CAPITAL AND REVENUE

Capital and Revenue expenditure Capital Expenditure means any expenditure incurred to : 1.Acquire an asset and bring it into working condition 2.Improve the efficiency or substantial working life of the asset 3.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.Purchase of building 2.Legal fees paid for assessing title deeds for purchase of building 3.Repair expenses incurred on an second hand machinery purchased 4.Salaries paid to staff 5.Expenses incurred for advertising the company’s product in local newspaper 6.Expenses incurred for shifting the raw materials from one godown to another 7.Replacement of a worn out part of machinery with a new part 8.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 Commission paid to estate agents Cost of clearing and levelling the land Cost of construction of building Cost of fencing Architects fees for building design Purchase price of machinery Installation charges for machinery Cost of trial runs Registration charges for title deed of land Repair charges of building wall damaged during installation of machinery Compensation paid to worker injured during const The project was financed partly by borrowings of 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 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 The assets and their FMVs are as under : Land Building Equipment Furniture Tools Accessories At what value should AB & Bros. capitalise its assets

3.A Ltd. exchanges a motor car for a new model costing Rs The seller gives an allowance of Rs for the old car. The book value of the motor car is At what value should the new motor car be capitalised in the books

4.A plant was brought on January for Rs The plant has an estimated useful life of 5 years. The company follows the SLM method of depreciation. The plant was revalued at Rs in Jan Calculate the amount to be transferred to Revaluation Reserve. 5.Francis purchased the business of a senior solicitor for Rs with the following assets and liabilities. Books and journals – Rs Furniture – Rs Office building – Rs Staff salary payable – Rs.3000 Calculate the amount of goodwill / capital reserve.

6.ABC transporters purchased a bus costing Rs The bus has an estimated useful life of kms. Assuming that the usage of the bus was km in the first year, kms in the second year, kms in the third and kms in the fourth year. Calculate the depreciation to be charged.