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 building2. Legal fees paid for assessing title deeds for purchase of building3. Repair expenses incurred on an second hand machinery

purchased4. Salaries paid to staff5. Expenses incurred for advertising the company’s product in local

newspaper6. Expenses incurred for shifting the raw materials from one godown

to another7. Replacement of a worn out part of machinery with a new part8. 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 furniture26 Transport charges paid for purchase of goods27 Temporary shed erected for storing materials for construction of

building28. Payment made to security agencies for guarding the factory

building29. Annual maintainance charges paid for computers30. Payment made for purchase of raw materials.

FIXED ASSETSAccounting 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 1ABC 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 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/cThe 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.60000Furniture – Rs.15000Office building – Rs.100000Staff 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 .