COOPERATIVE ACCOUNTING AND AUDITING

Level-III

Based on January 2022, Version Occupational

standard

Module Title: - Administering fixed Asset

LG Code: AGR CAA3 M01 LO (1-3) LG (1-3)
TTLM Code: AGR CAA3 TTLM 0223v1
March, 2022
Wolaita Sodo, Ethiopia
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 Table of Contents

Introduction to the Module............................................................................................3

LO #1- Create awareness about basic economic concepts in cooperatives............4

Instruction sheet...................................................................................................... 4
Information Sheet 1.................................................................................................5
Self-check 1.................................................................................................... 30
Operation Sheet -1................................................................................................31
LAP TEST-1....................................................................................................33

LO #2- Identify members transaction.........................................................................34

Instruction sheet.................................................................................................... 34
Information Sheet 2............................................................................................... 36
Self-Check – 2.................................................................................................44
Operation Sheet -2................................................................................................45
LAP TEST-2....................................................................................................46

LO #3- Implement surplus appropriate concepts of profit and surplus..................47

Instruction sheet.................................................................................................... 47
Information Sheet 3............................................................................................... 48
Self-Check – 3.................................................................................................57
Operation Sheet -3................................................................................................58
LAP TEST-3....................................................................................................59
Reference Materials........................................................................................60

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 LO1. Record fixed asset to general ledgers
1. Introduction

In this chapter, you will learn about the issues of fixed assets. Most business enterprise
holds such major assets as land, buildings, equipment’s, furniture’s, tools, and etc. These
assets help produce revenue over many periods by facilitating the production and sale of
goods or services to customers. Because these assets are necessary in a company’s day-to-
day operations, companies do not sell them in the ordinary course of business. Keep in
mind, though; one company’s long-term asset might be another company’s short-term
asset. For example, a delivery truck is a long-term asset for most companies, but a truck
dealer would regard a delivery truck as a current asset merchandise inventory.

1.1 Concept of fixed asset/PPE Assets.

Companies of all sizes and industries have assets — items they control that bring current and
future benefit to their business. Assets are listed on a company's balance sheet and their value
is generally proportional to a company's valuation. In other words, the more assets in a
business, the higher the business's total value is likely to be.

Certain assets, called fixed assets, provide value to a company over multiple fiscal years.
Commonly called property, plant and equipment (PPE), their primary function is to support a
business's operations. Fixed assets tend to be substantial — not only in terms of cost and,
sometimes, physical size, but also in the ways their accounting treatment brings benefits to a
company.

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Fixed Assets are the part of non-current assets, which are owned by the company with the
aim of productive use by the firm rather than resale.
Fixed assets are tangible, long-lived assets used by a company in its operations, such as
machinery, factories, tools, furniture and computers. They are listed in the noncurrent asset
section on a company's balance sheet because their useful lives extend beyond one year.

Fixed Assets expected to provide economic benefits for more than one accounting year and
are held by the company for carrying out business operations. On the balance sheet, fixed
assets are reported at their net book value. It consists of tangible fixed assets, intangible
fixed assets, capital work in progress .Fixed asset” (also known as property, plant, and
equipment) shall mean any property,

Fixed assets are long-term or relatively permanent assets, such as

equipment, machinery, buildings, and land. etc.
Other descriptive titles for fixed assets are plant assets or property, plant,
and equipment.
It is tangible in nature or fixed asset is non-current asset
Not easily convertible into cash or More than a year.
Fixed assets are tangible, long-lived assets used in the
normal course of business.
Fixed assets are the long terms assets which are acquired by the entity for the
purpose of continuing use, to generate income
Fixed asset costs include all costs necessary to get the asset ready for its
intended purpose or use.
 Almost all fixed assets have limited economic lives. As a result their cost is
converted to expense over the period of economic lives through the process
of depreciation
 Used in operations” and not for resale/investment.

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  Include standby assets (in non-continuous use)
 Exclude idle assets (land or building)-investment
 Revenue producing assets-productive purpose
 Long-term/long-lived in nature and usually depreciated.
 Long-term prepayments
 Bundle of future services

1.2 Identifying fixed asset

Fixed assets refer to long-term tangible assets that are used in the operations of a business. They
provide long-term financial benefits, have a useful life of more than one year, and are classified as
property, plant, and equipment (PP&E) on the balance sheet.

Key Characteristics of a Fixed Asset

1. They have a useful life of more than one year

Fixed assets are non-current assets that have a useful life of more than one year and appear on a
company’s balance sheet as property, plant, and equipment (PP&E).

2. They can be depreciated

With the exception of land, fixed assets are depreciated to reflect the wear and tear of using the
fixed asset.

3. They are used in business operations and provide a long-term financial benefit

Fixed assets are used by the company to produce goods and services and generate revenue. They
are not sold to customers or held for investment purposes.

4. They are illiquid

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Fixed assets are non-current assets on a company’s balance sheet and cannot be easily converted
into cash.

Type of fixed asset

Fixed assets are classified into two main types: Assets that can be used by a business
enterprise for relatively long period (usually more than one year) are called Long-Term
Assets. Long-term assets are divided into tangible and intangible categories.
a) Tangible Asset

Tangible assets (also called plant assets or fixed assets) are assets with physical substance
that can be charged in the operations of business for a relatively longer period of time,
usually more than one year or one operating cycle whichever is longer. Property, plant,
and equipment they are depreciable. They do have physical existence. Examples of
Tangible assets include land; buildings, machinery, equipment, leasehold improvements,
etc.
b) Intangible :
Intangible assets are assets, other than financial assets, that lack of physical substance.
They include such items as patents, copyrights, trademarks, franchises, and goodwill.
Despite their lack of physical substance, these assets can be extremely valuable resources
for a company. Generally, intangible assets refer to the ownership of exclusive rights that
provide benefits to the owner in the production of goods and services
Characteristics Intangible fixed assets
 Noncurrent asset without physical substance
 often provide exclusive rights or privileges
 U s e f u l life is often difficult to determine
 usually acquired for operational use.
A fixed asset administration system is a system of methods, policies, and procedures which
address the acquisition, use, control, protection, maintenance, and disposal of assets. The
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procedures for acquisition of fixed assets are covered through the general policies Manual
since they are part of the procurement processes.

1.3 Recognition, Measurement and De-recognition of Fixed Asset/PPE

Measurement at Recognition

PPE assets are initially measured at their cost, which is the cash or fair value of other assets given
to acquire the asset. A few key inclusions and exclusions need to be considered in this definition.
Any cost required to purchase the asset and bring it to its location of operation should be
capitalized. As well, any further costs required to prepare the asset for its intended use should also
be capitalized. The following is a list of some of the costs that should be included in the
capitalized amount:

 Purchase price, including all non-recoverable tax and duties, net of discounts
 Delivery and handling
 Direct employee labour costs to construct or acquire the asset
 Site preparation
 Other installation costs
 Net material and labour costs required to test the asset for proper functionality
 Professional fees directly attributable to the purchase
 Estimates of decommissioning and site restoration costs

Costs that should not be included in the initial capitalized amount include:

 Initial operating losses

 Training costs for employees
 Costs of opening a new facility
 Costs of introducing a new product or service
 Costs of reorganization and operation at a new location
 Administration and general overhead costs
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  Other revenue or expenses that are incidental to the development of the PPE

Cost Components/Elements [Subject to Mode of Acquisition

Let’s consider some specific assets.

a) Cost of Land

All expenditures made to acquire land and ready it for use. Land typically includes the purchase
price; closing costs (title fees, legal fees, recording fees); costs incurred to make the land ready for
its intended use (grading, filling, draining and clearing); the cost of assuming any liens (taxes in
arrears, mortgages or encumbrances on the property); any additional land improvements with an
indefinite life.

If land is purchased to construct a building, all the costs incurred up to the excavation for the new
building are considered land costs. Removal of any old buildings and clearing the remains are
considered land costs because these costs are necessary to get the land in condition and ready for
its intended purpose. Items with unlimited life such as roads, street lights, sewers and drainage are
often changed to land because they are relatively permanent and maintained. Improvements with
limited lives such as private driveways, sidewalks, fencing and parking lots are usually kept
separate and recorded as land improvements so they can be depreciated over their useful lives.

b) Cost of PP&E [Initial Valuation

 Improvements with limited lives, such as private driveways, walks, fences, and
parking lots, are recorded as Land Improvements and depreciated.
 Land acquired and held for speculation is classified as an investment.
 Land held by a real estate concern for resale should be classified as inventory.
Illustration: Sunrise Company acquires real estate at a cash cost of Br.100, 000. The
property contains an old ware house that is razed at a net cost of Br.6, 000 (Br.7, 500 in costs

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less Br.1, 500 proceeds from salvaged materials). Additional expenditures are the attorney’s
fee, Br.1, 000, and the real estate broker’s commission, Br.8, 000.
Required: Determine the amount to be reported as the cost of the land
land
 C a s h price of property Birr 100000
 N e t removal cost of warehouse (Br.7, 500-Br.1, 500) 6000
 A t t o r n e y ’ s fees (Br.1, 000) 1000
 R e a l estate broker’s commission (Br.8, 000) 8000
Cost of Land Br.115, 000
c) Cost of Land Improvements

Structural additions made to land. As the account name implies, leasehold improvements are
costs incurred to get a leased property ready to use. If a company has a long-term lease, usually
any leasehold improvements made to the property will revert to the lessor (owner) at the end of the
lease. Leasehold improvements is amortized over the remaining life of the lease, or the useful life
of the improvements, whichever is shorter. Cost includes all expenditures necessary to make the
improvements ready for their intended use

 Examples: driveways, parking lots, fences, landscaping, and underground

sprinklers, trees and shrubs, outdoor lighting, concrete sewers and drainage.
 Limited useful lives.
 Expense (depreciate) the cost of land improvements over their useful lives

d) Cost of Buildings

If land is purchases with a building that is onsite and that building is torn down to make way for a
new building, the cost of getting the land ready for use (tearing the building down) is part of land.
However, if a company already has a building and wants to tear the old building to construct a

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new building, the cost of the demolition is expensed as disposal costs of the old building – that
could increase the loss on disposal of the old building.

Includes all costs related directly to purchase or construction.

Purchase costs:
 Purchase price, closing costs (attorney’s fees, title insurance, etc.) and real estate
broker’s commission.
 Remodeling, and replacing or repairing the roof, floors, electrical wiring, and
plumbing. Reconditioning (purchase of an existing building)
Construction costs:
 Materials, labor, and overhead costs incurred during construction and
professional fees and building permits.
 Contract price plus payments for architects’ fees, Engineers’ fees, building
permits, and excavation costs.
 Companies consider all costs incurred, from excavation to completion, as part of
the building costs.
 Insurance & interest costs incurred during construction
 Walkways to and around the building
e) Cost of Equipment

The term equipment can cover a wide range of assets. Equipment can include office equipment,
factory equipment, machinery, furnishings, and at times various types of motorized vehicles. The
cost of these assets include the invoiced purchase price as well as any other costs incurred to make
the asset ready to use. Those costs could include: freight and delivery, insurance while in transit,
assembly and installation costs, testing and costs of make any adjustments to the asset to make it
operate as intended.

Include all expenditures incurred in acquiring the equipment and preparing it for use. Costs
include:

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  Cash purchase price,
 Freight and handling charges,
 Insurance on the equipment while in transit,
 cost of special foundations if required,
 Assembling and installation costs
 costs of conducting trial runs.
 Sales taxes
 Repairs (purchase of used equipment)
 reconditioning (purchase of used equipment)
 modifying for us
Illustration: Lenard Company purchases a delivery truck at a cash price of Br.22, 000.
Related expenditures are sales taxes Br.1, 320, painting and lettering Br.500, motor
vehicle license $80, and a three-year accident insurance policy Br.1, 600.
Compute the cost of the delivery truck
Truck
Cash price Birr22000
Sales taxes 1320
Painting and lettering 500
Cost of Delivery Truck Br.23, 820
: Example – Cost Of an Asset
MoFED purchased a Motor Vehicle from MOENCO. The vehicle is delivered at the
MOENCO store in Addis Ababa. The cost of the vehicle was Birr 500,000. VAT of Birr
75,000 was paid in addition. 2% or Birr 11,500 for title transfer was paid. In addition Roof
Rack and Tape-recorder were bought for Birr 5,000. The total cost of the vehicle that
should be accumulated and entered in the Model 19 is Birr 591, 500 and used for later
issue through is as follows.

