Understanding Non-Current Assets and Depreciation Methods
Non-Current Assets
Non-current assets include transportation equipment, machinery, land, buildings, office equipment, patents, and trademarks.
Requirements for Asset Recognition (IAS 16)
For an asset to be recognized, it must meet the following requirements according to International Accounting Standard (IAS) 16:
- The business is likely to obtain economic benefits from it.
- The cost can be measured reliably.
Determining the Cost of Fixed Assets
To determine the cost of fixed assets, one of three methods should be used:
At Cost
The cost of fixed assets is calculated by adding the price paid for the goods and all expenses incurred to have it in place and the conditions necessary for its proper functioning.
Construction Cost
The cost of the asset will be the sum of all direct and indirect costs incurred for manufacturing, if applicable.
At its Equivalent
This method applies when the purchase price of the asset does not reflect its real value, either because it was bought too cheaply or because it was donated to the business by a shareholder. In this case, a valuation should be obtained to determine its market value for registration.
Key Concepts for Depreciation
Two basic concepts for successful implementation of depreciation are:
Useful Life
According to IAS 16, “useful life” is the period during which a depreciable asset is expected to be used by the entity. It can also be the number of production or similar units expected to be obtained from the asset. This applies to machinery that can only work a certain number of hours or produce a limited number of products.
Residual Value
IAS 16 specifies that the “residual value” of an asset is the estimated amount that an entity would currently obtain from selling the asset, after deducting the estimated costs for such disposal, if the asset were already of the age and in the condition expected at the end of its useful life. In other words, it’s how much can be recovered by selling the asset when it is disposed of.
Depreciation Methods
Linear Methods
Straight-Line
This method assumes that the asset depreciates equally in each accounting period. Therefore, the depreciation charge will be the same every year or month. The formula for calculating it is:
Units Produced
This method considers that the asset’s useful life is not a function of time but depends on the amount of work it performs, whether by units produced, hours worked, or miles traveled. Therefore, the depreciation reflects the proportional use given to the asset. Its formula is:
Accelerated Methods
Double-Declining Balance (DDB)
In this method, the residual value is not taken into account. The current book value of the asset is multiplied by the depreciation rate obtained. This rate is twice the straight-line method rate. Its formula is:
Sum-of-Years’ Digits
This method assigns depreciation expense based on fractions of the cost, calculated from the asset’s useful life. Only the basis for calculating depreciation is considered in the depreciation expense.
Intangible Assets
Intangibles are non-current assets that, without being physical, represent a business advantage. They have two main characteristics: first, they represent costs incurred or rights or privileges acquired with the intention of making a profit; second, the future benefits to be gained are intangible.
Characteristics of Intangible Assets
Intangibles must meet three characteristics to be considered as such:
- Generate future economic benefits.
- Be identifiable, meaning they can be sold or transferred.
- Be controllable, meaning the business can legally restrict the benefits that third parties can obtain.
Types of Intangible Assets
There are two types of intangible assets:
- Those that represent the use of services or consumption of goods, which are expected to produce future income. Their implementation will be a deferred expense until that income is obtained, such as the cost of placing securities.
- Those that are a right or privilege that can reduce production costs, improve product quality, or promote sales, such as trademarks, patents, and licenses.
The value to be given to intangible assets is the cost of acquisition.