Capital Expenditure means any expenditure incurred to :
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.
Repairs of furniture
Painting of building
Purchase of stationery
Deferred Revenue expenditure means essentially a revenue expenditure but the benefit of which is received over a period of more than one year.
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.
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.
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
Self generated assets
Special class of assets
Natural resources .
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 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
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
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 :
1. Cost of land 1200000
2. Commission paid to estate agents 50000
3. Cost of clearing and levelling the land 5000
4. Cost of construction of building 2000000
5. Cost of fencing 30000
6. Architects fees for building design 40000
7. Purchase price of machinery 1500000
8. Installation charges for machinery 100000
9. Cost of trial runs 15000
10. Registration charges for title deed of land 25000
11. Repair charges of building wall damaged during
installation of machinery 8000
12. Compensation paid to worker injured during const. 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 :
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 .