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 B ir r
Cost of vehicle 500,000
VAT on it 75,000
2% paid for title transfer 11,500
Cost of tape and roof rack 5,000
591,500

f) Self-Constructed Assets

When a company chooses to build its own PPE, further accounting problems may arise. Without a
transaction with an external party, the cost of the asset may not be clear. Although the direct
materials and labour needed to construct the asset are usually easy to identify, the costs of
overheads and other indirect elements may be more difficult to apply. The general rule to apply
here is that only costs directly attributable to the construction of the asset should be capitalized.
This means that any allocation of general overheads or other indirect costs is not appropriate. As
well, any internal profits or abnormal costs, such as material wastage, are excluded from the
capitalized amount.

g) Borrowing Costs

One particular problem that arises when a company constructs its own PPE is how to treat any
interest incurred during the construction phase. IAS 23 (IAS, 2007) requires that any interest that
is directly attributable to the construction of a qualifying asset be capitalized. A qualifying asset is
any asset that takes a substantial amount of time to be prepared for its intended use. This definition
could thus include inventories as well as PPE, although the standard does not require capitalization
of interest for inventory items that are produced in large quantities on a regular basis.

h) Asset Retirement Obligations

For certain types of PPE assets, the company may have an obligation to dismantle, clean up, or
restore the site of the asset once its useful life has been consumed. An example would be a drilling
site for an oil exploration company. Once the well has finished extracting the oil from the reserve,
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local authorities may require the company to remove the asset and restore the site to a natural
state. Even if there is no legal requirement to do so, the company may still have created an
expectation that it will do so through its own policies and previous conduct. This type of non-
legally binding commitment is referred to as a constructive obligation. Where these types of legal
and constructive obligations exist, the company is required to report a liability on the balance
sheet equal to the present value of these future costs, with the offsetting debit being record as part
of the capital cost of the asset.

Consider the following asset retirement obligation (ARO) example:

Basic Drilling Company follows IFRS. On January 1, Y4, the company purchased an oil drilling
platform for $6,000,000. It’s estimated that this platform will last 6 years. At the end of the
platform’s useful life, the company expects cleanup, remediation and dismantling costs related to
the platform to be $1,000,000. The company uses a discount rate of 5%.

Prepare the journal entries for Year 4 and Year 5 related to this transaction.

On January 1, Y4, there are two separate entries that should be made. The entries can be combined
but for tracking and audit purposes, it’s better to have each transaction separate:

Table 1.1 Record the purchase of the drilling platform

Since we know that the future value of the remediation is estimated to be $1,000,000, we have to
determine the present value to set up the liability (using FV = 1,000,000, PMT = 0, Rate = 5% and
Term = 6 years). The result is $746,215 (rounded).

Table 1.2 Record the purchase of the drilling platform

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Since we know that the future value of the remediation is estimated to be $1,000,000, we have to
determine the present value to set up the liability (using FV = 1,000,000, PMT = 0, Rate = 5% and
Term = 6 years). The result is $746,215 (rounded) at the end of the year, two entries are required.
The first entry is depreciation based on the total cost of the drilling platform (6,000,000 +
746,215) = $6,746,215 divided by the useful life of 6 years.

Table 1.2 Record the purchase of the drilling platform

The second entry is to record interest expense. We use the effective interest method for IFRS.
(746,215 × 5%) The difference here between IFRS and ASPE would be the account to debit.
IFRS use Interest Expense. With ASPE use Accretion Expense:

Table 1.3 Record of interest expense

In Year 5, the depreciation entry remains the same:

Table 1.4 Record of Depreciation expense

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Since we know that the future value of the remediation is estimated to be $1,000,000, we have to
determine the present value to set up the liability (using FV = 1,000,000, PMT = 0, Rate = 5% and
Term = 6 years). The result is $746,215 (rounded) at the end of the year, two entries are required.
The first entry is depreciation based on the total cost of the drilling platform (6,000,000 +
746,215) = $6,746,215 divided by the useful life of 6 years. In Year 5, the interest expense amount
will change since we are using the effective interest method. Remember, we are trying to get our
ARO amount to be the estimated liability of $1,000,000. The amount of interest in Year 5 would
be: ($746,215 + $37,311) × 5% = $39,176

Table 1.4 Record of Interest Expense

Be aware that other factors could influence and change the ARO and the asset amount. First, the
liability at the end of the assets useful life is an estimate. For IFRS, the estimated remediation
amount should be revisited annually and updated as needed. If an update is required, the asset
value will change, causing a change to depreciation. Also, this example ignored inflation. If
inflation exists, the amount will impact the liability and the asset calculation as well.

i) Lump Sum Purchases

There are instances where a business may purchase a group of PPE assets for a single price. This
is referred to as a lump sum, or basket, purchase. When this occurs, the accounting issue is how to
allocate the purchase price to the individual components purchased. The normal practice is to
allocate the purchase price based on the relative fair value of each component. Of course, this
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requires that information about the assets’ fair values be available and reliable. Often, insurance
appraisals, property tax assessments, depreciated replacement costs, and other appraisals can be
used. The reliability and suitability of the source used will be a matter of judgment on the part of
the accountant.

Consider the following example. A company purchases land and building together for a total price
of $850,000. The most recent property tax assessment from the local government indicated that
the building’s assessed value was $600,000 and the land’s assessed value was $150,000. The total
purchase price of the components would be allocated as follows:

Land (150,000 × 850,000) ÷ (150,000 + 600,000) = $170,000

Building (600,000 × 850,000) ÷ (150,000 + 600,000) = $680,000

Total = $850,000

j) Non-monetary Exchanges

When PPE assets are acquired through payments other than cash, the question that arises is how to
value the transaction. Two particular types of transactions can occur: 1) a company can acquire a
PPE asset by issuing its own shares, or 2) a company can acquire a PPE asset by exchanging it
with another asset the company currently owns.

k) Asset Acquired by Issuing Shares

When a company issues its own shares to acquire an asset, the transaction should be recorded at
the fair value of the asset acquired. IFRS presumes that this fair value should normally be
obtainable. This makes sense, as it unlikely that a company would acquire an asset without having
a reasonable estimate of its value. If the fair value of the asset acquired is not determinable, then
the asset should be reported at the fair value of the shares given up. This value is relatively easy to

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determine for an actively traded public company. In cases where neither the value of the asset nor
the value of the shares can be reliably determined, the asset could not be recorded.

l) Asset Acquired in Exchange for Other Assets

When assets are acquired through exchange with other non-monetary assets or a combination of
monetary and non-monetary assets, the asset acquired should be valued at the fair value of the
assets given up. If this value cannot be reliably determined, then the fair value of the asset
received should be used. Notice how this differs from the rule for share-based payments. The
presumption is that the fair values of assets are generally more reliable than the fair values of
shares.

The implication of this general rule is that when non-monetary assets are exchanged, there will
likely be a gain or loss recorded on the transaction, as fair values and carrying values are usually
not the same. The recognition of a gain or loss suggests that the earnings process is complete for
this asset. This seems reasonable, as each company involved in the transaction would normally
expect to receive some economic benefit from the exchange.

There are two instances, however, where the general rule does not apply. These two situations
occur when:

 The fair values of both assets are not reliably measurable.

 The transaction lacks commercial substance.

Although it is an unusual situation, it is possible that the fair value of neither asset can be reliably
determined. In this case, the asset acquired would be recorded at the book value of the asset given
up. This means that no gain or loss would be recorded on the transaction.

A more likely situation occurs when the transaction lacks commercial substance. This means that
after the exchange of the assets, the company’s economic position has not been altered
significantly. This condition can usually be determined by considering the future cash flows
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resulting from the exchange. If the business is not expected to realize any difference in the
amount, timing, or risk of future cash flows, either directly or indirectly, then there is no real
change in its economic position. In this case, it would be unreasonable to recognize a gain, as
there has been no completion of the earnings process. This type of situation could occur, for
example, when two companies want to change their strategic directions, so they swap similar
assets that may be located in different markets. There may be no significant difference in cash
flows, but the assets received by each company are more suitable to their long-term plans. In this
case, the asset acquired is reported at the carrying value of the asset given up.

A brief summary of the methods described above:

When following general standards of asset exchanges. Keep in mind a series of steps that need to
happen when a transaction has commercial substance:

1. Derecognize (remove from the accounts) the carrying value of the asset given up.
Remember, the carrying value includes the cost of the asset AND accumulated
depreciation.
2. Recognize the fair value of the asset(s) received in exchange.
3. Record the difference as a gain or loss in net income.

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If the transaction lacks commercial substance, that is an exception to the fair value standard
(applied to transactions that have commercial substance). So the approach is slightly different.

If a transaction lacks commercial substance, there again, steps that should be considered to record
the transaction:

1. Derecognize (remove from the accounts) the carrying value of the asset given up.
Remember, the carrying value includes the cost of the asset AND accumulated
depreciation.
2. Recognize the carrying value of the asset(s) given up in exchange.
3. Only record a loss in net income (never again).

When the transactions cash component is significant, there is less need to question if the
transaction has commercial substance. As the amount of cash decreases, it’s likely that the
transaction lacks commercial substance. One more important point regarding exchanges that lack
commercial substance is to remember to check whether the fair value of the asset acquired it less
than the cost assigned to it. Assets cannot be recognized at more than their fair value. If the fair
value of the asset acquired is LESS than the cost assigned to it, the asset would have to be
recorded at the lower fair value amount and a loss equal to the difference recorded. Consider the
following illustrations of asset exchanges.

Commercial Substance

Com Link Ltd. decides to change its manufacturing process in order to accommodate a new
product that will be introduced next year. They have decided to trade a factory machine that is no
longer used in their production for a new machine that will be used to make the new product. The
machine that is being disposed of had an original cost of $78,000 and accumulated depreciation of
$60,000. The fair value of the old machine at the time of exchange was $22,000. The new machine
being obtained has a list price of $61,000. After a period of negotiation, the seller finally agreed to
sell the new machine to Com Link Ltd. for cash of $33,000 plus the trade-in of the old machine.

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As the new machine will be used to manufacture a new product for the company, and the old
machine was essentially obsolete, we can reasonably conclude that this transaction has
commercial substance. In this case, the journal entry to record the exchange will be:

Note that the new machine is reported at the fair value of the assets given up in the exchange
($33,000 cash + $22,000 machine). Also note that the gain on the disposal is equal to the fair value
of the old machine ($22,000) less the carrying value of the machine at disposal ($78,000 −
$60,000 = $18,000).

No Commercial Substance

Assume that Com Link Ltd. has a delivery truck that it purchased one year ago for $32,000.
Depreciation of $5,000 has been recorded to date on this asset. The company decides to trade this
for a new delivery truck in a different color. The new truck has the same functionality and
expected life as the old truck. The only difference is the color, which the company feels ties in
better with its corporate branding efforts. No identifiable cash flows can be associated with the
effect of this branding. The fair value of the old truck at the time of the trade was $28,000. The
seller of the new truck agrees to take the old truck in trade, but requires Com Link Ltd. to pay an
additional $5,000 in cash. In this instance, because there is no discernible effect on future cash
flows, we would reasonably conclude that the transaction lacks commercial substance. The journal
entry to record this transaction would be:

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Note that the new truck is reported at the book value of the assets given up ($5,000 cash +
($32,000 − $5,000) = $27,000 truck). Also note that the implied fair value of the new truck
($28,000 + $5,000 = $33,000) is not reported, and no gain on the transaction is realized.

A slight twist to the above example:

If the same exchange occurred, but we were able to ascertain that the fair value of the asset
acquired was only $30,000, it would be inappropriate to record the new asset at a value of
$32,000, as this would exceed the fair value. The journal entry would thus be:

Note that the new truck is recorded at the lesser of its fair value and the book value of the asset
given up. This results in a loss on the transaction, even though the transaction lacks commercial
substance.

