Purchase of Non-Current Depreciable Assets for Cash

1. Non-Current Assets: An Overview

• Definition: Assets that are expected to be used by the business for more than one accounting period.
• Characteristics of Depreciable Non-Current Assets:
  • Expected to be used for more than one accounting period (i.e., have a finite life).
  • Provide future economic benefit to the business.
  • Will decline in value over time (subject to depreciation).
• Examples: Buildings, equipment, vehicles, furniture. Land is a Non-current asset, but is not depreciated.
• Cost: The cost of a non-current asset includes all expenses incurred to bring the asset to its intended location and make it ready for use. This can include:
  • Purchase price
  • Delivery costs
  • Installation costs
  • Modification costs

KEY TAKEAWAY: Non-current assets provide long-term benefits and are subject to depreciation (except for land). The cost of the asset is not just the purchase price.

2. Depreciation: Fundamental Concepts

• Definition: The systematic allocation of the depreciable amount of an asset over its useful life.
• Depreciation Expense: The amount of depreciation recognized in an accounting period.
• Purpose of Depreciation:
  • Accrual Basis Assumption: To match the expense of using the asset with the revenue it helps generate.
  • Historical Cost (HC): Depreciation ensures that the carrying amount of the asset reflects its remaining economic value.
• Related Terms:
  • Useful Life (Life): Estimated period over which the asset is expected to be used.
  • Residual Value (RV): Estimated value of the asset at the end of its useful life.
  • Depreciable Value: The cost of the asset less its residual value. Calculated as:
    $$Depreciable \ Value = Cost - Residual \ Value$$
  • Accumulated Depreciation: The total amount of depreciation expense recognized for an asset from the date of acquisition to the balance sheet date.

EXAM TIP: Understand the relationship between depreciation expense, accumulated depreciation, and the carrying amount of an asset.

3. Recording the Purchase of a Non-Current Asset for Cash

• Double Entry Accounting: All transactions affect at least two accounts. The accounting equation (Assets = Liabilities + Owner’s Equity) must always balance.
• Journal Entry:
  • Debit: The specific Non-Current Asset account (e.g., Equipment, Vehicle, Furniture) for the full cost of the asset. This increases the asset balance.
  • Credit: Cash at Bank account. This decreases the cash balance.

• Example: Danny’s Donuts purchases an oven for \$8,000 cash on February 28, 2025. The journal entry would be:

  Date	Account	Debit ($)	Credit ($)
  Feb 28, 2025	Oven	8,000
  	Cash at Bank		8,000
  	Purchase of oven for cash

• General Ledger: Post the journal entry to the respective T-accounts in the General Ledger.

  Oven

  Date	Explanation	Amount ($)
  Feb 28, 2025	Cash at Bank	8,000

  Cash at Bank

  Date	Explanation	Amount ($)
  Feb 28, 2025	Oven	8,000

COMMON MISTAKE: Forgetting to include all costs associated with getting the asset ready for use when recording the purchase.

4. Reporting the Purchase in Financial Statements

• Balance Sheet (Statement of Financial Position):
  • The non-current asset is reported under the “Non-Current Assets” section at its cost.
  • Cash at Bank is reduced in the “Current Assets” section.
• Cash Flow Statement:
  • The cash outflow for the purchase is reported under “Investing Activities” as a purchase of property, plant, and equipment (PP&E).
• Income Statement (Statement of Profit or Loss):
  • The purchase itself is not reported on the Income Statement. The depreciation expense associated with the asset will be reported each period over its useful life.

STUDY HINT: Practice writing journal entries and posting them to the general ledger for various non-current asset purchases.

5. Impact on the Accounting Equation

• Assets = Liabilities + Owner’s Equity
• When a non-current asset is purchased for cash:
  • One asset (the non-current asset) increases.
  • Another asset (Cash at Bank) decreases.
  • The overall total of assets remains the same.
  • Liabilities and Owner’s Equity are not affected. Therefore, the Accounting Equation remains balanced.

REMEMBER: Purchase of asset for cash increases one asset and decreases another; no net change to total assets, liabilities, or equity.

6. Depreciation Methods (Brief Overview)

While the key knowledge point focuses on the purchase of the asset, understanding depreciation methods is essential for subsequent accounting.

• Straight-Line Method: Allocates an equal amount of depreciation expense each year.
  $$Depreciation \ Expense = \frac{Cost - Residual \ Value}{Useful \ Life}$$
• Reducing Balance Method: Applies a constant depreciation rate to the carrying amount of the asset each year. This method results in higher depreciation expense in the early years of the asset’s life and lower expense in later years.

APPLICATION: Businesses choose a depreciation method that best reflects how the asset is expected to contribute to revenue.

7. Disposal of Non-Current Assets

• When a non-current asset is sold, the following must be considered:
  • Calculate any depreciation up to the date of disposal.
  • Calculate the carrying amount of the asset at the date of disposal (Cost - Accumulated Depreciation).
  • Determine the proceeds from the sale.
  • Calculate any profit or loss on disposal:
    $$Profit/Loss \ on \ Disposal = Proceeds \ from \ Sale - Carrying \ Amount$$
  • Record the disposal in the General Journal.

VCAA FOCUS: VCAA Exam questions often require the calculation of depreciation expense, preparation of journal entries, and analysis of the impact on financial statements.