Class 7-B (Fixed Asset Accounting)

Class 7-B

(FADM-1; Dr. Ramana)

Depreciation:

· Allocation of COA over the life

ü Useful life (accounting life)

ü Economic life

· Depreciation (in Amount per year) = Rate *COA

· Depreciation (in Amount per year) = COA/Life (in years)

How Depreciation is calculated

ü Depreciation is calculated on the original cost throughout life (Straight Line Method)

ü Depreciation is calculated on the Book Value of the asset (Reducing / Diminishing Balance Method)

Acquisition of Asset

· For Cash

· For Credit

· On Lease – After the lease life, asset will cease to exist on Balance Sheet (BS) of the company. To reacquire the asset, company has to renew the lease again. Even if life an asset is say 20 years, and company has a lease of 5 years, for the remaining 15 years, somebody else can take the asset on lease.

Assets acquired on Lease

Check if the lease is -

1) Finance lease: If the lease life accounts for significant part (around 75%) of the life of the asset. Hence, finance lease is as good as company is buying / purchasing the asset.

a. Show the value of the asset on the Balance Sheet (even when the company is not buying the asset; only because it is a finance lease)

b. Value of the leased Asset = Present Value (PV) of the lease rental (& not the sum of lease rental; PV of lease rental will always be LESS than sum of lease rental)

Example -

Lease Rent	15000
Rate of Interest	8%
Life of lease (Years)	5
PV of Lease rents / Value of Lease Asset	59,890.65

PV of $ 15,000 paid every year at the rate of 8%. Actual money is $ 75,000 (5*15,000), but PV is $ 59,890.65.

Formula (in excel) for Value of Lease Asset = -PV(8%,15000,5)

Example –

	Opening Balance Sheet	After Finance Lease (Initial Recognition)
Capital	100000	100000
6% Loan	200000	200000
Lease Payable		59890.65
	300000	359890.65
Cash	300000	300000
Leased Asset (Finance Lease)	0	59890.65
	300000.00	359890.65

c. Initial Recognition:

i. Value of the asset for initial recognition = PV of Lease payable

ii. Show the assets on the BS at PV of the lease payable

iii. Show the corresponding liability

iv. In a finance lease, the lease component is divided into 2 components -

1. Principal

2. Interest

2) Operating lease – If the asset is not a finance lease, it is operating lease.

a. Initial recognition: No asset or liability

b. Lease rent is treated as an expense

Issues related to PPE Accounting (Summary)

· COA (Cost of Acquisition)

· Capitalization

· Depreciation

ü SLM or RBM

· Revaluation

· Impairment

· Leased Assets

ü Finance Lease

§ Value of the Asset = PV of the lease rent payable

ü Operating Lease

Bottom Line of asset accounting is possibility of converting an asset into expense (treating expense as an asset); in process managing (increasing) the profit of the company.