1.3.6. Deferred Payments

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When a PPE asset is purchased through the use of long-term financing arrangements, the asset
should initially be recorded at the present value of the obligation. This technique essentially
removes the interest component from the ultimate payment, resulting in a recorded amount that
should be equivalent to the fair value of the asset. Normally, the present value would be
discounted using the interest rate stated in the loan agreement. However, some contracts may not
state an interest rate or may use an unreasonably low interest rate. In these cases, we need to
estimate an interest rate that would be charged by arm’s length parties in similar circumstances.
This rate would be based on current market conditions, the credit-worthiness of the customer, and
other relevant factors.

Consider the following example. ComLink Ltd. purchases a new machine for its factory. The
supplier agrees to terms that allow ComLink Ltd. to pay for the asset in four annual instalments of
$7,500 each, to be paid at the end of each year. ComLink Ltd. issues a $30,000, non-interest
bearing note to the supplier. The market rate of interest for similar arrangements between arm’s
length parties is 8%. ComLink Ltd. will record the initial purchase of the asset as follows:

The capitalized amount of $24,841 represents the present value of an ordinary annuity of $7,500
for four years at an interest rate of 8%. The difference between the capitalized amount and the
total payments of $30,000 represents the amount of interest expense that will be recognized over
the term of the note.

1.3.7. Government Grants

Governments will at times create programs that provide direct assistance to businesses. These
programs may be designed to create employment in a certain geographic area, to develop research
and economic growth in a certain industry sector, or other reasons that promote the policies of the
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government. When governments provide direct grants to businesses, there are a number of
accounting issues that need to be considered.

IAS 20 states that government grants should be “recognized in profit or loss on a systematic basis
over the periods in which the entity recognizes as expenses the related costs for which the grants
are intended to compensate” (IAS 20-12, IAS, 1983). This type of accounting is referred to as the
income approach to government grants, and is considered the appropriate treatment because the
contribution is coming from an entity other than the owner of the business.

Consider the following example. ComLink Ltd. purchases a new factory machine for $100,000.
This machine will help the company manufacture a new, energy-saving product. The company
receives a government grant of $20,000 to help offset the cost of the machine. The machine is
expected to have a five-year useful life with no residual value. The accounting entries for this
machine would look like this:

Deferral Offset
Method Method
Credi
Entries Debit Credit Debit
t
100,00 80,00
Machine
0 0
Deferred grant 20,000 –
Purchase of machine 80,000 80,000
16,00
Depreciation expense 20,000
0
Accumulated depreciation 20,000 16,000
Deferred grant 4,000 –
Grant income 4,000 –
First year depreciation and revenue recognition.
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 Deferral Offset
Method Method
Credi
Entries Debit Credit Debit
t

For Depreciation expense, deferral method: ($100,000 ÷ 5 years = $20,000); offset method:
($80,000 ÷ 5 years = $16,000)

For deferred grant: ($10,000 ÷ 5 years = $4,000)

The net effect on income of either method is the same. The difference is only in the presentation of
the grant amount. Under the deferral method, the deferred grant amount presented on the balance
sheet as a liability would need to be segregated between current and non-current portions.

Companies may choose either method to account for grant income. However, significant note
disclosures of the terms and accounting methods used for grants are required to ensure
comparability of financial statements.

Determination of the Acquisition Cost of Fixed Assets

The acquisition cost of plant (fixed) assets is the cash or cash-equivalent purchase price,
including incidental costs required to complete the purchase, to transport the asset, and to
prepare it for use.
 Historical cost [Cost principle] measures the cash or cash equivalent price of obtaining
the asset and bringing it to the location and condition necessary for its intended use.
 Cost consists of all expenditures necessary & reasonable to acquire an asset and make it
ready for its intended use
 Companies value property, plant, and equipment in subsequent periods using either
the
 Acquisition cost” of a fixed asset consists of its purchasing price and all directly
attributable costs of bringing the fixed asset to working condition. These may include the
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 cost of site preparation; initial delivery and handling costs including freight and insurance
fees; installation costs; professional fees such as for architects and engineers
1.4 Recording capital expenditure
Expenditure is the end and aim of the collection of revenues.
Expenditure can also be classified into Plan and Non-plan Expenditure
Non-plan Expenditure: Non-plan expenditure of central government is divided into revenue
and capital expenditure
Capital expenditures refer to funds that are used by a company for the purchase, improvement, or
maintenance of long-term assets to improve the efficiency or capacity of the company.
Capital expenditures– initial expenditures that are included in the cost of the plant assets.
Revenue expenditures –expenditures that are treated as current period expenses.
Long-term assets are usually physical, fixed and non-consumable assets such as property,
equipment, or infrastructure, and that have a useful life of more than one accounting period.
Also known as CapEx or capital expenses, capital expenditures include the purchase of items such
as new equipment, machinery, land, plant, buildings or warehouses, furniture and fixtures,
business vehicles, software, or intangible assets such as a patent or license.
The expenditure amounts for an accounting period are disclosed in the cash flow statement.
Capital expenditures normally have a substantial effect on the short-term and long-term financial
standing of an organization. Therefore, making wise CapEx decisions is of critical importance to
the financial health of a company. Many companies usually try to maintain the levels of their
historical capital expenditure to show investors that the managers of the company are continuing
to invest in the growth of the business.
Capital Expenditures- are expenditures that improve the operating efficiency (or capacity)
or costs incurred to achieve greater future benefits. Capital expenditures included additions
and betterments.
Addition is an enlargement to the physical layout of a plant asset. Suppose for example, if a
new wing is added to a building, the benefits from the expenditure will be received over
several years, and the amount paid for it should be debited to the asset account. Betterment,
on the other hand, is an improvement that does not add to the physical layout of the asset.
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Installation of an air conditioning system is an example of betterment, Replacement of a
concrete floor for a wooden floor is also betterment that will provide benefits over a number
of years, so its cost should be charged (debited) to an asset account.
Extraordinary repairs: - Extraordinary repairs are repairs of a more significant nature.
They affect the estimated residual value or estimated useful life of an asset.

For example, a boiler for heating a building may be given a complete overhaul, at a cost of
Br. 3000 that will prolong its economic life by 5 years.
Extraordinary repairs are recorded by debiting the accumulated depreciation account, under
The assumption that some of the depreciation previously recorded has now been eliminated.
The effect of this reduction in the accumulated depreciation account is to increase the book
value of the asset by the cost of the extraordinary repair. As a result, the new boo k value of
the asset should be depreciated over the new estimated useful life.

Illustration: Suppose for example, a machine costing Br. 35,000 had no estimated residual
value and an original estimated useful life of ten years, has been depreciated for 7 years. At
the very beginning of the 8th year, the machine was given a major overhaul costing Br.3,
000. This expenditure extended the useful life of the machine 3 years beyond the original
estimate. The computation of the new book value and the entry for the extraordinary repair
would be as follows:
Solution: To record extraordinary repair
Jan. 4. Accumulated Depreciation – Machinery……………
3000

Cash …………………………………………………………3000

Extraordinary repair to machinery

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The revised annual depreciation for each of the six years remaining in the machine’s
useful life would be calculated as follows:

Cost of Machine……………………………………………………………… Birr

35,000

Accum Depreciation before extraordinary repair…………. Br. 24,500

Less: extraordinary repair (Debited to Accum. Depn)….. ------ 3,000

21,500

Book value (carrying value) after extraordinary repair……………… Br.13,

500

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 Revised Annual periodic depreciation = 13500 = Br.2,250
6 year

Revenue Expenditure are Expenditures that benefit only the current period are called revenue
expenditures Expenditure for ordinary repairs and maintenance On April 9, the firm paid $300
for a tune-up of a delivery truck

Descrbtion Debit Credit

repairs and maintenance 300
Cash 300
To expense an expenditure means to charge it to an expense account called Revenue
Revenue expenditures are expenditures incurred in order to maintain the normal operating
efficiency of the asset. Among the more usual kinds of revenue expenditures for plant asset are the
repairs, maintenance, lubrication, Cleaning and inspection necessary to keep an asset in good
working condition.
Ordinary repairs are expenditures that are necessary to keep an asset in good operating
conditions. Trucks must have tune-ups, their tires and batteries must be replaced regularly, and
other routine repairs must be made. Offices and halls must be painted regularly, and broken tiles or
woodwork must be replaced. Such repairs benefit only the current period and therefore must be
charged against the revenue in the current fiscal pried.
Types of CapEx
Many different types of assets can attribute long-term value to a company. Therefore, there are several types
of purchases that may be considered CapEx.

 Buildings may be used for office space, manufacturing of goods, storage of inventory, or other
purposes.
 Land may be used for further development. Accounting treatment may different for land
specifically held as a speculative long-term investment.

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  Equipment and machinery may be used to manufacture goods and convert raw materials into
final products for sale.
 Computers or servers may be used to support the operational aspects of a company including the
logistics, reporting, and communication of operations. Software may also be treated as CapEx in
certain circumstances.
 Furniture may be used to furnish an office building to make the space usable by staff and
customers.
 Vehicles may be used to transport goods, pick up clients, or used by staff for business purposes
 Patents may hold long-term value should the right to own an idea come to fruition through
product development.

Formula and Calculation of CapEx

CapEx=ΔPP&E+Current Depreciation
where:
CapEx=Capital expenditures
ΔPP&E=Change in property, plant, and equipment

Capital expenditures are also used in calculating free cash flow to equity (FCFE).
FCFE is the amount of cash available to equity shareholders. The formula FCFE is:
FCFE=EP− (CE−D) × (1−DR) −ΔC× (1−DR) - ΔC× (1−DR)
Where:
FCFE=Free cash flow to equity
EP=Earnings per share
CE=CapEx
D=Depreciation
DR=Debt ratio
ΔC=ΔNet capital, change in net working capital
Or, alternatively, it can be calculated as:
FCFE=NI−NCE−ΔC+ND−DR
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Where:
NI=Net income
NCE=Net CapEx
ND=New debt
DR=Debt repayment
 NB-The greater the CapEx for a firm, the lower the FCFE.
Example of How to Use CapEx
Here's a hypothetical example to show how CapEx works. Let's say ABC Company had $7.46 billion in
capital expenditures for the fiscal year compared to XYZ Corporation, which purchased PP&E worth $1.25
billion for the same fiscal year. The cash flow from operations for ABC Company and XYZ Corporation for
the fiscal year was $14.51 billion and $6.88 billion respectively.

CF-to-CapEx is calculated as follows:

CF/CapEx=Cash Flow from Operations Cap
CapEx
Where:
CF/CapEx=Cash flow to capital expenditure ratio

Using this formula, ABC's CF-to-CapEx is as follows:

$14.51 Billion
$7.46 Billion = 1.94

XYZ's CF-to-CapEx is as follows:

$6.88 Billion =5.49

$1.25 Billion
It is important to note that this is an industry-specific ratio and should only be compared to a ratio derived
from another company that has similar CapEx requirements.
1.5. Identifying Discrepancies of fixed asset
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Fixed assets have a substantial influence on your business’ balance statements. Not having an updated
record of all your fixed assets will cost your company thousands of dollars every year. The fact that you are
not constantly auditing your company’s fixed assets increases the chance for employee theft, misplacement,
loss, and undocumented damages that affect your asset’s value. Fixed assets’ value is based on age, working
and cosmetic condition, and if it is still under warranty or not. In addition to having a list of every asset your
company owns you must also record important information such as serial numbers, date of purchase, repair
and service completed.

Without accurate asset records, your financial balance sheets will be incorrect, losses may occur, or
necessary assets may not be available when needed. Routine audits ensure that your company’s financial
statements do not contain any inconsistency. Consequently protecting you and your business in the case of
external audits. Regularly auditing your fixed assets will assist with identifying discrepancies, isolating
errors, and keeping your company compliant with regulations.

