Month: September 2009

Capital Expenditure (24 September 2009)

Capital expenditure refers to the expenditure made by business entities which result in non-current assets or long-term assets and therefore are recognised and shown on the balance sheet of the business entities and not charged as expense in the income statement. Capital expenditure relates to the following items being acquired but take note that this is not the exhaustive list:

  1. Property, plant and equipment
  2. Investments in shares of companies
  3. Other form of investments e.g. property acquired for its investment potential ie capital appreciation and earnings by way of rental income earned

There is an important difference between capital expenditure on property, plant and equipment and capital expenditure made for investment purposes. For property, plant and equipment or fixed assets, the assets are acquired with a view or clear intention to use them in the operations of the business to generate the revenue (i.e. major source of income to the business entities). This is different to capital expenditure made for investment purposes such as b. and c. above. For capital expenditure made to acquire assets for their investment potential such as b. and c. above, the business entities have the intention to acquire the assets for their capital appreciation i.e. increase in market value over time and also for specific return from their acquisition e.g. dividend income for investment in shares of companies and rental income for investment in property.

This is the reason that property, plant and equipment acquired are subject to depreciation over the life of using the assets. Depreciation can be more easily understood as recognition of the consumption of the benefits that the assets give to the business entities systematically in the course of using them to generate the revenue of the business entities. However, business entities do not depreciation investment in shares or investment in property but they do recognise the decrease in value (market value is a good guide to be used as fair value) of the investments made earlier. I shall not discuss the effect of increase or decrease in value of investments and how to recognise them in accounting here because this is the topic of advance accounting.

Example – Purchase of Fixed Assets Or Property, Plant And Equipment

  • On 1/1/2007, Dragon Co. Ltd. purchased a car by issuing a cheque of $5,000 to Fantastic Cars Co. Ltd. as cash deposit. The balance of $145,000 is under hire purchase financing obtained from Rich Bank. The double entry to record this transaction is: –

  • On 31/1/2007, Dragon Co. Ltd. makes a monthly depreciation of $1,250 based on the annual depreciation rate of 10% on cost. The double entry to record this transaction is: –

The depreciation charge of $1,250 per month shall be done every month until the cost of acquiring the car of $150,000 is fully depreciated.

Click Here For Effect Of Depreciation Reflected In Balance Sheets And Income Statements

Capital Vs Revenue Expenditure (24 September 2009)

When a business entity spends money (or purchase on credit) to acquire goods or services, a decision need to be made as to the purpose and nature of the expenditure. The questions asked include something along these lines:-

  • What did I pay for?
  • Is the thing that I paid for have some value or benefits to my business over the long run? (e.g. more than one year)
  • Is it something that I paid because of something that the business had already enjoyed or used in the past? (e.g. electricity, phone, water & etc.)
  • Is it for something that the business intends to resell later?
  • Is it for packing of the goods meant to be sold later?

In accounting, the classification of the expenditure into either capital expenditure or revenue expenditure is required. Wrong classification of the expenditure may have a great impact on the financial position (meaning is the balance sheet of the business entity concerned) and the financial performance/results (meaning is the profit or loss performance of the business entity concerned referring to the income statement) of the business entity.

Do not get yourself confused between the capital expenditure and the capital contribution by business owners. They are two different things.

Capital expenditure refers to the expenditure made by business entities to acquire assets (usually non-current or fixed assets) that are expected to give the business entities future economic benefits (by way of using the assets in the business to generate revenue or income). Capital expenditure is recorded as asset and therefore would appear on the balance sheet of the business entities. Examples of capital expenditure are property acquired and used as office premises, computers, furniture, fixtures and fittings & etc. On the other hand, revenue expenditure refers to those expenses incurred to acquire goods or services that are also essential in terms of the daily operations of the businesses. However, the benefits that revenue expenditure gives to the business entities are of a shorter term in nature and usually in the day to day operations and DO NOT provide future economic benefits, i.e. the benefits are consumed over a short period of time (usually one year is the period that is used as the measurement).

Revenue expenditure is recorded as expenses in the Income Statement. Examples of revenue expenditure are office rentals, utilities such as water & electricity, printing & stationery, repairs and maintenance & etc. revenue expenditure also includes those incurred to maintain the earning capacity of non-current assets such as repairs and maintenance.

Sample Disclosure – Note On Land Held For Development (16 September 2009)

LAND HELD FOR DEVELOPMENT

Land Held For Development 

Land held for development of certain subsidiary companies are charged together with property development costs for banking facilities granted as disclosed in Note XX. 

Sample Disclosure – Land Held For Development And Property Development Costs (15 September 2009)

Land Held for Property Development and Property Development Costs

 

Land and development expenditure are classified as property development costs under current assets when significant development work has been undertaken and is expected to be completed within the normal operating cycle.

 

Property development revenue are recognised for all units sold using the percentage of completion method, by reference to the stage of completion of the property development projects at the balance sheet date as measured by the proportion that development costs incurred for work performed to-date bear to the estimated total property development costs on completion.

 

When the outcome of a property development activity cannot be estimated reliably, property development revenue is recognised to the extent of property development costs incurred that is probable of recovery.

 

Any anticipated loss on property development project (including costs to be incurred over the defects liability period), is recognized as an expense immediately as foreseeable losses.

 

Accrued billings represent the excess of property development revenue recognised in the income statements over the billings to purchasers while progress billings represents the excess of billings to purchasers over property development revenue recognised in the income statements.

 

Land held for development and costs attributable to the development activities which are held for future development where no significant development has been undertaken is stated at cost less impairment costs (if any). Such assets are transferred to property development activities when significant development has been undertaken and the development is expected to be completed within the normal operating cycle.

Sample Disclosure – Accounting Policy On Construction Contracts (15 Septemeber 2009)

Construction Contracts

Where the outcome of a construction contract can be estimated reliably, revenue and costs are recognised by reference to the stage of completion of the contract activity at the balance sheet date, measured as the physical proportion that contract costs incurred for work performed to date bear to the estimated total contract costs, except where this would not be representative of the stage of completion. Variations in contract work, claims and incentive payments are included to the extent that they have been agreed with the customer.

Where the outcome of a construction contract cannot be estimated reliably, contract revenue is recognised to the extent of contract costs incurred that it is probable will be recoverable. Contract costs are recognised as expenses in the period in which they are incurred.

When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised as an expense immediately as allowance for foreseeable loss.

When costs incurred on construction contracts plus recognised profits (less recognised losses) exceeds billings to contract customers, the balance is shown as amount due from contract customers. When billings to contract customers exceed costs incurred plus recognised profits (less recognised losses), the balance is shown as amount due to contract customers.