Unit 5- Depreciation and Capital and Revenue Expenditure

7/27/2019 Unit 5- Depreciation and Capital and Revenue Expenditure

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Learning objectivesNon-current assets

Capital and revenue expenditure

Depreciation- nature and calculation

Change in accounting date ofdepreciation

Revaluation of non-current assets


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Non-current assetsNon-current assets are distinguishedfrom current assets by the followingcharacteristics:-

Are long-term in natureAre not normally acquired for resale

Could be tangible or intangible

Are used to generate income directly orindirectly for a business

Are not normally liquid assets


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Non-current asset registers

Are records of the non-current assets held by abusiness. They form part of the internal control

system of an organization

Details held on such a register may include:-

Cost and date of purchase

Description, serial, reference number

Location of the asset

Depreciation method and expected useful life

Net book value


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Capital vs. revenue

expenditure


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Capital expenditure

Capital expenditure is long term in nature as thebusiness intends to receive the benefits of theexpenditure over a long period of time

It includes expenditure on the acquisition of non-current assets required for use in the business, notfor resale

It also includes expenditure on existing non-current

assets aimed at increasing their earning capacity


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Examplesi. Expenditure in connection with or incidental to the

purchase or installation of an asset (Carriageinwards on machinery bought)

ii. Acquisition of new assets.

iii. Expenditure incurred for putting the old asset

purchased, into working condition.iv. Additions and extensions to existing assets.

v. Legal costs of buying building

vi. Betterment of non-current assets or improvement of

an asset to produce more, to improve its earningcapacity or to reduce its operating expenses or toincrease the life of asset.


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Revenue ExpenditureRevenue expenditure consists of expenditureincurred in one period of the accounting, the fullbenefit of which is enjoyed in that period only.

This does not increase the earning capacity of thebusiness but it is incurred in order to maintain the

existing earning capacity of the business.It includes all expenses which arise in normal courseof business.

The benefit of such expenditure is for a short period,say, one year only and it is not to be carried forwardto the next year.

The expenditure is of a recurring nature i.e. incurredevery year.


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Examplesi. Purchase of raw materials for conversion into

finished goods.ii. Selling and distribution expenses incurred for sale of

finished goods e.g. sales office expenses, deliveryexpenses, advertisement charges, etc

iii. Establishment expenses like salaries, wages, rent,rates, taxes, insurance, depreciation on officeequipment.

iv. Depreciation of plant, machinery and equipment.

v. Expenses incurred in order to maintain the existingnon-current assets in an efficient and workable statesuch' as repairs to building, repairs to plant, white-washing and painting of building.


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Activity 1- Classify the following into capital or

revenue expenditure

1. Purchase of extra van

2. Cost of rebuilding warehouse which had fallen down3. Building extension to the warehouse

4. Painting extension to warehouse when it was first built

5. Repainting extension to warehouse three years later

6. Carriage costs on bricks for new warehouse extension

7. Carriage cost on purchases8. Carriage cost on sales

9. Legal cost on collecting debts

10. Legal charges on acquiring new premises for office

11. Fire insurance premium

12. Costs of erecting new machine


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Capital expenditure, revenue

expenditure and final accountsAccounts treat capital expenditure andrevenue expenditure in different ways

in the final accounts of the businessCapital expenditure- Statement offinancial position

Revenue expenditure- Incomestatement


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Activity 2Calculate cost of acquisition of micro-

computer
http://localhost/var/www/apps/conversion/tmp/scratch_9/Unit%201-%20Calculating%20cost%20of%20micro%20computer.doc


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What is depreciationIAS 16 defines depreciation as the measure ofthe cost or revalued amount of the economicbenefits of the tangible non-current asset that

has been consumed during the period

Depreciation is part of the cost of the non-currentasset consumed during its period of use by the

firm, therefore depreciation is the allocation of thecost of the non-current assets over its period ofuse


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Causes ofDepreciationPhysical deterioration

Wear and tear

Erosion, rust and decayEconomic factors

Obsolescence

Inadequacy

The time factor (e.g. assets of a fixed legal life)Depletion


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Methods of calculating depreciation

charges:-Straight line method

Reducing balance method


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Accounting treatment for

depreciation Dr Income statement

Cr Provision for depreciation account

Note

The non-current asset account continues to show theasset at cost each year

A separate provision for depreciation account must beopened for each class of non-current asset

The balance on the Provision for depreciation account

is deducted from the cost of the fixed asset in thestatement of financial position


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Straight line method

The total amount of depreciation that anasset will suffer is estimated as the differencebetween what it cost and the estimatedamount that will be received when it is sold or

scrapped at the end of its useful life.The total depreciation is then spread evenlyover the number of years of its expected life

Calculation: (Cost estimated proceeds on

disposal) estimated useful life in years


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Example 1- Straight line method

A machine cost Rs 20,000. It is expected tohave a useful life of five years at the end ofwhich time it is expected to be sold for Rs5,000.