STEPS IN A FIXED ASSET AUDIT

1. Decide on a starting point: Organize how to conduct your fixed asset audit. Will you separate your
audit by location, department, or will it be a widespread audit across your entire company?
2. Gather your assets’ records: Once you have devised a plan of action, gather a comprehensive list
of all of your assets.
3. Reassess regulations. Review internal and external procedures and regulations for conducting
audits.
4. Determine audit goals. For example, ensure that every fixed asset is accounted for and it’s properly
recorded and valued. However, if your tracking process has been negligent in the past, you should
first conduct a manual fixed asset audit to account for all of your assets. A manual fixed asset audit
will provide a starting point for better reporting in the future.
5. Review and account for inconsistencies. The final report will uncover problematic areas such as
ghosts assets, damaged assets, and assets that are no longer usable and need to be disposed.

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Regularly conducting fixed asset audits provide a clear picture of your business that oftentimes is
overlooked. Once you and your company develop the habit of conducting regular audits, you will be able to
make adjustments to spending and how to manage and support your fixed assets proactively rather than
reactively. However, internal controls are not usually implemented for a number of other fixed asset
transactions. Some examples of mistakes when tracking and managing fixed assets:

 Insufficient asset descriptions: missing manufacturer, model, and serial number information
 Lack of proper property identification tags - For example, barcodes
 Insufficient documentation of asset movements including possession, transfers, and disposal
 Incorrect depreciation calculation
 Irregular or no recurrent physical inventory and reconciliation

LO2. Recognize new fixed asset and fixed asset categories

2.1 Categories of New fixed asset/PPE

Fixed assets are long-term assets that a company has purchased and is using for the production of its goods
and services. They are sometimes referred to as non-current assets, as opposed to current assets, which
include things like stock. Assets can also be classed as physical or intangible and operating or non-
operating. Correctly identifying and classifying asset types is essential to fixed asset accounting and more
broadly to comply with all major accounting standards.

Fixed asset categories on financial statements

A company’s fixed assets are reported in the section described as property, plant and equipment within the
non-current (or long-term) asset section of the balance sheet. Current assets are reported separately under
the current assets section. Non-current assets will normally contain three separate line items:

 Tangible fixed assets (e.g. property including land and buildings, equipment, furniture and vehicles)
 Goodwill
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  Other intangible fixed assets (e.g. copyrights, patents or trademarks)

All the property, plant, and equipment are classified as fixed assets other than the following except if they
are being held for sale, or if they are classified as mineral or biological assets under IFRS 41. Neither is
categorized as a fixed asset for balance sheet reporting.

The ways Identifying New asset categories are the following.

1. Fixed Asset Register
Is a record of information on each asset that supports the effective and technical
management of the assets and meets statutory requirements. The Administration fixed
asset register would describe the trucks (indicate color, make, model), indicate their
purchase date and price, their amount of depreciation accumulated, and their estimated
salvage value.
The Administration asset register is important for keeping track of whether or not assets are still in
possession or are working, and is an important way of of keeping track of the value of your assets. It can
be helpful not only for business management purposes, but should also be provided to your accountant as
it is an easy way for him or her to to find information regarding the assets and their Value
BENEFIT OF FIXED ASSET REGISTER
 C o m p l y with statutory requirements.
 T r a c k and identify the asset.
 S e c u r i t y of the Asset specifically to prevent theft.
 C a l c u l a t e Depreciation annually.
 T r a c k Gross Book Value and Net Value of Assets.
 A s s i s t s in Conducting Audit of Assets and Asset Verification.
 H e l p s in estimating the repairs and maintenance cost.
 A s s i s t s in estimating the future capital investment in fixed assets.
 I n certain countries, subsidies are allowed on certain assets. The value of assets is
Determined from fixed asset registers.
 d e t e r m i n i n g business valuations.

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Criteria of fixed asset register.
Description: The description should be able to distinguish the specific asset from
other similar assets
Category of asset
Class of Asset
Purchase Cost of Asset: The cost is also mentioned as per the invoice.
Model code: Identification the unique identification code can be mentioned here.
Serial number/ Asset number/ID: This is the identification assigned by the manufacturer.
If your company has al so assigned a company ID, note that in your record: It will show
the count of entries.
Date of purchase: Include the date the asset was purchased. Date on which the
asset is purchased. It is normally invoice date.
Date asset placed in service: List the first day of usage for the asset.
Possibility to select start date for depreciation.
Possibility for different depreciation schedules. (Monthly, Quarterly, Yearly)
Location
Production Year.
Project and donor identification (if needed) Date of acquisition
Start of depreciation

2. Property identification of number (PIN) as the name implies is used to uniquely

identify new assets.
A logical and systematic number is assigned to new assets for ease of reference and
for summarizing and analyzing information on fixed assets.
In Property Identification number (PIN) development, alphabets, numbers and
other characters are used; the name ―number‖ should not be misunderstood.
 A l l assets owned by organization, Movable or immovable should be easily
recognized even if they change location.

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  the effort of improving the fixed assets management system is to enhance the
effectiveness of the existing control, to introduce new asset methods and
records
And to lay the ground for incorporating the value of fixed assets in the
financial accounts system.
 A unified coding system that enables summarization of assets under the custody
of all PBs into the categories of the fixed assets given in this manual is necessary.
 PIN needs to be easy to understand and logical.
 T a k i n g these basic principles in to account, the structure of the PIN for fixed asset
administration is the following.
Table 2 developing PIN for new asset organization

What does Public Source of Group of Make or Departmen Specific

it indicate Body budget the Asset sub group Location t or Section Code of
Code Code of assets Code or Division the asset
Code MOFED 101 4521 01 HO FD
Code 0001
The following principles are followed when developing PIN for the new
asst organization
1. Public Body Code (PBC) – Assets need to be identified by PB.
 Ministry of finance and economics development (MoFED)
 Ministry of Education, it is usual to abbreviate its name as ―MoE
 Likewise are being used and are easily recognized.
 These codes should be used as the Public body Code. Once the code is selected, it
should be used consistently.
2. Source of budget
 A s s e t s could be bought using the capital budget obtained from the government.

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 Similarly assets can be bought using other donors fund or assets could be
obtained in kind from the donors. To help identification of assets in the name of
each and every donor or the government, three digits code shall be used.

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  T h e code is used as follows: The first digit in the three digit number
indicates whether the fund is from government source or from other
sources.
 I f the code is 100 – the source is government. If the code is 200 – the source is other
source than government. 101; when the asset is obtained in kind from the
government, the last two digits become 102; and if there are other
government sources, the last digit will be changed.
 I n a similar way all funds obtained from donor sources, be it loan or grant, the first
digit becomes 2 and the last two digits shall be used to identify the donor.
 Each public body shall prepare a chart showing the different sources of funds to
purchase assets.
 T h e chart shall be updated from time to time when the number of sources increase
es. The Chart shall be prepared in the following way:
Table 3 source of budget and code
No Source of budget Code
1 Government 100
2 Capital budget 101
3 In kind contribution 102
4 Transfer from other Government agencies 103
5 Non – Government 200
6 IDA 201
7 UNFPA 202
WHO 203
USAID 204
3. Group of the Asset Code --this code is given to the asset on the basis of the
category it belongs to. When there is a need to crate new categories, the GPAD in
consultation with the CAD, creates and make the new category known to all PBs.
4. Make or sub group of assets code - This code is used to identify sub groups of assets.
For example, furnishings and fixture is a general group. Within it, there are sub groups
like, chairs, tables, cupboards, curtains, etc. Similarly within vehicle, sub groups could be
Tractor, Busts, Dumper, Bulldozer, etc. For each sub group a two digits code shall be

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assigned. Each public body shall develop a chart showing standard two digits code for sub
groups of assets.

The following is an example as to how to prepare the chart

Table 4 group of asset and their codes
Group of
Group of asset the sub group of assets
Asset
Vehicle and other 4521 Motor vehicles, motorcycles, bicycles, and trailers
vehicular transport
Aircraft, boats, etc. 4522 Aircraft and boats for non-military purposes.

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Plant and machinery 4523 Equipment for office and workshops including
generators, heavy construction equipment,
survey
Military equipment 4524 Military aircraft and boats; small arms, artillery, tanks,
trucks, etc.
Buildings – residential 4525 Purchase or construction of houses in the country or
abroad for residential use including dormitories,
Buildings – non 4526 Purchase or construction in the country or abroad of
residential administrative offices, warehouses, ,
Infrastructure 4527 museums,
All publicmonuments, etc.are not buildings including
structures that
roads, bridges, airfields, canals, irrigation systems,
Military purpose buildings 4528 Residential buildings, non-residential buildings and
infrastructure as defined above but for
Furnishings and fixtures 4529 military
, Exteriorpurposes.
and interior lighting fixtures of buildings,
furniture, carpets and drapes, pictures and photo
Livestock and transport 4530 Livestock for breeding and research purpose
animals and transport animals for government purpose..

Office equipment 4531 Equipment for office use including

computers,
typewriters, photocopiers, calculators, fax

Location Code – identifies location of the asset. Each PB will have its own way of
organizing this location code. “HO” above stands for Head Office. If the location is,
say, Adama AD ,Bahar Dar, the code would be “BD”, for Dire Dawa, “DD”, and for
Awassa, “AW”, and so on.

Department or Section or Division Code – is the specific location of the asset within
the PB and follows the organization structure. For example, “FD” for Finance
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Department, “AD” for Administration Department and “GS” for General Service, could
be used. For subdivisions, for instance, Budget Section under Finance, the code “BG”
could be used instead of “FD” to directly identify the asset.
Specific Code for the asset – is the specific counting number given to that specific
asset. In the example above, 0001 (four digits) identifies the asset.
The combined code of an asset looks like the following: MoFED-101-4521- 01-HO-FD-
0001

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  The combined code has seven parts.
 As discussed above these seven parts of the code should appear in every asset
of every PB.
 The third part ―4521‖ is the same for all PBs.
 The first, second and the fourth to sixth parts of the code differ from PB to PB
Although the principle and the meaning should remain the same. Let us take the
following examples:

Example 1 – PIN development or Complete Code Number for an Asset

 T h e code for the first vehicle in Ministry of Education (MoE)
 t h e vehicle is used in Head Office.
 t h e responsibility for the custody of the vehicle is that of the General Service (GS).
 t h e vehicle was purchased using government budget.
 T h e PIN should look like: MoE-101-4521-01-HO-GS-0001
Further Examples of Fixed Asset Numbering
You are given the following particulars to prepare the PIN for assets.

Account Make Source

Name of Public Code or sub of Location/ Type of Other
Body group budget Department Asset particulars
of
1. Ministry of 4531 01 101 Dire Dawa, A First
Capacity Building Budget computer computer
(MoCB) Section (DD,
2. Ministry of 4521 02 102 Mekele, A motor The
Revenue (MoR) General Bike fifteenth
Service (Mkl, item

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 3. Special 4529 03 201 Head Office, A filing Third
Prosecutor Finance cabinet asset
General’s Office Section (HO,

The Fixed Assets Codes for the above are as follows:

1. MoCB-101-4531-01-DD-BG-0001
2. MoR-102-4521-02-Mkl-GS-0015
3. SPG-201-4529-03-HO-FS-0003

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2.2 Preparing and processing Performa

Purchase
Purchasing describes the process of buying. It is the learning of the requirement, identifying and
selecting a supplier, negotiation price. Purchasing is an element of the wider function of
procurement and it includes many activities such as ordering, expediting, receipt and payment.
Purchasing is responsible for obtaining the materials, parts, supplies and services needed to
produce of a product or provide a service. (Joyce, 2006) Purchasing can be divided into two
broad categories, large and small purchases, based on seven characteristics of purchased product
volume, specificity, technological complexity, essentiality, fragility, variability, and economic
value. (Parikh, 2005)

What is procurement?
Procurement is the process of acquisition of goods, materials, works or services of the
right quality in the right quantity from the right source delivered to the right place at the
right time and right price.
Procurement is obtaining goods, works, consultancy or other services through purchasing,
hiring or obtaining by any other contractual means.
Public procurements undertaken by Public bodies using public funds, except when a
specific waiver is issued by PB in the interest of national security or national defense,
concerning the use .
Difference between purchasing and Procurement
 P r o c u r e m e n t involves the process of selecting vendors, establishing payment
terms, strategic vetting, selection, the negotiation of contracts and
actual purchasing of goods
 P r o c u r e m e n t is concerned with acquiring (procuring) all of the goods,
services and work that is vital to an organization.
 P r o c u r e m e n t is, essentially, the overarching or umbrella term within
which purchasing can be found.

