Revaluation of assets Pepperoni Ltd has a financial year ends on 30 June. On 1 J

Question

Revaluation of assets

Pepperoni Ltd has a financial year ends on 30 June. On 1 July 2011, the company acquired two assets within the same class of plant and equipment. Information on these assets is given below.

Cost Expected useful life

$ Years

Machine A 100,000 5

Machine B 60,000 3

At 30 June 2012, the fair value for machines A & B are $84,000 and $38,000 respectively. There is no change in the expected useful lives of the machines. The machines are depreciated using straight line method.

The management has decided to use the fair value basis for the measurement of its plant and equipment. These machines are hard to obtain and has in fact increased in value over the current period. The management is arguing that, as there has been no decline in fair value, no depreciation should be charged on these pieces of equipment.

Required:

As an accountant of Pepperoni Ltd, prepare a memorandum to the management:

(a) Explain why the depreciation of the equipment should be imposed despite the increase of their values; and

(b) Outline the journal entries for the financial periods ended 30 June 2012.

Source:

Leo, K., Hoggett, J., & Sweeting, J. (2008). Company Accounting (8th ed.). John Wiley & Sons, Milton, Queensland.

Explanation / Answer

1) Depreciation is a method of allocating the cost of a fixed asset to expense over the estimated useful life of the machine. It is part of the matching principle which says that the cost of assets should be matched with the revenues they produce. It is not a method of revaluing a fixed asset to it's current market value. 2) Journals Machine A DR Depreciation expense 20,000 (100,000/5 year life) CR Accumulated depreciation 20,000 DR Fixed Assets Machine A 4,000 (write up to 84,000 fair value) CR Revaluation surplus 4,000 Machine B DR Depreciation Expense 20,000 CR Accumulated depreciation 20,000 DR Impairment loss 2,000 (write down to 38,000 fair value) CR Fixed Assets Machine B 2,000

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