Session 1: 28th January, 2024

FINANCIAL ACCOUNTING

Financial Accounting is the process of recording, summarizing, analysing, and

reporting financial information to external users for them to make informed
economic decisions.

Financial accounts are prepared for external stakeholders. For example:

• Investors: To assess level of returns for their investments.

• Tax Authority: To determine tax liability on the business profits.

• Suppliers: To assess if the business is credit worthy.

• Customers: To determine if the business is a going concern to depend on the

supply of goods and services.

• External Auditors: To check whether the FSs comply with accounting standards.

• Other businesses: To compare performance.

• Lenders: To assess whether the business is capable of repaying any borrowings.

• Government: To assess whether the conditions of any grants are being complied
with.

Internal users such as managers and employees may also benefit from the FS's but
it is not prepared for them.

Differences between MA and FA

• MA are prepared for internal users while FA are for external users.
• MA focus on the past, present and future while FA is concerned with recording
past transactions only.

• MA are required by management while FA are required by law.

• MA has no specific formats and rules while FA are prepared following

accounting standards and practices.

• MA information can be both financial and non-financial while FA is mainly

financial.

• MA information are both quantitative and qualitative but FA is mainly

quantitative.

• MA are detailed while FA are summarised.

• MA will focus on individual functions, products and managers while FA focus on

the entire company.

• MA are prepared frequently while FA are prepared annually.

• MA are private records while FA for public companies are publicized.

MA FA
Internal users External users
Private Public
Past, present and future Past
No formats and rules Follow rules with specific formats
Financial and non-financial information Financial information
Detailed Summarised
Prepared frequently Prepared annually
Voluntary Mandatory

Quantitative and qualitative Quantitative

Focus on individual departments, products Focus on the organization as a whole
 BUSINESS ORGANISATIONS

There are many forms of business organizations but the following are the three main
types:
1. Sole Trader
2. Partnership
3. Company

Businesses may either be unincorporated or incorporated.

An incorporated business is a legal person [artificial entity] as opposed to a

natural person.

A company is an incorporated entity which means in the eyes of the law, a company
is a legal person with rights and responsibilities similar to a natural person.

Unincorporated businesses such as sole traders and partnerships are not legal
persons and therefore debts of the business are legally debts of the owner(s), i.e.,
the owner(s) have unlimited liability.

The greatest benefit of incorporation is limited liability, i.e., shareholders are only
liable for company debts to the extent of their capital contribution. Therefore, should
the company become insolvent and liquidate, then the maximum shareholders may
lose is the amount paid for shares.

Limited Liability offers protection to shareholders in the event of a dissolution

where their personal assets will be safeguarded.

A sole trader is an unincorporated business owned by one person.

A partnership is an unincorporated business owned by two or more persons.

A Company is an incorporated entity owned by at least one member [shareholder]

but managed by a board of directors.
 THE ACOUNTING PROCESS

Source documents → Books of original or prime entry [Day books] → General ledger
[GL] → Trial Balance [TB] → Financial Statements [FSs]

• Source documents are evidence that the transactions occur.

• Information from source documents will be summarized and recorded in the day
books.

• All the day books will be totalled and the totals will be ‘posted’ to the relevant
accounts in the GL.

• The accounts in the GL will be balanced and the balances will be extracted and
listed in a TB.

• After the TB is prepared there may be errors and omissions [E&Os] which needs
to be corrected and reconciliations performed along with a number of other
adjustments.
• Finally. the FSs will be prepared using balances and information from the TB and
year-end adjustments.

The above describes the sequential stages in which financial transactions are
recorded.