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  P u r c h a s i n g is a subset of procurement simply to buying goods or services
 p u r c h a s i n g often includes receiving and payment as well.
 P u r c h a s i n g is the process of how goods and services are ordered.
 P u r c h a s i n g can usually be described as the transactional function of procurement
for goods or services
Elements of purchasing asset administration

 D e m a n d estimation
 I d e n t i f y the needed items

 Calculate from the trends in Consumption during last 2 years.

 Review with resource constraints
Procurement asset cycle
 Review asset selection
 Determine needed quantities
 Reconcile needs & funds
 Choose procurement method
 Select suppliers
 Specify contract terms
 Monitor order status
 Receipt & inspection
Objectives of procurement system
 Acquire needed supplies as inexpensively as possible
 Obtain high qualit y fixed asset or supplies
 Assure prompt & dependable delivery
 Distribute the procurement workload to avoid period of idleness & overwork
 Optimize asset management through scientific procurement procedures
Open tender
 Public bidding, resulting in low prices Published in newspapers .

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  Quotations must be sent in the specific forms that are sold, before the time &date
mentioned in the tender form ,In technical items, ‘two packets or two bins’
system is followed. Offers are given in two separate packets, Technical bid
,Financial bid
 First technical bid is opened & short listed
 Then financial bid of selected companies are opened & lowest is selected
 Delayed tenders & late tenders are not accepted. But if, in case of delayed
tenders, if the rate quoted is very less, then it can be accepted.
• quotation are opened in presence of indenting department, accounts &
authorized persons of party

Restricted or limited tender: From limited suppliers (about 10), Lead-time is reduced,
Better quality
Negotiated procurement: Buyer approaches selected potential Suppliers & bargain
Directly used in long time supply contracts
Direct procurement: Purchased from single supplier, at his quoted price, Prices may
be high Reserved for proprietary materials, or low priced, small quantity & emergency
purchases
Rate contract: Firms are asked to supply stores at specified Rates during the period by the
Contract
Spot purchase: It is done by a committee, which includes an officer from stores, accounts &
purchasing departments
Risk purchase: If supplier fails, the item is purchased from other agencies & the
difference in cost is recovered from the first supplier
Points to remember while purchasing: Proper specification, Invite quotations from reputed
firms, Comparison of offers based on basic price, freight & insurance, taxes and levies
, Quantity & payment discounts, Payment terms

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Delivery period, guarantee, Vendor reputation, (reliability, technical capabilities,
Convenience, Availability, after-sales service, sales assistance), Short listing for
better negotiation terms Seek order acknowledgement
Storage: Store must be of adequate space .Materials must be stored in an appropriate place
, in a correct way , Group wise & alphabetical arrangement helps in , identification &
retrieval First-in, first-out principle to be followed ,Monitor expiry date ,Follow two
bin or double shelf system, to avoid Stock outs , Reserve bin should contain stock that
will cover .lead time and a small safety stock
Inventory control
It means stocking adequate number and kind of stores, so that the materials are
available whenever required and wherever required. Scientific inventory control results
in optimal balance

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Functions of controlling fixed asset
To provide maximum supply service, consistent with maximum efficiency &
optimum investment.
To provide cushion between forecasted & actual demand for a material
Economic order of quantity
EOQ = Average Monthly Consumption X Lead Time [in months] + Buffer Stock –
Stock on hand
• R e -order level: stock level which fresh order is placed.
• A v e r a g e consumption per day x lead time + buffer stock
• L e a d time: Duration time between placing an order & receipt of material
HISTORY SHEET OF EQUIPMENT
HISTORY SHEET OF EQUIPMENT.

 Name of equipment
 Code number  Guarantee period
 Date of purchase  Warranty period
 Name of supplier  Life of equipment
 Name of manufacturer  Down time / up time
 Date of installation  Cost of maintenance
 Place of installation  Unserviceable date
 Date of commissioning  Date of condemnation
 Environmental control  Date of replacement
 Spare parts inventory
 Techn. Manual /
circuit diagrams /
literatures
Maintenance sheet:

 A n n u a l maintenance contract [AMC]

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  S t a r t i n g date

  M a t e r i a l s / spares used
E
 C o s t of repairs
pi
ry  O u t s i d e agency
d
t New purchases of
assets,
  Fixed assets are purchased like any other stock item by purchase policy
S and are taken to store. .
er  All fixed assets newly obtained should go through the store system.
vi
 No one should be allowed to use fixed asset that has not gone through
ce
the store system.
/
 When the store receives the purchased asset the storekeeper issues Receipt for
r
Fixed Assets Received (RFAR).
p
 The format is developed to be used for fixed assets. This form is not used to
i
receive consumable stocks. The distribution shall be:
d
Original & copies Distribution
s
Original - To the person or entity who delivered the items
r Second copy - To Finance Department to be attached with the Payment
p Voucher
o Third copy - To the FAAU of the PB.
Fourth copy - to Store
th Remains in the Pad.
5

 The history of the asset should be kept with the FAMU.

 As the store is getting copy of all documents like the copy of the supplier
invoice, copy of the contract, copy of the packing list, copy of tax
declarations, those copy
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a  This Model together with the supporting documents shall be filed in box files in
c the
e FAMU.
a  When one wants to refer to the history of the asset, it can easily be
a obtained in those files.
c
 When fixed assets are issued from the store, Receipt for Fixed Assets
w
Requested & Issued (FAIRR) is used.This format is to be used only for fixed
t
assets. It should not be used to issue consumable stocks. The distribution
t
shall be:
c
Original & Distribution
y copies
Original - To recipient
Second copy - To Finance Department of the PB.
t
Third copy - Gate Pass
R Fourth copy - Store
th
A 5 Remains in the Pad

The third copy is the one that is used in the fixed assets management process. .

Fixed asset management performs are the following tasks:

Identify the appropriate category of the fixed asset with purchase

Assign PIN for the asset

Register the asset on the FAR if the item worth more than the minimum
threshold for fixed asset..

Print the PIN on the fixed asset.

Issue the fixed asset to the user

A pro Forma invoice is a preliminary record of sale that serves as a stand-in until
transaction details are finalized. Like any other invoice, this one should contain an itemized
list of items and costs. However, since this document is not necessarily in final form,
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shipp at that may be required by the buyer to apply for an import license, contract for pre-
ing shipment inspection, open a letter of credit or arrange for transfer of hard currency.
costs
Businesses use ProForma invoices as written estimates that can help with bookkeeping and
,
customs processing and can serve as the basis for hammering out a final agreement between
taxes
buyer and seller – so invoices should always be prepared in good faith and delivered
, and
promptly.
other
detai
ls
What to Include
may
be
subje
ct to
chan
ge.

A
pro
form
a
invoi
ce is
a
quot
e in
an
invoi
ce
form
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 le from a standard one, with the caveat that its figures are subject to change. It should
include:

 The name, address, and phone number of both buyer and seller
 An itemized list of all items and their costs
 The estimated subtotal due, estimated taxes due, and estimated total due
 The payment due date and any penalties for late payment

How to Use a ProForma Invoice

1. Calculate Goods to be sent

Review the order in detail and calculate the total preliminary costs.

2. Describe Each Preliminary Charge

The Complete the invoice by filling out these preliminary quantities and costs. It may be wise to
ProF highlight particular elements that are most likely to change.
orma
3. Submit Invoice
invoi
ce Submit the invoice when ready, and make sure to express that it is the ProForma, not the
shoul final version. Speak to the customer and ensure agreement on all terms.
d be
basic 4. Ship the Goods
ally
Once the ProForma Invoice has been delivered and an agreement is achieved, you can send
indis
goods. Remember to record any changes in costs or quantities. Then, prepare the final
tingu
invoice and deliver it promptly to the customer.
ishab

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2.3 Acquisition cost of property, plant and Equipment

According to the Financial Accounting Standards Board (FASB), the historical cost of
acquiring an asset includes the costs necessarily incurred to bring it to the condition and
location necessary for its intended use. In terms of property, plant, and equipment, this
means that all the reasonable and necessary costs required to get an asset to its location and
ready for use are included in the acquisition cost. For example, the acquisition cost of
equipment includes any transportation charges, insurance in transit, installation, testing
costs, and normal repairs before putting the asset into service. All of these costs are
necessary to bring the equipment to a location and condition to make it ready for its
intended use. However, the acquisition cost does not include unexpected costs, such as the
cost of repairing damage incurred in transportation, purchase discounts lost, or, in most
cases, interest costs.

These costs, as well as normal repairs and maintenance expenses incurred in subsequent
periods, are considered period expenses when incurred. Each type of asset within the
property, plant, and equipment category has special conventions regarding the particular
items that should be included in the asset’s acquisition cost.

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Cash the asset’s net cash equivalent price paid plus all other costs necessary to get the asset ready
Acq
to use. To illustrate, assume the Miller Company purchases a lathe from the Arnold
uisiti
ons Company. The price of the lathe is $15,000, and the terms of sale are 2/10, n/30.

Whe
Sales tax is 6%, freight charges are $850, and installation costs are $150. The total
n
acquisition cost of the equipment is $16,600, computed as follows:
prop
erty,
plant
, and
equi
pme
nt
are
purc
hase
d for
cash,
the
acqui
sitio
n
price
is
easy
to
deter
mine
. It is

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 included in the cost of the equipment but instead should be considered as an interest
expense.

Other Methods of Acquiring Property, Plant, and Equipment

There are a variety of ways in which an enterprise can acquire property, plant, and
equipment other than by direct cash purchase. These include basket purchases, noncash
exchanges such as in exchange for the firm’s own capital stock, donation, and self-
construction. The determination of cost in these types of acquisitions is often more difficult
than in straightforward cash exchanges and thus warrants special attention.

Basket or Group Purchases

Whether or not the purchase is for cash, a firm’s property, plant, and equipment are often
purchased together in one lump sum. For example, when an existing building is purchased,
the land on which that building is situated is also usually purchased. The agreed-upon
purchase price represents the total cost of both the building and the land, and in many cases,
the total purchase price is more or less than the individual fair market values of the building
and the land.

As a result, the total purchase price must be allocated between the individual assets. This is

If the especially important because the building is subject to depreciation, but the land is not. The
disco allocation is often based on appraisals or property records.
unt is
Example 1.
not
taken To illustrate, assume that the H. Jones Company purchases an existing office building and
, the the site land. The total purchase price is $1 million.
$300
shoul An independent appraiser determines that the building and land have fair market values of
d not $900,000 and $300,000, respectively. The $1 million purchase price is allocated as follows:
be
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*$900,000 / $1,200,000 = 75% * Percentages x $1,000,000 = Purchase price

As this example illustrates, the acquisition cost is the basis for recording assets, even though
their individual appraised values may be higher.

2. Non-cash Exchanges

In some situations, property, plant, or equipment is purchased through non-cash

transactions. For example, a firm may purchase land and, in exchange, issue the firm’s stock
to the seller. In these transactions, the application of the cost method requires that the
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acqui However, if it is difficult or impossible to determine with reasonable accuracy the fair
sitio market value of the non-cash consideration, the market value of the particular asset that is
n purchased should be used.
price
Example 2
of
the
asset
be
equal
to
any
cash
give
n,
plus
the
fair
mark
et
value
of
any
non-
cash
consi
derat
ion
give
n.
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 Company, a larger public company, purchases site land in downtown Los Angeles on which
to build its corporate office. In exchange for the land, the Orange Company issues 10,000
shares of its capital stock to the seller.

At the time of the transaction, Orange Company’s stock is selling on a national exchange for
$78 per share. To record this transaction, the Orange Company makes the following entry:

3. Self-Constructed Assets

In some circumstances, a building or a piece of equipment is constructed by the enterprise

itself. These assets are named self-constructed assets. The acquisition costs of these assets
include materials and labor used directly in the construction process as well as a portion of
overhead. Overhead costs include supervisory labor, utilities, and depreciation on the
factory building.