(i) What would be the annual depreciation onthe machine

(ii) Prepare the provision for depreciation ofthe machine for each year

(iii) Prepare a statement of financial positionextract to show the non-current asset ofmachine at the end of each year


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Activity 3

A motor vehicle cost Rs 18,000. It is expectedto have a useful life of seven years and to besold for Rs 4,000 at the end of that time. Thebusiness uses the straight line method of

depreciationPrepare the Provision for depreciation ofMotor vehicles account for each year.

Prepare a statement of financial position(statement of financial position) extract toshow the non-current asset of Motor vehiclesat the end of each year


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Assets bought/sold in a period

If an asset is bought or sold in a period, thereare two ways in which the depreciation could

be accounted for:-

Provide a full years depreciation in the year of

acquisition and none in the year of disposal

Monthly or pro rata depreciation, based on the

exact number of months that the asset has been

owned


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Activity 4Compute the depreciation charge based on the following

information, given that depreciation is charged using thestraight line method at the rate of 10 % and that theyear end is 31/12.

01/01 Balance b/d 10,000 01/06 Disposal 3,000

01/10 Additions 5,000 31/12 Balance c/d 12,000

15,000 15,000

01/01 Balance b/d 12,000

NON CURRENT ASSET ACCOUNT


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Reducing balance method

Also known as the diminishing balancemethod

A fixed percentage for depreciation is

deducted from the cost in the first year.In the second or later years the same

percentage is taken from the reduced

balance.


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Example 2A machine cost Rs 20,000. It is

expected to have a life of five years.

Depreciation is to be calculated at therate of 25 % per annum on the reducing

balance method.


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Activity 5A machine costing Rs 40,000 and with anexpected life of five years is to bedepreciated by the reducing balancemethod. The annual rate of depreciation is30 %.

(i) Prepare the provision for depreciation ofMachinery account for the years 1 to 5

(ii) Prepare a statement of financial positionextract at the end of each of the five years


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Choice of depreciation methodProviding for depreciation is an application of thematching principle, and the method chosen for anyparticular type of asset should depend upon the

contribution the asset makes towards earningrevenue.

Straight line method should be used for assets thatare expected to earn revenue evenly over their usefulworking lives

It is also used where the pattern of an assets earningpower is uncertain.

The reducing balance method should be used when itis considered that an assets earning power will

diminish as the asset gets older


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How to account for the disposal

of non-current assetsWhen a non-current asset is sold, the

difference between its net book value and the

proceeds of sale represents a profit or loss ondisposal

This profit or loss is transferred to the P&L

account (Income statement)

The profit or loss is calculated in a disposalaccount

Double entry bookkeeping for disposal of non-current


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Double entry bookkeeping for disposal of non-current

assets

Transfer the cost price of the assetsold to an asset disposal account

Dr Disposalaccount

Cr non-current

assetaccount

Transfer the depreciation provided todate on the asset to the assetdisposal account

Dr Provisionfordepreciation

Cr Disposalaccount

For the amount received on disposal:- Dr Bank/Cash Cr Disposalaccount

A debit balance remaining on disposalaccount is a loss

Dr Incomestatement

Cr DisposalA/c

A Credit balance remaining ondisposal account is a Profit

Dr DisposalAccount

Cr Incomestatement


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Example 3- Disposal of non-

current assetsAt 01 December 2003, a machine whichhad cost Rs 20,000 was sold for Rs

500.A total of Rs 18,000 had been providedfor depreciation on the machine

Show the accounting entries to recordthe above


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Double entry for Disposal through part exchange

agreement

Transfer the cost price of the asset sold to an

asset disposal account

Dr Disposal

account

Cr non-

current assetaccount

Transfer the depreciation provided to date onthe asset to the asset disposal account

Dr Provisionfordepreciation

Cr Disposalaccount

Record part exchange allowance (PEA) asproceeds

Dr non-current assetaccount

(part of costof new asset)

Cr Disposalaccount(saleproceeds ofold asset)

Record the cash paid for the new asset Dr non-current assetaccount

Cr Cash


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Activity 6

Robin started business in January 2002 and bought amachine CAT for Rs 2500. He depreciates hismachine using the straight line method at a rate of 20%.