Documenting [Source documents] → Summarizing [Day nooks] → Posting [GL]

→ Analysing [FSs]

The TB is a memorandum record which is primarily prepared to detect errors but it

also simplifies and speed up the preparation of the FSs as all balances are listed in
one place.
 BUSINESS TRANSACTIONS

A financial transaction is an economic event between the business and third

parties and it is measured in a monetary value. For example:

✓ Owner[s]: Capital, drawings

✓ Lenders: Borrowings, repayment
✓ Banks: Loans, overdraft, deposits, withdrawals
✓ Customers: Sales, sales return [return inwards], bad debts, contra, discounts
allowed, payments
✓ Suppliers: Purchases, purchases return [return outwards], contra, discounts
received, payments
✓ Government: Grants, taxes
✓ Service providers: Expense payments

Capital are investments made by the owners to generate profit.

Drawings are withdrawal of profit and capital by the owners for personal use.

Sales return is the return of goods by credit customers.

Purchases return is the return of goods to credit suppliers,

Discount allowed is a reduction given to credit customers due to early payment.

Discount received is a reduction given by credit suppliers due to early payment.

Transactions are filtered into two main stages before recorded in the FSs:
1. Day books [primary books]
2. GL accounts [secondary books]

A ledger is a book that contains accounts and an account records transaction.

Transactions are grouped twice, once in the day books and then once in the GL
accounts before they are recorded in the FSs.
Further explanations of business transactions:
• Sale of inventory to customers for immediate payment [cash sales] or for
deferred payment [credit sales].

• Purchase of inventory from suppliers for immediate payment [cash purchases] or

for deferred payment [credit purchases].

• Return of goods from credit customers [sales return or return inwards] or to

credit suppliers [purchases return or return outwards].

• Writing off of an irrecoverable receivable balance [bad debts] and any

subsequent recovery [bad debts recovered].

• Payments from credit customers or to credit suppliers.

• Payment for delivery cost of goods from supplier [carriage inwards] or for
delivering goods to customers [carriage outwards].

• Proceed from a bank loan and its subsequent repayment.

• Deposits into and withdrawals from bank accounts.

• Investing capital or withdrawing profits [drawings].

• Purchase or sale of any asset.

• Cancellation of a receivable and payable balance where the customer is also a

supplier [contra].

• Granting discounts to customers for early payment [discount allowed] or

receiving such discount from suppliers [discount received].

• Receiving invoices for expenses and subsequent payments.

• Processing refunds to customers or from suppliers due to overpayment.

 ELEMENTS OF FINANCIAL STATEMENTS

There are five main classifications of items in the FSs:

1. Revenues
2. Expenses
3. Assets
4. Capital
5. Liabilities

There are two FSs:

➢ Statement of profit and loss [P&L]
➢ Statement of financial position [SOFP]

The P&L shows the financial performance of a business for an accounting period.
It records revenues and expenses for one accounting period to show profitability.

The SOFP shows the financial position of a business at the reporting day, i.e., at
the end of the financial year. It records accumulated balances of assets, capital,
and liabilities as at a particular date.

Differences between the P&L and SOFP.

▪ The P&L shows the business financial performance while the SOFP shows its
financial position.

▪ The P&L records revenues and expenses and the SOFP records assets, capital
and liabilities.

▪ The P&L shows balances for one year only while the SOFP shows accumulated
balances.

▪ The P&L is prepared before the SOFP so that the net profit or loss can adjust
the capital balance in the SOFP.

▪ The P&L shows profitability while the SOFP shows wealth.

 REVENUES

Revenues are income arising in the normal course of business. For example:

• Sale of inventory [main revenue]

• Fees from providing services [main revenue]
• Interest received
• Rent received
• Commission received
• Discount received
• Dividend received
• Bad debts recovered
• Profit on disposal of NCA
• Reduction in receivable allowance

The following are not revenues:

✓ Proceeds from sale of NCA
✓ Proceeds from issue of shares and loan notes
✓ Receipts from credit customers
✓ Capital contribution by owner[s]
 EXPENSES

Expenses are costs incurred to generate revenues. For example:

• Loan and overdraft interest

• Wages and salaries
• Rent
• Telephone charges
• Electricity charges
• Water rates
• Internet Fees
• Stationary
• Carriage outwards
• Depreciation
• Legal and professional fees
• Bad debts
• Insurance
• Bank charges
• Advertising
• Loss on disposal of NCA
• Increase in receivables allowance
• Sales commission
• Repairs and maintenance
• Audit fee

Small and other expenses can be grouped into categories such as general
expenses, sundry expenses, miscellaneous expenses, motor expenses, admin
expenses, selling and distribution expenses, finance cost [interest].