To
illust
rate,
assu
me
the
Oran
ge

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 4. Capitalization of Interest

Interest is the time value of money and, as such, is generally considered an expense in the
period incurred. Thus, when property, plant, or equipment is purchased through the issuance
of a note, the interest related to that note is expensed when incurred. However, in 1979 the
(Financial Accounting Standards Board) FASB issued Statement 34, which requires that in
limited circumstances interest be capitalized and thus be included in the acquisition cost of
certain non-current, non-monetary assets.

In particular, Statement 34 requires that when an enterprise constructs its own assets or has
another entity construct an asset for it, and when there is an extended period to get it ready
for use, interest incurred in the construction should be capitalized as part of the acquisition
or production cost of the asset.

LO3. Prepare Depreciation schedules

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 3 is defined as a systematic allocation of the depreciable amount of an asset over
. its useful life. An entity is required to depreciate an item of property, plant and
1
. equipment when it is available for use and to continue depreciating it until it is
Cderecognized…
o
n
c Fixed assets, lose their ability, over time, to provide services. Thus, the costs of fixed
e
passets such as equipment and buildings should be recorded as an expense over their
t useful lives.. All tangible long-term assets are depreciable except land, intangible
o
f assets are also amortized over their useful life unless they have indefinite life and
Dnatural resources are exhausted as more and more units of minerals extracted.
e
p
r The adjusting entry to record depreciation debits Depreciation Expense and credits a
e
c contra asset account entitled Accumulated Depreciation or Allowance for
i
a
t
i
o
n
D
e
p
r
e
c
i
a
t
i
o
n
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 n. The use of a contra asset account allows the original cost to remain unchanged in
the fixed asset account.

What is a Depreciation Schedule?

A depreciation schedule is required in financial modeling to forecast the value of a

company’s fixed assets (balance sheet), depreciation expense (income statement), and
capital expenditures (cash flow statement).Depreciation occurs as an economic asset is used
up. Economic assets are different types of property, plant, and equipment (PP&E). As the
assets are used, they begin to degrade and lose value. Different assets lose value at different
rates. A depreciation schedule helps to calculate the differences.

The schedule will list the different classes of assets, the type of depreciation method they
use, and the cumulative depreciation they’ve incurred at various points in time. The
depreciation schedule may also include historic and forecasted capital expenditures
(CapEx).

D
e
p
r
e
c
i
a
t
i
o
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Table10 5-year straight-line depreciation, from CFI’s e-commerce financial modeling
course.

Setting up the Depreciation Schedule

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To use sales revenue is a common driver for both capital expenditures and depreciation
begi expense.
n,
creat Below this, prepare a section for capital expenditures and reference historical CapEx from
e the any available periods. Project future capital expenditures by using an appropriate forecasting
struc assumption. Apply intuition to determine the proper forecasting assumption to use from the
ture following:
for
 CapEx as a percentage of sales
the
 Fixed recurring amount
depr
 Reasonable “hard dollars” that one would expect a company to incur as they operate
eciati
on
sche Depreciation can be caused by physical or functional factors.
dule
1. Physical depreciation factors include wear and tear during use or from exposure to
as
weather.
follo
ws. 2. Functional depreciation factors include obsolescence and changes in customer
The needs
first that cause the asset to no longer provide services for which it was
line intended. For example, equipment may become obsolete due to
item changing technology.
to be
3.2. Factors that affect the computation of Depreciation.
refer Factors in Computing Depreciation Expense
ence
Three factors determine the depreciation expense for a fixed asset. These three factors
d
are
shoul
d be as follows:
sales  The initial cost of a fixed asset is determined using the concepts
reve discussed and illustrated earlier in this chapter.
nue. Depreciation base = original cost/initial -residual value
This  The expected useful life of a fixed asset is estimated at the time the
is
asset is placed into service..
beca
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The is the amount of the asset’s cost that is allocated over its useful life as depreciation
diffe expense. If a fixed asset has no residual value, then its entire cost
rence
betw
een a
fixed
asset
’s
initia
l cost
and
its
resid
ual
value
is
calle
d the
asset
’s
depr
eciab
le
cost.
The
depr
eciab
le
cost
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 during the first half of a month, many companies compute depreciation on the asset for the
entire month.
Four Factors That Affect the Computation of Depreciation

1. Cost.

 Net purchase price.

 All reasonable and necessary expenditures to get the asset in place and ready for
use.

2. Residual value (salvage or disposal value).

shou
ld be  An asset’s estimated net scrap, salvage, or trade-in value as of the estimated date of
disposal.
alloc
ated 3. Depreciable cost.
to
 Cost less residual value.
depr  Depreciable cost is allocated over the useful life of an asset.
eciat
4. Estimated useful life.
ion.
 Total number of service units expected from a long-term asset.
For
May be measured in years, miles, units, or similar measures.
an
3.3. Methods of computing depreciation
asset
place Depreciation methods differ primarily in the amount of cost allocated to each period. A list
d of depreciation amounts for each year of an asset’s useful life is called depreciation
into schedule. The most common methods of computing depreciation for plant assets are:
or The straight-line method
taken The double-declining balance method,
out The sum-of- the years-digits method and
of The units of production method
servi
1. Straight-Line Method (SLM)
ce

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 T iable cost of the asset is Spread evenly (uniformly) over the useful life of an
hi asset
s  T h e straight-line method provides for the same amount of depreciation
m expense for Each year of the asset’s useful life.
e
h
d
i
u
e
t
a
o
a
e
d
p
ec
a
o
,
t
e
d
p
e

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 pays $24,000 for the boat. The boat has an estimatedresidual value of $3,000 and an
estimated useful life of 5 years. Compute depreciation for 2006 using the straight-line
method:
 Initial cost: $24,000
 Expected useful life 5 years
 Estimated residual value: $3,000
The annual straight-line depreciation of $4200 is computed below:
Annual Depreciation= Cost – Residual Value
Useful
Life
Annual Depreciation = Birr 24000 – Birr 3000 = Birr210 00/yea= 4200
Instr 5years
uctio The journal entry to record the depreciation expense at the end of 2011 is:
n On Depreciation expense ………………. $4200
Janu Accumulated depreciation……………………$4200
ary The depreciation to be reported for each of the five years would be as follows:
1, Depreciation - Straight-Line Schedule,
2006 Year Cost Dep. Yearly Accumulated (Book
, expence Depreciation Depreciation Value)
Bass st Br. 4200 - - Br. 24000
Beginning of 1
Co. 24000
st 24000 Br Br. 4200 19800
buys End of 1 year
4200 4200.
a End of 2nd year 24000 4200 8400 15600
new 4200
End of 3 rd year 24000 4200 12600 11400
boat.
4200
Ba
End of 4th year 24000 4200 4200 16800 7200
ss
Co th 24000 4200 3000
End of 5 year
. 21000 4200 21000
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 NB. There are three important points to note from the depreciation schedule
for the straight-line depreciation method.
 First, the depreciation is the same each year.
 Second, the accumulated depreciation increases uniformly.
 Third, the carrying (Book) value decrease uniformly until it reaches the
estimated residual value.
2. Double-Declining Balance Method (DDBM)
 t h e declining-balance method is the most common accelerated method of
depreciation.
 T h i s method is based on the assumption of the passage of time
 Most kinds of plant assets are most efficient when new, and so they provide
more and better service in the early years of useful life
The double-declining-balance method is applied in three steps:
Step 1. Determine the straight-line percentage using the expected useful life.
Step 2. Determine the double-declining-balance rate by multiplying the straight-
line rate from Step 1 by 2.

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 Step 3. Compute the depreciation expense by multiplying the double-declining-
balance rate from Step 2 times the book value of the asset, the method is usually
called the double-
declining balance method.
 the double-declining-balance rate is determined by doubling the straight-line
rate.

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 a ght-line rate is to divide one by the number of years (for example, 1 ÷ 5 =
s 0.20).
o On January 1, 2006, Bass Co. buys a new boat. Bass Co. pays $24,000 for the
c boat. The boat has an estimated residual value of $4,000 and an estimated useful
t life of 5 years.
to Compute depreciation for 2006 using the double-declining balance me
d Using the double-declining-balance method, a five-year life results in a 40 percent rate
t (0.20 × 2)
mi '2006. Depr. Expense= Remaining Book Value x Accelerated Depreciation Rate
n Depreciation Expense=Remaining Book Value x Accelerated Depreciation Rate
ng =240000 x 1/5
t =24000 x 40%
e =96000
s For the first year, the book value of the equipment is its initial cost of $96, 00
a After the first year, the book value (cost minus accumulated depreciation) declines and,
thus, the depreciation also declines
Depreciation in the early years of an asset’s estimated useful life is higher than in later
years.

The depreciation to be reported for each of the five years would be as follows

Depreciation Schedule, Double-Declining Balance Method

Year (BV)- Fixed Yearly Accumula Carrying

beginning Depn. Depreciati Td Value (BV)-
Rate on on Depreci ending
Date of purchase Br24000 - - - Br. 24000
End of 1st year 24000 40% Br.9600 Br. 9600 11400
End of 2nd year 14400 40% 5760 15360 8640
End of 3rd year 8640 40% 3456 18816 5184
End of 4th year 5148 40%- 2074 20890 3110
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 always applied to the Book value at the end of the previous
year.
 the depreciation is greatest in the first year and declines each

 year after that.

 finally, the depreciation in +the 3rd and 4th years is limited to
the amount
necessary to reduce book value to residual value.
Example $30000 pickup $5000 salvage value 5 year
useful life
 Year 1 depreciation = $30000/5 X 2 = $12000
 Year 1 ending book value = $18000
 Year 2 depreciation = $18000/5 X 2 = $7200
 Year 2 ending book Value = $10800
 year 3 depreciation = $10800/5 X 2 = $4320
 Year 3 ending book Value = $6480
 Year 4 depreciation = $6480 /5 X 2 = $2592
 We are only allowed to depreciate a value equal to the salvage value so $6480 -
$5000 = $1480 year 4 depreciation

3. The Sum-of-the-Years’-Digits Method (SOYD)

 h i g h e r amount of periodic depreciation expense in the earlier use of the asset's life
 U n d e r this method, first we must determine the denominator of the fraction which
is
the sum of the digits representing the years of life.
 W h i l e computing depreciation, the denominator of the fraction is unchanged and
would remain the same.
 O n the other hand, the numerator of the fraction, decreases year by year (e.g.,5/15
4/15, 3/15, 2/15, 1/15).

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 t the amount of depreciable cost, for instance, depreciable cost for
h previous example is Br. (24000-4000).
e  a t the end of the asset’s useful life, the balance remaining should equal the residual

n
e v
x
t

s
t
e
p

i
s

t
o

d
e
t
e
r
m
i
n
e

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 Depreciation Schedule Sum-of-the-Years-Digits Method
Year Depreciable Rates Yearly Accumulated Book
Cost Depreciation Depreciation Value

Date of Br. 24000 - - - Br.

purchase 24000

End of 1styr 20000 5/15 Br. 7000 Br. 7000 17000

End of 2ndyr 21000 4/15 5600 12600 11400
End of 3rdyr 21000 3/15 4200 16800 7200
End of 4thyr 21000 2/15 2800 19600 4400
End of 5thyr 21000 1/15 1400 21000 3000
21000

NB. The above illustration for the sum of year’s digit method is based on the
assumption that the first use of the asset coincides with the beginning of the fiscal
period. When the first use of the asset does not coincide with the beginning of a fiscal
year, it is necessary to allocate each full year’s depreciation between the two fiscal
years benefited.
4. Units of Production Method
The units-of-production method provides the same amount of depreciation expense for
each unit produced or each unit of capacity used by the asset.
Step 1. Determine the depreciation per unit as
: Depreciation per Unit= Cost – Residual Value

Total Units of Production

Step 2. Compute the depreciation expense as

: Depreciation Expense = Depreciat ion per Unit x Total Units of
Output Used

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base eciation process. If we assume that the office equipment from the previous illustration has
d on an estimated useful life of 10,000 hours, the depreciation cost per hour would be
the determined as follows:
assu Hourly depreciation = Cost – Salvage value
mpti = Br. 24000.00 – 3000 = Br. 2.1
on
that Rate Estimated units of useful life 10,000 operating hrs
depr
eciat
ion
is
main
ly
the
resul
t of
use
and
that
the
passa
ge of
time
plays
no
role
in
the
depr
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 perH

3.4 Comparison of Depreciation Methods

Concept on comparing depreciation methods

One of the most important points to note is that in all cases, the total depreciation expense over
each of the five years is $36,000. As a consequence, the balance in the accumulated depreciation
account at the end of the fifth year is also $36,000 in all cases. This shows that we are dealing
with various ways to allocate the same depreciable cost of $36,000. It also indicates that each
method results in a different expense pattern within the five-year period.

