Depreciation Method
The declining balance depreciation method uses the depreciable basis of an asset multiplied by a factor based on the life of the asset. The depreciable basis of the asset is the book value of the fixed asset -- cost less accumulated depreciation.
The factor is the percentage of the asset that would be depreciated each year under straight line depreciation times the accelerator. For example, an asset with a four year life would have 25% of the cost depreciated each year. Using double declining balance or 200%, which is the most common, would mean that depreciation expense in the first year would be twice that or 50%. So to calculate the depreciation expense each year the depreciable basis would be multiplied by 50%.
Example: A copy machine is purchased for $3,217.89. The expected life is 4 years. Using double declining balance the depreciation would be calculated as follows:
factor = 2 * (1/4) = 0.50
1 3,217.89 3,217.89 * 0.5 1,608.95 1,608.94
2 1,608.94 1,608.94 * 0.5 804.47 2,413.41
3 804.48 804.48 * 0.5 402.24 2,815.65
4 402.24 402.24 * 0.5 201.12 3,016.77
What if there is a salvage value?
Sum of the Years Digits
The first step is to sum the digits or numbers starting with the life and going back to one. For example, an asset with a life of 5 would have a sum of digits as follows: 5+ 4+ 3 +2 + 1 = 15
To find the percentage for each year divide the year's digit by the sum. In the example above the percentage would be calculated as follows:
Year 1 5 / 15 = 33.34%
Year 2 4 / 15 = 26.67%
Year 3 3 / 15 = 20 %
Year 4 2 / 15 = 13.33 %
Year 5 1/ 15 = 6.67%
Example: A conference table is purchase for 1,467.89. The expected life is 5 years. Since this is a 5 year asset the yearly factors have been calculated above.
1 1,467.89 * 33.34 % 489.40
2 1,467.89 * 26.67 % 391.49
3 1,467.89 * 20 % 293.58
4 1,467.89 * 13.33 % 195.67
5 1,467.89 * 6.67 % 97.91
Please also add: As we are blind from the nature of stock (inventory ) we would consider that inventory is not in term of final goods such as vehicles stock and that is the reason we are not charging depreciation. In case of stock in warehouse in term of vehicles available which are not sold so far, we may proceed according to mentioned in the case study but teacher does not both situation... your logical explanation may clear facts and figures according to your understanding and that is the main thing is being required from us....
No need of too much explanation about this topic as you mentioned below/above while its simple things to understand the main concept of treating any transaction.....
thanks for explanation !!!!!!!!!!!
Land is probably the most commonly encountered property that is not depreciable. As a rule you can only "recover" the cost of land when you eventually sell it, at which point you'll subtract the cost from the sales price to determine your taxable gain. So, when you purchase a business building and the land on which the building is situated, the cost of the land must be subtracted from the total cost of the property. Only then can you determine the depreciation expense for the building itself.
The costs of clearing, grading, planting, landscaping, or demolishing buildings on land are not depreciable, but are added to the tax basis of the land, so they can reduce your taxable gains on the property when it comes time to sell.
Depreciation is not allowed on personal assets, such as a residence used by you and your family, or an automobile used for pleasure purposes only. If an asset is used partly for personal purposes and partly for business, only the portion of the asset used for business purposes is depreciable.
Other items that are not depreciable are inventory and property you lease or rent from others. However, if you pay for some permanent improvements on property that you lease (for example, you remodel your leased office or store), you can depreciate the cost of the improvements.
thnx to all ! vvv good work