An expense is really a benefit received.

Profit or loss is the difference between revenues and expenses.

When the income earned for the period exceeds expenditure incurred for that
period then the business made a profit and vice versa creates a loss instead.
 ASSETS

An asset is a present resource controlled by an entity as a result of a past

transaction and from which future economic benefits are expected to flow to the
entity.

Assets are expected to result in an inflow of economic benefits in the future.

Fun facts:
• Legal ownership is no longer a criterion to recognize an asset in the SOFP.

• An asset may be owned by one person but controlled by another, in which case,
the person who controls it records it.

• A present asset must have been acquired in the past.

• There is a high probability that there would be an inflow of future benefits.

• When assets are consumed, they become expenses.

FSs are prepared following a financial reporting framework. 180 countries in the
world have adapted the IASB’s Conceptual Framework along with the IASs/IFRSs
to prepare the FSs. Therefore, accountants across the world seek guidance on how
to record transactions by making references to the framework and the accounting
standards.

According to the IASB’s Conceptual Framework, there are two conditions that must
be met for an asset to be recognized:

1. It must be probable [highly likely, i.e., more than 50% chance] that future
economic benefits associated with the asset will flow to the entity.

2. The cost of the asset can be measured reliably.

Classification of assets
1. Non-current assets [NCA]
2. Current assets [CA]

NCA are expected to bring benefit for more than one year. For example:
• Land and building
• Motor vehicles
• Equipment
• Fixtures & fittings
• Machinery
• Furniture

Features of NCA:
▪ NCA are required for use in production, administration, selling and distribution
and not for sale.

▪ NCA will generate sales or save costs for multiple years.

▪ NCA can be acquired for rental or capital appreciation.

▪ NCA can be tangible, intangible or long-term investments.

Tangible NCAs can be seen and felt such as all those listed above.

Intangible NCAs have no physical substance but they give ‘rights’ to benefits such
as goodwill, licence, patents, brands and capitalized development costs.

Long-term investments refer to acquiring shares to earn dividend purchasing loan

notes to receive interest.

CAs are short-term assets which are expected to bring benefit within the next 12
months. These are highly liquid assets such as cash and items which can be quickly
converted into cash.
For example:
• Inventory
• Receivables
• Cash
• Prepayments
• Short-term investments

Inventories are items purchased or manufactured resale.

Receivables are amounts owing to the business. For example:

• Credit customers owe for inventory [trade receivables]
• Tenants owe for rent; government owe for tax refund [other receivables]

Cash refers to notes and coins [cash-in-hand] as well as money in a bank account
[cash-at-bank].

A prepayment is an expense paid for but not yet incurred, i.e., an advance payment.

Short-term investments include certificate of deposits [CDs} or fixed deposit

accounts where money is deposited for a fixed period [a month, quarter or year] to
earn interest.

Examples of past events or transactions that creates control over assets: -

• A purchase e.g., inventory
• A finance lease agreement e.g., NCA
• Credit sales will result in trade receivables
• Cash can be generated from a number of transactions

The following will result in derecognition of assets:

1. Sale of assets.
2. Credit customers making payment or writing it off as bad debts will remove trade
receivables.
3. Some transactions may result in the derecognition of one asset and the
recognition of another i.e., assets are simply changing form.
Classification of asset in a matter of intention i.e., NCAs are intended to bring
benefit for multiple years while CAs are intended to be consumed within a year.

