Capital vs. RevenueCapital vs. Revenue

Why segregate ?

£ essential for accounting concept of matching costs with revenues

£ distinction affects the ‘bottom line’ directly

Fixed AssetFixed Asset

A fixed asset

is an asset held with the intention of being used

for the purpose of producing goods

and is not held for sale

in the normal course of business.

Capital ExpenditureCapital Expenditure

An expenditure incurred with a view to bringing

an asset into existence oran advantage or a benefit of an enduring nature

for the business, is treated as capital expenditure.

Revenue ExpenditureRevenue Expenditure

An expenditure incurred

for day-to-day running

of the business,

is treated as revenue expenditure.

Deferred Revenue ExpenditureDeferred Revenue Expenditure

An expenditure which is not in the nature of capital expenditure

or does not bring any asset into existence, but yet

the benefit of which to the business would be enjoyed over, say 3-5 subsequent

years, is treatedas deferred revenue expenditure.

Components of Cost of Fixed AssetComponents of Cost of Fixed Asset

1. Purchase Price.2. Import duty / any other non-refundable levy.3. Any directly attributable cost of bringing the

asset to its working condition.4. Borrowing cost of funds that finance the

asset.5. Commissioning and trial expenses until

commencement of production.

Revaluation of Assets Revaluation of Assets

Generally not allowed unless there are valid and compelling reasons.These reasons & basis for revaluation must be disclosed.A class of assets is revalued and not an individual one.Increase in value is credited to Revaluation Reserve a/c and decrease written off to Profit & Loss a/c

Machinery Spares Machinery Spares

‘ not specific to a particular machine / asset & can be used for generally for various items of assets’ are treated as any other inventory and expensed on issue.

‘ specific to a particular machine / asset & can be used in connection with that asset only’

‘ use expected to be irregular’ are capitalized to be written off in a systematic manner over a period.

Accounting for Fixed AssetsAccounting for Fixed Assets

Asset Account Related Expense*

Land NoneProperty, Plant, Equipment DepreciationNatural Resources Depletion(like mines, oilfields )Intangibles Amortization* on income statement

DepreciationDepreciation

Every year depreciation is calculated and journal entry passed as under

Depreciation Expense a/c drTo Accumulated Depreciation a/c*

* is a contra account and its matching pair is the asset a/c.

DepreciationDepreciation

Every year depreciation is calculated and journal entry passed as underDepreciation Expense a/c dr

To Accumulated Depreciation a/c- is a contra account and its matching pair is the asset

a/c.- is a non cash expense, hence added to net

income in cash flow statement.

DepreciationDepreciation

In the Balance Sheet Assets are shown at

Gross Valueless Accumulated Depreciation_________________________Book Value

DepreciationDepreciation

GAAP provide for several methods of depreciation – we study these three

i ] Straight Lineii ] Units of Production (UOP)iii ] Written Down Value (WDV)

DepreciationDepreciation

GAAP provide for several methods of depreciation – we study these three

i ] Straight Line –

straight line depreciation allocates an equal amount of expense each year during useful life of the asset.

DepreciationDepreciation

GAAP provide for several methods of depreciation – we study these three

i ] Straight Line –straight line depreciation allocates an equal amount of expense each year during useful life of the asset.

cost of asset less its residual valueCalculation =

expected useful life in years

DepreciationDepreciation

GAAP provide for several methods of depreciation – we study these three

i ] Straight Lineii ] Units of Production ( UOP )–

Method involves two step process1. Calculate the UOP rate

= cost of asset less its residual valuedivided by expected useful life in UOP

DepreciationDepreciation

GAAP provide for several methods of depreciation – we study these three

i ] Straight Lineii ] Units of Production ( UOP )–

Method involves two step process1. Calculate the UOP rate2. Multiply the rate by actual UOP during the

period.

DepreciationDepreciation

GAAP provide for several methods of depreciation – we study these three

i ] Straight Lineii ] Units of Production (UOP)iii ] Written Down Value (WDV) –- depreciation is calculated as %.- following year’s depreciation at % above,

applied to the book value at beginning of the year.

DepreciationDepreciation

GAAP provide for several methods of depreciation – we study these three

i ] Straight Lineii ] Units of Production (UOP)iii ] Written Down Value (WDV) –

- approved by Indian Income Tax laws.- ignores residual value in the first year’s depreciation.

DepreciationDepreciation

i ] Straight Lineii ] Written Down Value (WDV) –

If asset put to use in the middle of a year. depreciation in the first year is equal todepreciation for full year x fraction of year asset used.If asset commissioned in January , depreciation will be one fourth of full year.

Sale of AssetSale of Asset

at some point , fixed assets are no longer useful and need to be sold, exchanged or discarded.

at this time asset account is credited &accumulated depreciation is debited.

Sale of AssetSale of Asset

at some point , fixed assets are no longer useful and need to be sold, exchanged or discarded. at this time asset account is credited &accumulated depreciation is debited.if sale value of the discontinued asset is more (less) than its book value, a gain (loss) is realized.this is credited to (written off) profit & loss account.

“ Accounting for capital expenditure is critical as segregation between capital & revenue expense has direct impact on the bottom line.

Depreciation is a major non-cash expense that provides cash inflow for business.

All assets are depreciated in a consistent manner so that there are no hits to bottom line when asset reaches end of its useful life”