These differences are significant and can have a great effect on earnings for each year. For
example, in the first year, the double-declining depreciation is $16,000, and depreciation under
the units-of-production method is only $6,600.These differences tend to lessen in the middle
years of the asset’s life and again increase in the last years of the asset’s life. However, in the last
years, the differences reverse. That is, straight-line and units-of-production depreciation is
greater than depreciation under either of the accelerated methods.

Of course, the pattern under the units-of-production method could differ greatly in different
situations

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 Comparison of Four Depreciation Methods

Selecting a Depreciation Method for Financial Reporting Purposes

Since all four depreciation methods are generally accepted accounting methods, a company’s
managers can choose whichever they would like for reporting purposes. In fact, it is possible to
use one method to depreciate equipment and another method to depreciate buildings. All of these
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methods are used in practice. However, a recent survey of 600 companies, as shown below,
suggested that the straight-line method is the most popular depreciation method.

Theoretically, the best depreciation method is one that allocates the cost of the individual asset to
the years of the asset’s useful life in the same pattern as do the benefits or revenues that the asset
produces. Given that different assets have different revenue patterns, all of the methods are
appropriate and have relevance in specific circumstances.

The theoretical soundness of a depreciation method is not, however, an absolute requirement for
its use. In choosing a particular method for financial reporting purposes, management is usually
more concerned with practical factors, such as simplicity and impacts on financial statements.

To a large extent, this explains the popularity of straight-line depreciation. It is easy to compute
and results in a constant expense spread over the asset’s useful life. Because the choice of
depreciation methods can have a significant effect on a firm’s financial statements, current
accounting rules require that a firm disclose how it depreciates its assets.

3.5. Updating Depreciation expense

Changes in Depreciation Estimate

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A depreciation estimate is calculated based on the chosen method of depreciation, and on
estimates of an assets useful life and salvage value.

Of course both useful life and salvage value cannot be known at the time and it is often the case
than one or the other or both need to be revised during the lifetime of an asset. Factors such as a
change in how an asset is used, unexpected wear and tear, technological advancement, and
changes in market conditions, may indicate that the salvage value or useful life of an asset has
changed. In addition, the chosen method of depreciation may no longer be appropriate. The
pattern of usage of the asset may change to such an extent that an alternative method of
depreciation may need to be used.

When there is an indication that a change in depreciation method, salvage value, or estimated
useful life is necessary, then the business should revise its depreciation estimates accordingly.
Example

Suppose for example, a business originally purchased an asset for 120,000, and at the time
decided to use the straight line method of depreciation, with an estimated useful life of 10 years
and salvage value of zero. The depreciation estimate when purchased is calculated as follows:

Depreciation estimate = (Cost - Salvage Value) / Useful Life

Depreciation estimate = (120,000 - 0) / 10
Depreciation estimate = 12,000 per year

The depreciation estimate journal each year would be as follows:

Original Depreciation Estimate Journal

Account Debit Credit
Depreciation expense 12,000
Accumulated depreciation 12,000
Total 12,000 12,000

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Asset Useful Life Changes

As time passes, the asset is depreciated at this rate and after 4 years the accumulated depreciation
on the asset is 12,000 x 4 = 48,000. At this stage, at the start of the fifth year, the business
decides that although the straight line method of depreciation is still appropriate, the asset has a
remaining useful life of 8 years, and due to a change in market conditions, has an estimated
salvage value of 16,000.

Both the useful life and salvage value estimates have changed and so the depreciation asset for
the future remaining years needs to change. At the start of the fifth year, the asset is in the books
of the business at cost less accumulated depreciation, referred to as the net book value or NBV.

Net Book Value = Cost - Accumulated depreciation

Net Book Value = 120,000 - 48,000
Net Book Value = 72,000
This net book value of 72,000 needs to be depreciated over the remaining useful life of the asset, taking into account
the revised salvage value. The revised depreciation estimate is calculated as follows:
Depreciation estimate = (Cost - Salvage Value) / Useful Life
Depreciation estimate = (72,000 - 16,000) / 8
Depreciation estimate = 7,000

Notice that the remaining net book value has been substituted for the cost in the depreciation
formula. The depreciation estimate is now 7,000 per year.

The depreciation estimate journal each year would be as follows:

Revised Depreciation Estimate Journal

Account Debit Credit
Depreciation expense 7,000
Accumulated depreciation 7,000
Total 7,000 7,000
The revised depreciation estimate only applies to the remaining years, no adjustment is made to
the past 4 years.

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Asset Depreciation Summary

A summary of the depreciation estimates for the asset over its lifetime are set out in the table
below.

Summary of Asset Depreciation

Year Opening Depreciation Ending
Year 1 120,000 12,000 108,000
Year 2 108,000 12,000 96,000
Year 3 96,000 12,000 84,000
Year 4 84,000 12,000 72,000
Estimates revised
Year 5 (1) 72,000 7,000 65,000
Year 6 (2) 65,000 7,000 58,000
Year 7 (3) 58,000 7,000 51,000
Year 8 (4) 51,000 7,000 44,000
Year 9 (5) 44,000 7,000 37,000
Year 10 (6) 37,000 7,000 30,000
Year 11 (7) 30,000 7,000 23,000
Year 12 (8) 23,000 7,000 16,000
Summary 120,000 104,000 16,000

The table shows that the original depreciation estimate of 12,000 continues for the first 4 years
and is then revised to 7,000 for a further 8 years. After this period of time, the total depreciation
is 104,000 and the net book value of the asset is 16,000, which is the estimated salvage value of
the asset.
3.6 Determining the carrying amount of fixed asset

Your account books don't always reflect the real-world value of your business assets. The
carrying value of an asset is the figure you record in your ledger and on your company's balance
sheet. The carrying amount is the original cost adjusted for factors such as depreciation or
damage. These factors may not reflect what the asset would sell for. Suppose your company
carries a building on its books for a decade but keeps it in excellent condition. If you sell the
building you might realize much more than its book value.
Calculating Carrying Value
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The equation for calculating carrying value on most assets is simple. Take the original purchase
cost. Add up the depreciation or amortization over the years you've held the asset and subtract
the total from the purchase price. Then subtract any impairments on the value.

Depreciation is an accounting tool for acknowledging wear and tear on the value of tangible
assets such as equipment, buildings, vehicles and furniture. The exact method for figuring
depreciation each year depends on the kind of asset and the depreciation method you choose. A
straight-line method, for example, subtracts the same percentage of value every year. Suppose a
$40,000 asset has a 10-year useful life and will be worth $2,000 in salvage value at the end of the
decade. Subtract $2,000 from $40,000 to get $38,000, then divide that by 10 years. You can take
$3,800 in depreciation each year.

Other methods get you different results. The "double-declining balance" depreciation method, for
instance, gives you a bigger write-off up front but slows down later. "Units of production" bases
depreciation on the number of units, such as shoes or hammers, which the asset will manufacture
over time. "Sum of the years" is based on the asset's remaining life; it's another method that gives
you higher depreciation up front.

You can use whichever depreciation method gives you the best deal on a given asset. Once you
decide which method to use, it's not easy to change, so consider the financial benefits of each. If
you think it's in your interest to deduct a lot of depreciation on your taxes immediately, the
double-declining balance method might be a good bet. The straight-line method might be
preferable if you want a steady deduction year after year.

Amortization is depreciation applied to intangible assets such as patents and copyrights. It's
always calculated by the straight-line method. Unlike tangible assets, there's no salvage value
when an asset's useful life expires.

1. Making the Impairment Calculation

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Unlike the gradual loss from depreciation, impairment represents an abrupt decrease in value.
The decrease happens when something drops the asset's recoverable value below the carrying
amount. The recoverable value includes any future cash flows the asset might generate and the
final salvage value.

Possible impairments include physical damage, obsolescence and regulations that make it harder
to use the asset. For an impairment example, assume you have an office building with a book
value of $1 million. After fire damage, the remaining recoverable amount is $400,000. That's a
$.6 million impairment. Your accountant will have formulas for figuring the exact impairment
amount.

2. Figuring Bonds' Book Value

Calculating book value of bonds works a little differently. You start with the face value of the
bond, then you add or subtract any unamortized premiums or discounts on the bond. Investors
pay premiums for bonds with a high rate of interest and discounts when they think the rate is too
low. If you have a 10-percent discount on a $5,000 face value bond, you will amortize that $500
discount over time until you finally cash the bond. Each year you add the unamortized amount to
the previous year's carrying value to get the current book value.

3.7. Preparation of Spread sheets and reconciliation

A spreadsheet is a computer program that can capture, display and manipulate data arranged in
rows and columns. Spreadsheets are one of the most popular tools available with personal
computers. A spreadsheet is generally designed to hold numerical data and short text strings. In a
spreadsheet program, spaces that hold items of data are called spreadsheet cells. These can be
renamed to better reflect the data they hold and can be cross-referenced through row numbers
and column letters.

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A single spreadsheet can be used as a worksheet to compile data for a purpose, or multiple sheets
can be combined to create an entire workbook. Each column or row cell references a value and is
labeled according to its placement (for example: A1, A2, A3). Data can be exported as a CSV
file and imported into other software or vice versa.

What are some commonly used spreadsheet features?

The following are just a few of the features available in most spreadsheet programs.

Cell formatting

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Within the spreadsheet, selected cells can be formatted to represent various numeric values. For
example, financial data can be given accounting formatting, which will apply decimal places and
commas to represent dollars and cents.

Formulas

Under the formula bar, users can perform calculations on the contents of a cell against the
contents of another cell. For example, if a person were using the spreadsheet to reconcile
transactions, they could highlight all the cells that need to be added up and insert a sum function.

Pivot tables

Using a pivot table, users can organize, group, total, average or sort data via the toolbar. It's
important to note that the exact tools and functions will vary depending on the application the
user chooses.

Using Spreadsheets for Reconciliations

Account reconciliations are considered a critical key control for ensuring financial statement
accuracy. How- ever, they can only succeed if they are meeting their purpose: Assessing the
validity, correctness or appropriateness of an account balance at a specific point in time,
documented by relevant calculations, clear and com- plate explanations and copies of supporting
documents. The following focuses on the inherent risks and issues with manually preparing
account reconciliations, the benefits a company can expect from automating this process and a
best-practices approach to implementation to ensure optimization and a significant return on
investment.
Left in an uncontrolled, manual environment, reconciliations can cause difficulties for companies
— from over- time and poor employee morale to large adjustments and material weaknesses.
Even if done correctly, a spreadsheet-driven account reconciliation process is still
manual and requires extensive labor hours and audit effort to complete and properly document.