NCAs and CAs are separately grouped so that users can access whether there are
enough NCAs to sustain the entity in the long term.
 Session 2: 4th February, 2024

ACCOUNTING CONCEPTS

Accounting concepts are Generally Accepted Accounting Principles [GAAPs]

applied when preparing the FSs. For examples:

1. Substance over form concept

2. Reporting entity concept
3. Materiality concept
4. Money measurement concept
5. Matching or Accruals concept
6. Prudence concept
7. Dual aspect concept
8. Consistency concept
9. Historical cost concept
10. Going concern concept

Substance over form concept

When the substance or economic reality of a transaction differs from its legal form
then it is the substance which is recorded, i.e., reality rather than legality.

For example, with a finance lease, the lessee controls the asset even though it is
legally owned by the lessor.

The lessor legally owns the asset and acquired it primarily for the lessee to rent. In
essence, the lessee bears all the risks and enjoys all the rewards incidental to
ownership even though they are not the legal owner. In such a case, the lessee
records the asset as NCA as they have control over it.

Generally, the party that maintains the asset controls it.

Money measurement concept
The measurement or valuation of items in the FSs must be objective [not bias,
neutral, impartial] rather than subjective [bias], therefore, only assets that can be
reliably measured will be included in the SOFP.

For example, employees will not be recorded as assets as [1] the entity has no
control over them as they can leave and [2] it is impossible to objectively value a
natural person.

A transaction has a mirror image where from one party angle, it is recorded in a
particular way, but for the other party it is the opposite. For example, a bank loan
will be a liability for the bank but an asset for the bank.
 CAPITAL

Capital is also referred to as net assets or equity.

The accounting equation is A = C + L, i.e., at any point in time the value of assets
should be equal to the value of capital and liabilities.

Assets need to be financed and this is done using the owners’ equity [capital] and
third-party liabilities. Capital is a form of financing for assets.

Capital can be defined in many ways:

• Capital is the owner’s contribution towards financing assets.

• Capital is the residual interest of an entity after all liabilities are deducted from
assets, i.e., C = A - L.

• Capital is the owner’s personal investment to earn profits.

• Capital is the amount the business owes the owner[s].

• Capital is personal resources used to start and expand a business.

A personal loan invested in the business is recorded as capital and not a liability as
the business owes the owner and not the bank directly.

A business loan is recorded as a liability and not capital as the business directly
owes the bank.

Reporting entity concept

For the purpose of accounting all businesses are treated as a separate entity from
their owner[s], irrespective of their legal status.

When recording transactions, the business is one entity and the owner[s] a separate
entity. Therefore, only business transactions are recorded in the entity’s
accounting records and personal transactions are kept separate.
Income tax for sole traders and partners in a partnership will not be recorded in the
books of the business as it is a personal expense. However, income tax will be
recorded in company accounts as it is an expense for the company itself.

Sources of capital
• A sole trader can use savings, inheritance and borrowings to invest.
• A partnership will obtain capital from contributions of the partners.
• A company will issue shares and loan notes to raise finance or from retained
earnings.

For a sole trader, funds can come from liquidating personal assets, investing lottery
winnings, using personal assets for business purpose or from venture capital or
business angels [wealthy friend].

Once the resource comes from the owner[s], then the business acquired capital.
Where and how the owner obtained the funds is irrelevant to the business.

Capital is increased through ‘profits’ and additional ‘capital introduced’.

Capital is decreased by ‘losses’ and through ‘drawings’.

The value of assets will always be more than liabilities since the excess represents
capital, i.e., Capital = Assets - Liabilities.

The difference between current assets and current liabilities is referred to as

working capital or net current assets, i.e., Working capital = CA - CL

A positive working capital means the business has enough current assets to offset
current liabilities.

A negative working capital means they are more CL than CA and the business can
experience liquidity problems as they are using NCL to finance CA.

As a general good business practice, short term assets should be financed by short
term liabilities and same applies to long term.
Drawings are resources the owner took from the business for personal use, and it
can take many forms. For example:
▪ Removing inventories for personal use.

▪ Using the business cash to purchase a personal asset or to pay for a personal
expense.

▪ Utilizing a business asset personally.

