CAPITAL AND REVENUE
Capital and Revenue expenditure
Capital Expenditure means any expenditure incurred to :
1.
2.
3.
Acquire an asset and bring it into working condition
Improve the efficiency or substantial working life of the asset
Improve the performance of the business
.
Eg. 1.Purchase of machinery
2. Fees paid for installation of machinery
3. Custom duty paid for import of machinery
Revenue Expenditure means any expenditure incurred to
maintain the assets in working condition and for the operation of
the business.
Examples
1.
Repairs of furniture
2.
Painting of building
3.
Purchase of stationery
4.
Salaries
Deferred Revenue expenditure means essentially a revenue
expenditure but the benefit of which is received over a period of
more than one year.
Examples :
1.Heavy research expenditure
2. Heavy advertisement expenditure
The most important factor affecting the classification is the nature of
business.
Need to classify expenses into capital and revenue
1. To adhere to Matching Principle
2. To enable a true and fair view of financial statements
3. To show correct financial results
Class exercise 1
Classify the following expenditure into capital , revenue and
deferred revenue.
1.
2.
3.
4.
5.
6.
7.
8.
Purchase of building
Legal fees paid for assessing title deeds for purchase of building
Repair expenses incurred on an second hand machinery
purchased
Salaries paid to staff
Expenses incurred for advertising the company’s product in local
newspaper
Expenses incurred for shifting the raw materials from one godown
to another
Replacement of a worn out part of machinery with a new part
The coal fired engine broke down and it was replaced with a gas
fired one.
9. Freight paid on purchase of machinery
10. Installation and commisioning charges paid for erection of
machinery’
11. Built an extension to the factory building
12. Rebuilt a wall destroyed by storm
13. Repair expenses incurred on new machinery before installation.
14. Heavy expenditure on research for development of new product .
The research was successful
15 Heavy expenditure on research for development of new product .
The research was not successful
16. Heavy marketing expenditure incurred on launching a new product.
17.Purchase of second hand furniture
18. Purchase of motor car
19. Purchase of petrol for the new motor car
20. Purchase of new tyres for an old motor car
21. Interest paid on loan taken for the purchase of machinery. The
commercial production has not yet begun
22. Interest paid on loan taken for the purchase of machinery. The
commercial production has begun.
23. Heavy legal fees paid to lawyers for a suit filed against the
company. The case was successful.
24. Heavy legal fees paid to lawyers for a suit filed against the
company. The case was not successful.
25 Transport charges paid for purchase of furniture
26 Transport charges paid for purchase of goods
27 Temporary shed erected for storing materials for construction of
building
28. Payment made to security agencies for guarding the factory
building
29. Annual maintainance charges paid for computers
30. Payment made for purchase of raw materials.
FIXED ASSETS
Accounting for fixed assets involves the
following :
• At what cost should an asset be recorded in
books ?
• How should use of assets be recorded?
• How should the sale, disposal, retirement of
asset be recorded ?
so that the assets in the Balance Sheet
show a true and fair view
• Cost of acquisition of assets
• Borrowing costs
• Basket purchases
• Donated assets
• Self generated assets
Special class of assets
• Natural resources.
• Intangible assets
Goodwill , Brand , licenses, know how, patents,
franchises etc.
• Research and development costs
• Computer Software costs
• Accounting of assets of low unit cost
Revaluation of assets
• Assets are shown in the balance Sheet at their historical
cost. It is often argued that such values do not reflect the
current worth of the assets . This is more so with land and
buildings whose value may increase due to inflation.
Hence many companies have adopted the practice of
revaluing the assets to reflect their current market price.
Revaluation should be done for the entire class of assets
or a systematic basis should be adopted for selective
revaluation of assets.
• The increase in the value of assets is credited to
Revaluation reserve. Since such reserve is unrealised
profit, it is a capital reserve not available for distribution as
dividend or for issue of bonus shares.
Depreciation
Depreciation is based on 2 estimates :
• Useful life of the asset
• Expected salvage value of the asset
Hence depreciation =
cost of the asset – salvage value
estimated useful life
Methods of depreciation
1.Straight line method / original cost method
2.Accelerated methods
Written down value method
Sum of digits method
3. Production units method
Issues in depreciation accounting
1.Computing depreciation for partial accounting
periods
2.Revision of estimated lives and depreciation
rates
3.Group depreciation
Disposal of assets
• Asset sold for cash
• Discarded assets
• Assets exchanged for other assets
• Amortisation of intangible assets
• Impairment of assets
Class exercise 1
ABC Ltd. took up an project to expand its existing capacities. All the costs incurred were debited to Project
Account as under :
Rs.
1. Cost of land
2. Commission paid to estate agents
3. Cost of clearing and levelling the land
4. Cost of construction of building
5. Cost of fencing
6. Architects fees for building design
7. Purchase price of machinery
8. Installation charges for machinery
9. Cost of trial runs
10. Registration charges for title deed of land
11. Repair charges of building wall damaged during
installation of machinery
12. Compensation paid to worker injured during const.
1200000
50000
5000
2000000
30000
40000
1500000
100000
15000
25000
8000
10000
The project was financed partly by borrowings of Rs.3000000 @ 12% interest. Interest paid was debited to
interest A/c. A supervisor was deputed for the project work. He spent 1 month for the selection and
preparation of land and 4 months for the construction of building and 2 months for machinery installation. His
annual salary of Rs.60000 is debited to Salary A/c
The project commenced on February’10 and plant was installed and commissioned in Sept’10.
Determine the costs at which land, building and machinery should be capitalised. Assume that the borrowings
were used equally for building and machinery.
2.AB & Bros. purchased a automobile
showroom for Rs.5000000. The assets and
their FMVs are as under :
•
Land
2000000
•
Building
3000000
•
Equipment
500000
•
Furniture
200000
•
Tools Accessories 500000
At what value should AB & Bros. capitalise its
assets
3.A Ltd. exchanges a motor car for a new
model costing Rs 500000. The seller
gives an allowance of Rs. 100000 for
the old car. The book value of the motor
car is 125000.
At what value should the new motor car
be capitalised in the books
4.
A plant was brought on January 1 2005 for Rs.15000. The
plant has an estimated useful life of 5 years. The company
follows the SLM method of depreciation . The plant was
revalued at Rs.25000 in Jan 2008. Calculate the amount to
be transferred to Revaluation Reserve.
5.
Francis purchased the business of a senior solicitor for
Rs.200000 with the following assets and liabilities.
Books and journals – Rs.60000
Furniture – Rs.15000
Office building – Rs.100000
Staff salary payable – Rs.3000
Calculate the amount of goodwill / capital reserve.
6.ABC transporters purchased a bus costing
Rs. 720000. The bus has an estimated
useful life of 200000 kms. Assuming that
the usage of the bus was 10000 km in the
first year, 30000 kms in the second year ,
20000 kms in the third and 50000 kms in
the fourth year. Calculate the depreciation
to be charged .