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It is true that the more complex an organization — one with multiple and remote locations,
foreign currencies and disparate source systems, for example — the greater the benefit of going
beyond traditional accounting and finance sys- terms and implementing account reconciliation
technology. Yet, regardless of a company’s size or requirement to comply with the Sarbanes-
Oxley Act of 2002 or other regulations, finance, accounting and compliance executives will
benefit from having greater visibility into their financial close process and enhanced control over
the quality and completeness of their account reconciliation.
Left in an uncontrolled, manual environment, reconciliations can cause difficulties for companies
from over- time and poor employee morale to large adjustments and material weaknesses. Even
if done correctly, a spreadsheet-driven account reconciliation process is still manual and requires
extensive labor hours and audit effort to complete and properly document. It is true that the more
complex an organization — one with multiple and remote locations, foreign currencies and
disparate source systems, for example — the greater the benefit of going beyond traditional
accounting and finance sys- terms and implementing account reconciliation technology- gy. Yet,
regardless of a company’s size or requirement to comply with the Sarbanes-Oxley Act of 2002 or
other regulations, finance, accounting and compliance executives will benefit from having
greater visibility into their financial close process and enhanced control over the quality and
completeness of their account reconciliation savings, reduced paper and storage needs and lower
audit fees and
travel costs.

Benefits of Automating Account Reconciliation

Streamlining and automating the account reconciliation process will help a company tackle this
compliance-driven activity.
Among the benefits: Centralized visibility and control. Management and executives have real-
time dashboards and reports and can rely on improved accountability from specific account
ownership.
Monitoring: Balance changes, new accounts, delinquencies and other risk-associated events can
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be monitored proactively through email alerts.
Increased productivity and efficiency: Standardized tem- plates with pre-defined formats,
including access to policies and procedures, allow reconcilers and man- agers to concentrate and
communicate on content rather than form.
Reduced operational costs: Just the cost savings from the elimination of paper, binders and
storage associated with the account reconciliation process has encouraged companies to purchase
this solution. Headcount reduction, information technology support and maintenance costs are
other potential hard cost savings. Documented case studies prove quick and substantial returns
on investment, in even as little as two months.
Reduced audit cost and risk. Data presented in a consistent format as well as the direct
accessibility of reconciliations empowers auditors to revise their audit approach and do so from
their offices, reducing both personnel and travel costs. Complete and consistent reconciliations
across the entire organization reduce the risk that unrecorded adjustments and material
misstatements exist.

3.8. Capital expenditure and revenue expenditure

3.8.1 Capital expenditure

Capital expenditure (CapEx) is money that is spent to acquire, repair, update, or improve a fixed
company asset, such as a building, business, or equipment. A CapEx is different from an
everyday business, which falls under the operating expense category. While often used
interchangeably, operating expenses (OpEx) and capital expenditures (CapEx) are not exactly the
same.

The major differences between CapEx and OpEx are that a capital expenditure is a one-time cash
outlay, not recurring, and it impacts a long-term asset, or something that can’t be deducted in full
in the year in which it was bought. A new personal printer can be fully written off as an expense
when you buy it, but a new roof for your offices cannot be—that’s a major expenditure, or

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CapEx. OpEx are generally deducted from revenue as an expense and the profits that are left
over are invested in CapEx, to create future growth and opportunity.

 Capital expenditure examples

Capital expenditure is one of many types of expenditures businesses need to understand at a high
level. CapEx investments need to fall into one of these categories to qualify as such:

 Acquiring, or buying, a fixed tangible asset, such as a building, or intangible asset, such
as a patent or license.
 Upgrading an existing asset to expand its capacity or capability, such as a computer
network or major equipment.
 Renovating an obsolete or non-functioning asset to make it usable.
 Repairing an asset to make it usable once again.
 Adapting an asset for a new use, different from what it had been previously used for.
 Starting or acquiring a new business.

Again, capital expenditures refer to long-term investment related to your business over a multi-
year timeline. Any investment with a useful life expectancy of under a year would not qualify.

How to calculate capital expenditures

When calculating capital expenditures, it’s critical to understand the concept of “useful life.”
Useful life refers to the estimated and generally agreed upon shelf life of a specific business
asset. Because capital expenditures are long-term investments, for assets to fall under the CapEx
destination, the investments must have a useful life of one year or more.

A CapEx is amortized, or its value is deducted a little each year based on the total cost and its
expected useful life. A car’s useful life is now considered to be five years, according to the IRS,
while a new building’s is 39. So the cost of those assets is divided by their useful life to
determine how much your business can deduct each year as depreciation. Referencing your
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businesses income statement and balance sheet, you can calculate capital expenditures using the
following formula:

CapEx = PPE (current period) – PPE (prior period) + Depreciation (current period)

PPE refers to “property, plant, and equipment.” While the formula is relatively straightforward,
it's highly recommended to seek the guidance of both a tax and financial professional to ensure
you are calculating your capital expenditures properly.

3.8.2 Revenue Expenditure

The definition of revenue expenditures is an expense that is incurred by your business as a result
of producing its products and services. In other words, it refers to operational expenditure.
However, it is a specific type of operational spend. Revenue expenditure refers specifically to
expenses that are significant for generating revenue within the same accounting period in which
they’re spent.

In order to properly account for revenue expenditures, they need to be charged to expense as
soon as the cost is incurred. This ensures the matching principle is used to link the expense your
business has incurred to the revenues it generates. This makes for clearer and more accurate
income statement reporting.

Different types of revenue expenditure

Revenue expenditures typically fall into two categories:

 Expenses for maintaining revenue-generating assets – Such as repair and maintenance of

equipment or any other costs to support current operations.
 Expenses for generating revenue – These are day-to-day expenses that are linked to
revenue-generating activities such as utilities, rent, office supplies and the salaries of your
sales team.

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Examples of revenue expenditure

In order to properly account for them, you need to know what is and is not classed as revenue
expenditure. While these can vary enormously by industry, let’s look at some common examples
of revenue expenditure to illustrate the principle. Remember that revenue expenditures are
expected to generate revenue (either directly or indirectly) within the same accounting period,
which is usually a year.

Some examples of these expenditures may include:

 Selling expenses such as shipping fees, import duties etc.

 Marketing expenses to promote the launch of a new product
 Software upgrades
 Costs of maintaining or repairing plant and machinery
 The cost of utilities and telecoms
 The rental costs of your business premises or factory
 Interest charged on financing new equipment
 Salaries and commissions paid to your team

The difference between Capital and Revenue expenditures

Capital expenditures are for fixed assets, which are expected to be productive assets for a long
period of time.

Revenue expenditures are for costs that are related to specific revenue transactions or operating
periods, such as the cost of goods sold or repairs and maintenance expense. The differences
between these two types of expenditures are noted below.

A) Timing Differences

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Capital expenditures are charged to expense gradually via depreciation, and over a long period of
time. Depending on the asset, depreciation charges could extend out for more than a decade.
Revenue expenditures are charged to expense in the current period, or shortly thereafter.

B) Consumption Differences

A capital expenditure is assumed to be consumed over the useful life of the related fixed asset. A
revenue expenditure is assumed to be consumed within a very short period of time.

C) Size Differences

A more questionable difference is that capital expenditures tend to involve larger monetary
amounts than revenue expenditures. This is because an expenditure is only classified as a capital
expenditure if it exceeds a certain threshold value; if not, it is automatically designated as a
revenue expenditure. However, certain quite large expenditures can still be classified as revenue
expenditures, as long they are directly associated with revenue transactions or are period costs.

D) Types of Capital Expenditures

Capital expenditures are usually recorded within one of the major fixed asset classifications.
Examples of these classifications are buildings, computers, furniture and fixtures, machinery,
and vehicles. The useful life of a capital expenditure may be determined based on the
classification assigned to it.

E) Types of Revenue Expenditures

Revenue expenditures are recorded within the expense classifications. Examples of these
classifications are administrative expenses, compensation, research and development, property
taxes, travel, and utilities.

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3.9. Processing accurately special transactions

Functions of Transaction Processing Systems

A transaction is an elementary activity conducted during business operations. Transaction

processing systems (TPS) process the company's business transactions and thus support the
operations of an enterprise. A TPS records a non-inquiry transaction itself, as well as all of its
effects, in the database and produces documents relating to the transaction.

TPS are necessary to conduct business in almost any organization today. TPSs bring data into the
organizational databases, these systems are also a foundation on which management oriented
information systems rest.

System Charts

Systems charts are well-established tools which are used to describe TPSs. These charts show the
sources of input into the system, major processing steps, data storage, and systems outputs.

Transaction Processing Modes

Transaction processing may be accomplished in one of two modes:

1. On-line mode
2. Batch mode

Characteristics of on-line transaction processing:

1. Each transaction is completely processed immediately upon entry.

2. OLAP is the most common mode of used today
3. More costly than batch processing
4. Database is always up to date
5. Require the use of fast secondary storage such as magnetic disks
Characteristics of batch transaction processing:

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1. Relies on accumulating transaction data over a period of time and then processing the entire
batch at once.
2. Batch processing is usually cyclic: daily, weekly, or monthly run cycle is established
depending on the nature of the transactions
3. Cheaper than on-line processing
4. Easier to control than on-line processing
5. Database is constantly out of date
6. Batch processing is now being captured using disk files

Transaction Processing Subsystems in a Firm

Overall transaction processing, also known as data processing, reflects the principal business
activities of a firm. The principal transaction processing subsystems in a firm are those
supporting:

1. Sales 6. Receiving
2. Production 7. Accounts payable
3. Inventory 8. Billing
4. Purchasing 9. Accounts receivable
5. Shipping 10. Payroll
11. General ledger

Transaction Processing Activities

The processing of individual transactions, of course, depends to a degree on their nature. The
general elements of transaction processing include:

1. Data capture and validation

2. Transaction - dependent processing steps
3. Database maintenance

1. Date Capture

Direct data entry is commonly employed through source data automation. Increasingly,
transaction processing systems rely on electronic data interchange (EDI). By replacing paper
documents with formatted transaction data sent over telecommunications networks, these
systems provide for computer-to-computer communication without repeated data entry.

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Although used internally by some firms, EDI primarily serves the needs of intercompany
communication.

2. Data Validation

Typical validation tests include checking for missing data items, valid codes, and valid values.
More extensive validation may entail authorization of the transaction based on the customer=s
record and available inventory.

Processing Steps Dependent on the Transaction and on Processing Mode

Depending on the nature of the transaction and on whether the system operates in on-line or
batch mode, the following processing steps may be performed:

1. Classification: The system classifies incoming transactions to select further processing steps.

2. Sorting: Transaction records are arranged in order of the value of the data item(s) that
uniquely identifies each of them.

3. Data Retrieval: The purpose of an inquiry transaction is retrieval of data from the database.
Other transactions may involve data retrieval as well.

4. Calculation: The calculations required depend on the nature of the transaction.

5. Summarization: Usually performed to obtain simple reports offered by TPS, this step
computes summaries across all or some of the transactions.

Database Maintenance

After transactions other than inquiries, system files or databases must be updated. The data
accumulated by TPSs thus serve as a source of detail for management oriented components of
information systems.

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Outputs Provided by Transaction Processing Systems

The outputs provided by TPSs may be classified as:

1. Transaction documents
2. Query responses
3. Reports

Transaction Documents

Many TPSs produce transaction documents, such as invoices, purchase orders, or payroll checks.
These transaction documents produced by TPS may be divided into two classes: action
documents and information documents.

1. Action documents direct that an action take place. Turnaround documents initiate action and
are returned after its completion to the requesting agency. They therefore also serve as input
documents for another transaction.

2. Information documents confirm that a transaction has taken place or inform about one or
several transactions. Transaction documents require manual handling and, in some cases,
distribution of multiple copies. The process is costly and may lead to inconsistencies if one of the
copies fails to reach its destination.

Query Responses and Reports

TPS offer certain querying ad simple reporting capabilities, albeit much less elaborate than those
of management reporting systems. Most queries produce a screenful of information. However,
reports are also often produced as a result of inquiries.

Unlike management reporting systems, TPSs typically provide a limited range of preplanned
reports. The content and format of such reports are programmed into the TPS software and the
reports are produced on schedule. The TPS reports are often quite long.

The following report types are produced by TPS:

1. Transaction Logs - are listings of all transactions processed during a system run and include
purchase order manifests or sales registers.

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2. Error (Edit) Reports - error reports list transactions found to be in error during the
processing. They identify the error and sometimes also list the corresponding master file or
database records.

3. Detail Reports - detail reports are extracts from the database that lists records satisfying
particular criteria.

4. Summary Reports - typical summary reports produced by TPSs include financial statements.

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