▪ A salary paid to a sole trader is recorded as drawings and not a business

expense.

Drawings are not business expenses, but rather an appropriation of the net profit.
Therefore, drawings will be deducted from capital in the SOFP.
 LIABILITES

A liability is a present obligation [legal or constructive] triggered by a past event

and which is expected to result in an outflow of economic benefits from the entity
when the obligation is settled in the future. [IASBs Conceptual Framework].

Liabilities are debts of the business i.e., amounts owed by the business to third
parties.

Liabilities are borrowings and credit taken to finance assets.

A legal obligation is imposed by law e.g., repayment of a bank loan.

A constructive obligation is created by custom and practice e.g., warranty claims.

To budget cash flows to settle obligations as they fall due, liabilities will have two
classifications.
1. Non-current liability [NCL]
2. Current liabilities [CL]

NCLs are long-term obligations which are expected to be settled in more than 12
months from the date of classifications, for example a bank loan.

CLs are short-term obligations which are expected to be settled within the next 12
months from the date of classification, for example:
• Payables
• Bank overdraft
• Accruals

As time moves into the future all NCLs will eventually be reclassified as CLs.

Payables are amounts owing by the business to third parties, for example:
▪ Suppliers for goods bought on credit [trade payables]
▪ Government for VAT [other payables]
An overdraft [OD] is a facility the bank offers to current account holders [chequing
accounts] which permits them to withdraw more than their balance.

An OD is a negative bank balance the business owes the bank, and it is usually
used to finance working capital [CA – CL].

No specific time is set for the repayment of an OD, however, a feature of OD is that
it is repayable on demand, hence why it is classified as CL and not NCL.

Accruals are expenses incurred, but not yet paid for i.e., an expense owing or
outstanding or in arrears.

Matching concept
The profit or loss for a period is calculated by ‘matching’ revenues earned and
expenses incurred regardless of receipts and payments.

Accrual accounting records transactions when they occur rather than when the
cash is paid or received, Therefore, the P&L will record revenues ‘earned’ and not
those received. Similarly, expenses ‘incurred’ rather than those paid will be charged
against profits.

Sales revenue is earned on the date the goods are delivered to the customer and
not the date of the sales order nor the invoice or payment dates.

Similarly purchase costs are incurred on the date the goods are received and not
the date of the purchase order nor the date of the invoice or payment.

Once the items are ‘delivered’, risks are transferred and therefore the buyer incurs
a purchase cost, and the seller earns revenue.

Note:
✓ A prepaid expense is an asset, but a prepaid income is a liability.
✓ An accrued expense is a liability, but an accrued income is an asset.
A prepaid expense will not be charged against profit as the benefit has not been
received, hence it is still an asset [CA].

A prepaid income will not be added to profit as the revenue has not yet been
earned, hence a liability until the benefit is actual realised.

An accrued expense will be charged against profit as the benefit has been realised,
and simultaneously recorded as a liability [CL] until paid off.

An accrued income will be added to profit as the revenue has been earned and
benefit realised, and simultaneously recorded as an asset [CA] until received.

The P&L only charge expenses incurred in that period against profits therefore if an
expense relates to less than 12 months then such expenses will need to be
‘prorated’ i.e., charge for only the number of months incurred and not the entire 12
months.

The SOFP will list assets and liabilities in order of permanency rather than liquidity,
i.e., least liquid assets to most liquid, long term before short term.

Summary

NCAs CAs NCLs CLs Revenues Expenses

Land Inventory Loan Overdraft Sales Rent
Building Receivables Payables Rent received Utilities
Machinery Cash Accruals Commission rec Depreciation
Vehicles Prepayment Discount received Carriage out
Equipment Interest received Bad debts
Furniture Profit on NCA sale Insurance
Fixtures Bad debts recover Bank charges
Fittings Stationery
Maintenance
Wages, salary
Note:
• Fuel and stationery, when initially acquired, can be treated as assets until
consumed and then they become expenses.

• As assets are used up to bring benefits they are tuned into expenses.