He charges full year depreciation in acquisition yearsand none in disposal years

His business has grown in 2005 and he requires abetter machine CATII.

CATII salesman offered him the following deal:-

Part exchange allowance for Cat for Rs 750

Balance to be paid in cash for CATII Rs 4850.

Show the ledger entries for the year ended 31December 2005


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Change in accounting date- Example 4Zaza has prepared his financial statement up to 30

April each year until 30 April 2007, when Zazachanged the accounting date by making up the nextfinancial statements for 16 months to 31st August2008.

Zazas policy is the charge proportionatedepreciation in periods of purchase and sale and asfrom the first day of the month in which assets areacquired, and up to the last day of the month

before the month of disposal.Annual depreciation on motor vehicles is on 10 %straight line basis.


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Change in accounting date (Cont)

Additional information are as follows:Motor vehicles at cost: 192,000

Accumulated depreciation 64,000

During the 16 months ended 31st August 2008 the

following transaction took place:-On 15 June 2007, a new motor vehicle waspurchased for 12,000.

An existing vehicle which had cost 16, 000, andwhich had a book value of 8,000 on 15 May 2007,was given in part exchange at an agreed price of5,000. The remaining balance of 7,000 was paid incash.


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Change in accounting date (Cont)

Prepare the following accounts:-

1. Motor vehicle

2.Accumulated depreciation3. Disposal account


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Revaluation of non-current

assets


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Non-current assets revaluation

Some non-current assets such as land and buildingsmay rise in value over time.Businesses may choose to reflect the current value ofthe assets in the statement of financial position. Thisis known as revaluing the asset

The difference between the NBV of the asset and therevalued amount is recorded in a revaluation reservein the capital section of the statement of financialpositionThis gain is now shown in the income statement

under comprehensiveOn revaluation, the accumulated depreciationaccount is cleared off.


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Example 6A company runs a business for many yearsfrom a building which originally cost Rs

300,000 and on which Rs 100,000 totaldepreciation has been charged to date.

The company wishes to revalue the buildingto Rs 750,000.

What is the double entry to record therevaluation?


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Activity 7Jones owns a factory. The premises werepurchased on 1 January 20X1 for Rs 450,000

and depreciation charged at 2 % pa straightline.

Jones now wishes to revalue the premises toRs 800,000 on 1 January 20X7 to reflect the

market value.What is the balance on the revaluationreserve after the transaction?


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Depreciation of a revalued

assetWhen a non-current asset has been revalued, thecharge for the depreciation should be based on therevalued amount and the remaining useful life of the

asset.This charge will be higher than depreciation prior torevaluation.

The excess of the new depreciation charge over theold depreciation charge should be transferred from

the revaluation reserve to accumulated profits (withinthe capital section of the statement of financialposition):

Dr Revaluation reserve

Cr Accumulated profits


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Activity 8Alpha owns a retail unit. He bought it25 years ago for Rs 100,000,

depreciating it over 50 years. At thestart of 20X6 he decides to revalue theunit to Rs 800,000. The unit has a

remaining useful life of 25 years.What accounting entries should bemade in 20X6?


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Activity 9

The statement of financial position of afootball club at 31 December 20X7 includesthe following information:-

Stadium cost Rs 1,500,000Depreciation Rs 450,000

Depreciation has been provided at 2 % onthe straight line basis.The stadium is revalued on 30 June 20X8 toRs 1,380,000. There is no change in the

estimated useful life.What is the depreciation charge for the yearended 31 December 20X8.


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Activity 10-Disposal of a revalued

assetA company runs a club. Some years ago, thecompany purchased land next to the existingclub, with the intention of making another

club for its foreign staffs. The cost of the landwas Rs 260,000. The company has not yetbuilt the new club but has revalued the landfor Rs 600,000. The company has now

decided that building the new club will beuneconomical and has found a buyer who iswilling to pay Rs 695,000 for the land.

What are the ledger entries on disposal?

Documents

Unit 5- Depreciation and Capital and Revenue Expenditure