9706 · 1.3.2
Changing asset values — FAQ
Frequently asked questions for 9706 Changing asset values. Direct answers first, then deeper explanation — then practise with marking.
Why don't businesses just record the full cost of a large machine as an expense in the year they buy it?
This would violate the matching principle. The machine will help generate revenue for many years (its useful life). Depreciation systematically spreads the cost of the machine over these years, matching the expense of using the asset against the revenue it helps to earn in each period. Expensing it all at once would drastically understate profit in the year of purchase and overstate it in subsequent years.
Is the profit on disposal of an asset the same as the cash the business receives?
No, this is a common misconception. The cash received is the 'disposal proceeds'. The 'profit on disposal' is a calculated figure: Disposal Proceeds minus the Net Book Value (NBV) of the asset. For example, if you sell an asset with an NBV of £5,000 for £6,000 cash, you receive £6,000 in cash, but your profit on disposal is only £1,000. This profit is reported in the income statement.
If a revaluation increases an asset's value, does that mean the business has made a profit it can pay out to shareholders?
No. The increase is an 'unrealised' gain because the asset has not been sold. It is credited to the Revaluation Surplus, which is a capital reserve within equity, not to the income statement. Therefore, it does not increase distributable profits and cannot be paid out as dividends. It simply reflects the asset's current fair value on the statement of financial position.