• An asset is a future benefit but an expense is a past benefit.

• A payment for a benefit not yet received is treated as an asset but a payment for
a benefit already realized is treated as an expense.

• An income received in advance of earning it will be a liability until it is actually

earned.
 BANK LOANS

There are three different loan repayment profiles:

1. Bullet repayment: The entire loan principal will be repaid at the end of the loan
period. Initially such as loan will be classified as NCL and in the final year it will
be reclassified as CL.

2. Balloon repayment: Some of the loan principal will be repaid during the loan
period, but a substantial amount will be repaid until the end.

3. Amortizing or straight-line repayment: The loan interest and principal will be

repaid in equal installments, either monthly, quarterly, half yearly or annually.
Such a loan may have a portion which is CL and the balance NCL.

The date of classification is the end of the financial year i.e., the reporting date on
which the FSs are prepared.

Examples of accounting periods:

➢ From 1st January, 2022 to 31st December, 2022
➢ From 1stFebruary 2021 to 31st January, 2022
➢ From 1st July, 2019 to 30st June, 2020
➢ From 31st August, 2017 to 30th August, 2018
➢ From 1st January, 2015 to 31st December, 2015
➢ From 1st November, 2022 to 31st October, 2022
➢ From 31st July 2020 to 30th July, 2021

Note:
• The year will end one day before it started 12 months into the future.
• The year started one day after it ended 12 months ago.

Example 1
On 1st April, 2017 the business took a loan of $360,000 and $12,000 is repayable
monthly on the last day of every month starting from the end of April 2017. How will
the loan balance be classified on the 31st December, 2017?
The Loan balance at 31st December, 2017 is $252,000 i.e., $360,000 less $108,000
[$12,000 x 9 months] paid off. All expected payments by the end of next year will be
CL and the balance NCL.

Between 31st December, 2017 and 31st December, 2018, a total of $144,000 [$12,000
x 12 months] is expected to be repaid and this will be classified as CL. The balance
of $108,000 [$252,000 - $144,000] will be classified as NCL as this amount is
repayable in more than 12 months.

Example 2
At 30th June, 2020 the business had a loan balance of $500,000 which is expected to
be repaid in ten equal quarterly installments [$500,000÷10 = $50,000] starting on
the 1st January, 2021. How will the loan balance be classified at 30th June, 2020?

1st January, 2021 $50,000

1st April, 2021 $50,000
1st July, 2021 $50,000
1st October, 2021 $50,000
1st January, 2022 $50,000
1st April, 2022 $50,000
1st July, 2022 $50,000
1st October, 2022 $50,000
1st January, 2023 $50,000
1st April, 2023 $50,000
1st July, 2023 $50,000

Between 30th June, 2020 and 30th June, 2021, a total of $100,000 [$50,000 on 1st
January, 2021 plus $50,000 0n 1st April, 2021] is expected to be repaid and this will
be classified as CL and the balance of $400,000 [$500,000 - $100,000] as NCL. How
will the loan balance be classified at 30th June, 2021?

The loan balance at 30th June 2021 will be $400,000 [$500,000 less $100,000 repaid].
Between 30th June, 2021 and 30th June, 2022, a total of $200,000 [$50,000 x 4
payments] is expected to be repaid and this will be classified as CL and the balance
of $200,000 [$400,000 - $200,000] as NCL.
Example 3
On 1st April,2015, the business took a loan of $300,000. The loan is repayable $6,000
every month end starting from the end of April 2015.

How will the loan balance be classified as at 31st December, 2015?

The loan balance at 31st December 2015 will be $246,000. i.e., $300,000 - $54,000
paid off ($6,000 x 9 months from April to December 2015)

The next 12 months from date of classification will be the next financial year end
i.e., 31st December, 2016. All payments expected between this year end and next
year end will be CL. i.e., $6,000 x 12 months = $72,000 and the balance of the loan
liability will be NCL i.e., $246,000 - $72,000 = $174,000.

