Depreciation, Part-Year Charges and a Disposal at Bramble Engineering
Bramble Engineering prepares accounts to 31 December. On 1 April 20X3 it bought a CNC machine for £96,000, estimated residual value £12,000 and useful life six years. On 1 July 20X4 it bought a delivery van for £30,000, residual value £6,000 and useful life four years. The accounting policy is to charge depreciation monthly from the month of acquisition up to and including the month of disposal, using the straight-line method. The machine was sold on 30 September 20X5 for £62,000. The van remains in use. The accountant has calculated the 20X5 depreciation only on assets held at the year end and has credited the £62,000 proceeds to sales. She now proposes switching the machine to reducing-balance depreciation at 25% to 'make profits more stable' and asks whether prior years should be restated.
1. Calculate the 20X5 depreciation for the machine and van, and the profit or loss on disposal of the machine.
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Machine: depreciable amount = £96,000 − £12,000 = £84,000; annual charge = £84,000/6 = £14,000; monthly = £1,166.67. The 20X5 charge to 30 September is 9 months × £1,166.67 = £10,500. Accumulated depreciation at disposal = 9 months in 20X3 (£10,500) + 20X4 (£14,000) + 20X5 (£10,500) = £35,000. NBV = £96,000 − £35,000 = £61,000. Proceeds £62,000 − NBV £61,000 = £1,000 profit on disposal.
Van: depreciable amount = £30,000 − £6,000 = £24,000; annual charge = £24,000/4 = £6,000; monthly = £500. The 20X5 full-year charge is £6,000. Accumulated at 31 December 20X5 = 6 months in 20X4 (£3,000) + £6,000 = £9,000; NBV = £21,000.
Total 20X5 depreciation expense = £10,500 + £6,000 = £16,500.
2. Advise whether the proposed switch to reducing-balance depreciation is acceptable and how it should be treated.
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Changing the method is not a free choice to smooth profits. It is acceptable only if reducing balance better reflects the pattern in which the machine's benefits are consumed. Under IAS 8, a change in depreciation method is a change in accounting estimate, not a change in accounting policy. It is applied prospectively from the date of change; prior years are not restated. The remaining carrying amount at the date of change is depreciated over the remaining useful life using the new method.
'Making profits more stable' is not by itself a valid reason. The change and its effect should be disclosed. If the machine has already been sold in 20X5, a change for 20X5 would be too late to affect the disposal calculation and would look like an attempt to alter the reported profit.
3. Explain the effect on 20X5 profit and net assets of the accountant's treatment of the disposal proceeds and the machine depreciation.
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Crediting the £62,000 proceeds to sales overstates revenue and gross profit. The proceeds belong in the disposal account, where they are compared with the carrying amount of £61,000. The correct entries are Dr Bank £62,000, Cr Disposal £62,000; Dr Disposal £61,000, Cr Machine £61,000; Dr Accumulated depreciation £35,000, Cr Disposal £35,000; and Dr Disposal £1,000, Cr Profit on disposal £1,000.
Because the machine is no longer in use at the year end, the accountant's depreciation calculation also omits the £10,500 charge for January to September. The combined effect is that sales and profit are overstated, and the profit on disposal is not shown separately. Net assets are not affected by the proceeds entry alone, but the depreciation omission overstates net assets by £10,500.