Principle of accounting chapter 11 Non current assests

what does NCA mean

it refers to resources that businesses owns or control that are expected to provide future benefits beyond financial year

What are the accounting terms for nca

1. capital expenditure

2. Revenue expenditure

What is the definition of Capital Expenditure

Costs to bring and buy NCA

More about capital expenditure(NCA)

1. includes expenditure to bring and buy nca to their intended use(legal, delivery and installation

2. Money spent to enhance NCA

3. Provides benefits for more than 1 accounting year

4. recorded as nca in financial posiiton

whats the definition of Revenue expenditure?

Costs to Operate, repair and maintain the NCA in working conditions

more about Revenue expenditure

1. money spent to repair/maintain NCA in working conditions

2. Provides benefits which will be used within 1 accounting year

3. recorded as an expense in financial performance

What happens when a capital expenditure is wrongly recorded as revenue expenditure?

1. NCA is understated

2. Profit for the year is understated

3. Expenses overstated

Whats the definition of Depreciation

Depreciation is the allocation of cost of a NCA over its estimated useful life

causes of depreciation

1. Physical wear and tear

2. obsolescence(outdated)

3. Usage

4. Legal limits

whats Materiality theory?

A transaction is considered material if it makes a difference to the decision making process

whats matching theory

Expenses incurred must be matched against income earned in the same period to determine the profit for that period

Whats prudence theory?

The accounting treatment chosen should be the one that least overstates assets and profits and least understates liabilities and losses

Whats consistency theory?

Once an accounting method is chosen, this method is applied to all future accounting periods to enable meaningful comparison

Using a relavant accoutning theory, explain why a business should depreciate its non current assets

According to matching theory, expenses incurred must be matched against income earned in the same period to determine the profit for the period. As NCA are being used to generate income, a portion of the cost of using the NCA should be matched to the income earned in the same financial period to determine the profit for the period

methods to calculate depreciation

1. straight line method

2. reducing balance method

whats the straight line method?

1. Annual depreciation= cost-scrap/useful life

2. Annual depreciation = rate of dep x(cost of nca - scrap)

whats the reducing balance method

Annual dep exp= rate of depreciation x NBV

when do we use straight line method?

the benefits from the NCA tend to be the same over the years

when do we use reducing balance method

there tends to be more benefits from NCA during the first few years of their usage, hence there is more depreciation expense for the earlier year

Effects of depreciation methods on profit

1. Different depreciation methods will result in different depreciation expense amount

2. Under the straight line depreciation method, the depreciation expense is equal. Therefore, the profit decreases by an equal amount every year

3. Under the reducing balance method, there is higher depreciation expense in the earlier years and reduce over time. Hence, profit decreases by a higher amount in the earlier years

4. once the method of depreciation is chosen for the NCA, it should be applied consistently throughout the years. This is in line with the consistency theory