How will the loan balance be classified as at 31st December, 2016?

The loan balance at 31st December, 2016 is $174,000, i.e., $246,000 - $72,000 paid.
$72,000 is payable in next 12 months ending 31st December, 2017 and this will be
classified as CL with the balance of $102,000 ($174,000 - $72,000) as NCL.

Classify the loan at 31st December, 2017

The loan balance at 31st December,2017 will be $102,000 i.e. ($174,000 Balance -
$72,000 paid). $72,000 will be CL and $30,000 NCL.

Classify the loan balance at 2018 year end.

At 31st December 2018, the entire $30,000 will be settled within the next 12 months
and therefore CL.

As time moves into the future all NCLs will eventually be reclassified as CLs and
liabilities are extinguished when paid or settled.
Example 4
At June 30th 2017, a business had a loan balance of $90,000 and this is expected to
be repaid in 10 equal payments every 3 months with the first payment expected on
1st October, 2017. How will the loan balance be classified at 30th June, 2017?

1 October 2017 $9,000

1 January 2017 $9,000 = $27,000 CL
1 April 2018 $9,000
1 July 2018 $9,000
1 October 2018 $9,000
1 January2019 $9,000
1 April 2019 $9,000 = $63,000 NCL
1 July 2019 $9,000
1 October 2019 $9,000
1 January 2020 $9,000

The Next 12 months ends on 30th June, 2018 and 3 payments totaling $27,000 are
expected to be made within this period (CL).

Example 5
At 31st December, 2018, the loan balance was $300,000 which is expected to be
repaid $10,000 monthly starting on the 1st January, 2019 and on the 1st day of each
month thereafter. How will the loan balance be classified as at 31st December,
2018 in the SOFP?

Step 1: Write the date when the next 12 months will end i.e., 31st December, 2019.

Step 2: All expected payment from the date of classification [31st December, 2018]
and the end of the next financial year [31st December, 2019] will be CL.

Step 3: The balance of the loan repayable after the end of the next financial year will
be classified as NCL.
Expected payments:
1st January, 2019 $10,000
1st February, 2019 $10,000
1st March, 2019 $10,000
1st April, 2019 $10,000
1st May, 2019 $10,000
1st June, 2019 $10,000
1st July, 2019 $10,000 $120,000: CL
1st August, 2019 $10,000
1st September, 2019 $10,000
1st October, 2019 $10,000
1st November, 2019 $10,000
1st December, 2019 $10,000

Therefore, NCL: $300,000 - $120,000 = $180,000

How will the loan balance be classified as at 31st December, 2019?

At 31st December 2019, the loan balance will reduce to $180,000 since $120,000
would’ve been paid off.

Between 31st December, 2020, 12 payments totalling $120,000 would be classified

as CL. The balance outstanding of $60,000 [$180,000 - $120,000] will be classified
as NCL.

Classify the loan at 31st December, 2018 if the payment was $10,000 at the
beginning of every quarter starting on 1st February, 2019.

Expected payments:
$10,000 at the beginning of every quarter starting on 1st February, 2010, i.e., $40,000

Therefore, NCL is $300,000 - $40,000 = $260,000

NCL will eventually become CL because the future will one day become the present
and then the past.
A bank loan can be classified as CL, NCL or both depending on the expected
repayment.

Liabilities are extinguished when they are paid.

How will the loan be classified at 31st December, 2018 if the first payment is
expected on the 1st February, 2020 amounting to $100,000 and the balance
yearly.

No repayment is expected within the next 12 months hence, the entire $300,000 will
be classified as NCL as at 31st December, 2018.

Example 6
A business took a loan of $200,000 on 1st March, 2015 and it is expected to be
repaid over 5 quarters of equal payments with the first payment being made on the
30th September, 2015. How will the loan be classified as at 30th November, 2015?

