FINANCIAL ACCOUNTING I

KWADWO ADJEI - BOAKYE

CAPITAL EXPENDITURE AND
REVENUE EXPENDITURE
 WHAT IS CAPITAL EXPENDITURE
• This is made of expenditure, the benefits of which is
not fully consumed in one financial period (one year)
but spread over several periods.
• It consists of the cost of purchase of fixed asset, cost of
transporting the fixed assets to the business,
installation cost, other cost needed to get the fixed
asset ready for use,
• and cost of remarkably improving the performance of
the fixed asset.
• All capital expenditure items appear in the balance
sheet or statement of financial position.
 WHAT IS REVENUE EXPENDITURE
• This is made up of expenditure incurred in one
financial period, but full benefit of which is
consumed in that period.
• Examples includes rent and rates, wades and
salaries, carriage, insurance, advertising etc.
• Appears in the trading and profit and loss
accounts (Income Statement).
 DEPRECIATION
• Is defined as the allocation of the depreciable amount
of an asset over its estimated useful life.
• Depreciation is an expense, therefore must be charged
to income statement (profit and loss account) whether
profit is made or not.
• No matter the repairs cost, depreciation should be
provided because repairs ensure that the life of the
asset is not unduly shortened.
• Failure to charge depreciation leads to overstatement
of profit.
• Furthermore, the value of fixed assets is overstated in
the balance sheet.
 FACTORS TO BE CONSIDERED IN THE
MEASUREMENT OF DEPRECIATION
• The cost of asset

• The estimated scrap value/residual value

• The estimated useful life of the asset

• The method of depreciation

 PURPOSE OF DEPRECIATION
• To spread the depreciable value over the
estimated useful life of the asset.
• It is provided in other not to overstate profit in
the income statement.
• To match cost with revenue.
• Preserving the capital of the business.
• To be able to show the unexpired cost fixed
asset in the balance sheet.
 PROBLEMS OF DEPRECIATION
• Estimated useful life: It is difficult to give the exact number of
years the asset would be used in the business.
• Estimation of the scrap/residual value of the asset: It is also
difficult to know the value at which the asset would be
disposed off at the end of the asset’s useful life.
• Obsolescence: It is difficult to predict the trend of technology
and as a result difficult to know when the asset would
become outmoded.
• Repairs and maintenance: If the repairs and maintenance are
extensive, the life of the asset may be influenced.
 CAUSES OF DEPRECIATION
• Wear and tear: It is the loss in value of the
asset through usage.
• Obsolescence: It is the loss in value of asset
due to the invention of new technology.
• Effluxion of time: It is the loss in value due to
age and passage of time.
• Inadequacy: This occurs when the existing
assets cannot cope with the growth of the
firm
 METHODS OF CALCULATING
DEPRECIATION
• Fixed installment or straight line
• Reducing or diminishing balance
• Sum of the year’s digit
1. Straight line method: The depreciable value of the fixed asset is
spread equally over its estimated useful life. The calculation of
depreciation is as follows:
Annual depreciation charge = original cost – estimated residual value
estimated useful life (years)
Example:
Faith bought a sewing machine which has an estimated useful life of 5
years for 480,000cfa. It is expected that it would also have a scrap
value of 40,000cfa after 5 years of use. Compute the depreciation
charge under the straight line method over the first 3 years.
2. Reducing balance method: The depreciation charge is
determine by applying a fixed rate of
depreciation to the cost of asset in the first year but in
subsequent years, it (rate) is applied to the asset’s net book
value at the beginning of each year. The depreciation
charge tends to reduce year after year.
Example:
A trader purchased a machine for 100,000cfa. Calculate the
depreciation charged for each of the first four years,
assuming the depreciation rate on the reducing balance to
be 20% per annum
DOUBLE ENTRY FOR DEPRECIATION
1. On acquisition of the fixed asset:
Dr. fixed asset account
Cr. Cash book, with the original cost of asset acquired.

2. At the end of each year, make adjustment for depreciation:

Dr. Profit and loss account
Cr. Provision for depreciation account, with the
depreciation charge for the year.
 ILLUSTRATION 1
In a business with financial years ended 31 December. A
machine is bought for $2,000 on 1 January, 2010. The estimated
useful life is 3 years.
You are to show:
a) Statement of depreciation
b) Machinery account
c) Provision for depreciation
d) Profit and loss account
e) Balance sheet as at those date
Using straight line method and reducing balance method, at the
rate of 20%.
 Disposal Account

• Should be opened when

– The asset is sold, or
– The asset is disposed of due to an accident.
 Accounting treatment on disposal
account
On disposal of fixed assets (sale of fixed assets) -
The following entries are made:
i. Dr. Disposal of asset a/c
Cr. Fixed asset a/c, with the cost of the asset being
disposed off.
ii Dr. Provision for depreciation a/c
Cr. Disposal of asset a/c, with the accumulated
depreciation
iii Dr. Cash book
Cr. Disposal of asset a/c, with cash receipt
iv Dr. Disposal of asset a/c
Cr. Profit and loss a/c, with profit on the sale
Depreciation on monthly/full-year basis
• Fixed assets can be purchased and sold at any time
during the accounting year.
– Depreciation on a monthly basis:
• Based on the fraction of the year in which the asset is held.

– Depreciation on a full-year basis:

• Full year’s depreciation in the year of purchase and none in the
year of disposal irrespective of the period in which the asset is
held.
• In an examination, it is necessary for the students to follow the approach
required by the question. Where no indication is given, the full year
basis approach is recommended.
 ILLUSTRATION 2
The Information below was extracted from the books of peace
service ltd.
Asset Date of Cost price Date of Selling price
purchase $ disposal $

Equipment 1 1-2-1996 48,480 30-6-1999 32,000

Equipment 2 1-1-1998 64,720 30-9-2000 29,000

Equipment 3 1-10-2000 56,800 - -

Additional information:
• A full year’s deprecation is charged in the year of acquisition.
No depreciation is charged in the year of disposal.
• The company’s financial year ends on 31st December each
year.
• Depreciation is charged at a rate of 12.5% p.a
You are required to prepare the following accounts
 Statement of deprecation
 Equipment account
 Equipment disposal account
 Provision for depreciation account
 ILLUSTRATION 3
The following data relates to fleet of vehicles of GSM.

Vehicle Date acquired Cost Date of disposal

cfa

A 1/1/2005 20,000 30/6/2007

B 30/6/2005 30,000 -

C 1/1/2007 40,000 31/12/2008

D 30/9/2007 50,000 -
GSM depreciates its vehicles at the rate of 20% p.a using straight line method
on one - month ownership basis. The financial year ends 31st December, each
year.
Vehicle A and C were sold for 12,500cfa and 22,000cfa respectively.
You are required to prepare:
(a) Statement of depreciation
(b) Vehicle account
(c) Provision for depreciation account
(d) Vehicle disposal account
(e) Profit and loss account and balance sheet extracts
 Group work
BBA ltd stated business on 1st January, 2000. The purchase and disposal of
fixed assets of the business are as follows:
Asset Date of Cost Date of Proceeds on
purchase $ disposal disposal
$
Plant A 1/1/2000 250,000 1/1/2002 45,000

Plant B 1/1/2001 125,000 - -

Plant C 1/1/2002 350,000 - -

The rate of depreciation is 20% p.a on cost
You are required to prepare the following:
a. Statement of depreciation
b. Plant account
c. Provision for depreciation
d. Disposal account