1 payment is equal to $40,000 [$300,000÷5]

30th September, 2015 $40,000 [paid off]

31st December, 2015 $40,000
31st March, 2016 $40,000
30th June, 2016 $40,000
30th September, 2016 $40,000

At the 30th November, 2015, the loan balance to be classified is only $160,000 since
$40,000 was paid off.

The next 12 months will end on the 30th November, 2016 and the $160,000 is
expected to be repaid before this, therefore all of the loan liability will be classified
as CL.

The FS’s will be prepared each year on the same day and month.
 CAPITAL AND REVENUE EXPENDITURES

Expenditures are spending or costs which bring benefits.

A capital expenditure [CAPEX] is a cost expected bring benefit in the long-term

i.e., for multiple accounting periods.

CAPEX are NCA and it includes any spending to acquire new assets or improve the
earning capacity of existing NCAs.

Revenue expenditures [REVEX] are costs which are expected to bring short-term
benefits within a year.

REVEX are day to day expenses and includes spending to maintain NCAs.

CAPEX vs REVEX
• CAPEX are recorded as NCA in the SOFP while REVEX are recorded as
expenses in the P&L.

• REVEX will be charged fully against the profit of one period as the benefit is
realized in that period.

CAPEX will be charged against profits as depreciation over the period the NCA
is expected to realize benefit i.e., more than one year.

Expenditures or costs are charged against profits when the benefits are realised
from them.

Examples of CAPEX and REVEX

Property: Costs such as legal fees of acquisition, the cost of purchasing or

constructing the property itself, any enhancement costs such as painting for the first
time, extensions to the building as this adds value or any other costs which extends
its life will be CAPEX. Costs such as building insurance, repairs and maintenance,
utilities and replacements of items such as a broken window will be REVEX.
Motor vehicle: The purchase cost, accessorising such as installing music systems
and legal fees of acquisition such as transfer of registration are all CAPEX.
Operational costs such as fuel, road licence, tyre replacements, oil change,
servicing, car wash, repairs and maintenance and insurance are all REVEX.

Computer equipment: The purchase cost including delivery, installation and

testing, upgrading the operating system and storage space, refurbishment of the
entire system, accessorising with printers, scanners and cameras and software are
all CAPEX. Repairs and maintenance, insurance, internet charges and replacement
of parts are all REVEX.

CAPEX includes the following:

• Purchase price of NCA less any trade discounts
• Construction costs of NCA including materials, labour and overheads
• Delivery charges to get the NCA to a specific location
• Import duties
• Non-refundable sales tax if the business is not VAT registered
• Site preparation costs to accommodate the NCA
• Testing to ensure the NCA is functional
• Legal and professional fees incidental to the acquisition to the NCA
• Borrowing costs during the construction period [IAS 23]
• Any other costs incurred to get the NCA in its present location and condition
ready for use

Note:
• Once value is added to NCA the expenditure is CAPEX but restoring value is
REVEX.

• Minor repairs are REVEX but major repairs are CAPEX.

• The purchase of items which are expected to be consumed within the next 12
months are REVEX. For example, inventory and stationery.

• All operational expenses are REVEX.

• REVEX already brought benefits to the business or the benefit is expected to be
realised within the next 12 months.

• Costs for upgrade, refurbishment, enhancement and improvements that will

either add values or extend NCA life are CAPEX.

• Any cost incurred to acquire NCA including legal fees are CAPEX but costs
incurred after the NCA is operational will be REVEX unless it adds value or
extend the NCA life.

• Insurance and maintenance are always REVEX.

Incorrect classification of expenditures will affect expenses, profits, asset values

and capital balances.

CAPEX as REVEX
✓ Year 1: Expenses overstated and profit and net asset understated.
✓ Subsequent years: Expenses will be understated and profit overstated but,
capital will remain understated by progressively lower amounts until it is
unaffected at the end of the final year.

REVEX as CAPEX
✓ Year 1: Expenses will be understated and profit and net asset will be overstated.
✓ Subsequent years: Expenses will be overstated and profit will be understated but
capital will remain overstated by progressively lower amounts until it is no longer
affected at the end of the final year.