Question Tag: Capital Expenditure

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  • 20 Marks

FA – May 2016 – L1 – SB – Q6 – Elements of Financial Statements

Classify various expenditures as revenue or capital and their impact on financial statements and non-current asset register.

Given below are items of “Revenue” and “Capital” expenditure:

(i) A number of new cars that had recently been cleared by a motor car dealing company.

(ii) Two new motor boats acquired by a ferry service agency.

(iii) Vacant houses owned by an estate developing company in respect of which negotiations are ongoing for assistance for their sale to prospective landlords.

(iv) New buildings acquired for the purpose of holding the items of plant and machinery belonging to a detergent manufacturing company.

(v) Cost of acquiring a leasehold property for office use.

(vi) Granites purchased by an engineering contractor for use at a construction site.

(vii) Cost of rehabilitating a dilapidated housing unit owned by an estate developer.

(viii) Repairs to plant and machinery in a manufacturing company.

Required:

a. For each of the above, state whether it is a “Revenue” or “Capital” expenditure. (4 Marks)

b. State how each will be recognised in the statement of profit or loss and the statement of financial position as the case may be. (12 Marks)

c. State how the non-current assets register will be affected by any of the transactions. (4 Marks)

(a) Classification of Expenditure:

Item Type of Expenditure
(i) A number of new cars that had recently been cleared by a motor car dealing company. Revenue
(ii) Two new motor boats acquired by a ferry service agency. Capital
(iii) Vacant houses owned by an estate developing company in respect of which negotiations are ongoing for assistance for their sale to prospective landlords. Revenue
(iv) New buildings acquired for the purpose of holding the items of plant and machinery belonging to a detergent manufacturing company. Capital
(v) Cost of acquiring a leasehold property for office use. Capital
(vi) Granites purchased by an engineering contractor for use at a construction site. Revenue
(vii) Cost of rehabilitating a dilapidated housing unit owned by an estate developer. Capital
(viii) Repairs to plant and machinery in a manufacturing company. Revenue

Explanation:

  1. Revenue Expenditure: Costs related to the daily operations, which do not provide long-term benefit, such as the purchase of inventory (item i), maintenance and repairs (item viii).
  2. Capital Expenditure: Costs incurred to acquire or improve a long-term asset, which will provide benefits over time, such as purchasing new boats (item ii) and buildings (item iv).

(b) Recognition in Financial Statements:

Item Statement of Profit or Loss Statement of Financial Position
(i) A number of new cars that had recently been cleared by a motor car dealing company. Cost of Goods Sold / Inventories Current Asset – Inventories
(ii) Two new motor boats acquired by a ferry service agency. Depreciation Expense Non-Current Asset – Property, Plant, Equipment (PPE)
(iii) Vacant houses owned by an estate developing company in respect of which negotiations are ongoing for assistance for their sale to prospective landlords. Sales Revenue (upon sale) Current Asset – Inventories
(iv) New buildings acquired for the purpose of holding the items of plant and machinery belonging to a detergent manufacturing company. Depreciation Expense Non-Current Asset – Property, Plant, Equipment (PPE)
(v) Cost of acquiring a leasehold property for office use. Amortization Expense Non-Current Asset – Leasehold Property (Intangible)
(vi) Granites purchased by an engineering contractor for use at a construction site. Cost of Goods Sold / Work-in-Progress Current Asset – Inventories / WIP
(vii) Cost of rehabilitating a dilapidated housing unit owned by an estate developer. Depreciation Expense (if capitalized improvements) Non-Current Asset – Property, Plant, Equipment (PPE)
(viii) Repairs to plant and machinery in a manufacturing company. Repairs and Maintenance Expense Not Recognized

(c) Effect on Non-Current Assets Register:

  1. Item ii: Increase in the asset register with the addition of two new motor boats.
  2. Item iv: Increase in the asset register with the addition of new buildings.
  3. Item v: Increase in the asset register under leasehold property.
  4. Item vii: Increase in the asset register as rehabilitated housing units are capitalized.

Other items classified as revenue expenditure do not affect the non-current assets register.

  • 1 Marks

FA – May 2016 – L1 – SA – Q18 – Accounting for Property, Plant, and Equipment (IAS 16)

Determining which item qualifies as capital expenditure.

Which of the following is a capital expenditure?
A. Purchase of inventories
B. Purchase of motor vehicle for sale
C. Subscription paid
D. Extension of building
E. Repair of generator

Answer: D. Extension of building

Explanation:
The correct answer is D because capital expenditure refers to funds used by an organization to acquire or upgrade physical assets such as property, buildings, or equipment. The extension of a building is a capital expenditure because it enhances the value of the existing building and is expected to provide long-term benefits.

Run down:
The selected answer is D since extending a building qualifies as capital expenditure. It involves upgrading a long-term asset, which aligns with the definition of capital expenditure.

  • 1 Marks

FA – Mar/July 2020 – L1 – SA – Q4 – Accounting for Property, Plant, and Equipment (PPE) in Accordance with IAS

Identifying an example of capital expenditure

Which of the following payments is an example of capital expenditure?
A. Refurbishment as part of upgrading a building
B. Carriage outwards in respect of goods sold
C. Legal fees incurred to recover customer debts
D. Bonuses to production operatives
E. Maintenance cost of building

A. Refurbishment as part of upgrading a building

Explanation:
Capital expenditure refers to spending on acquiring or improving long-term assets, like property or equipment. Upgrading a building is considered capital expenditure as it enhances the asset’s value.

  • 5 Marks

PT – Mar 2024 – L2 – Q4b – Income Tax Liabilities

State the differences between capital expenditure and revenue expenditure with relevant examples.

With relevant examples, state the differences between capital expenditure and revenue expenditure. (5 marks)

  • Capital Expenditure:
    • It is an expenditure incurred for the acquisition or improvement of a fixed asset, such as buildings, plant & machinery, and vehicles.
    • It gives rise to an advantage of an enduring nature, meaning the benefits of the expenditure are consumed over more than one accounting period.
    • Example: Purchase of a factory building, or installation of machinery.
  • Revenue Expenditure:
    • It is an expenditure incurred for the day-to-day running of a business, necessary for the normal operation of the business, such as rent and stationery.
    • The benefit of the expenditure is consumed within one accounting period.
    • Example: Payment of salaries or rent for the office premises.
  • 3 Marks

CR – May 2019 – L3 – Q2c – Non-current assets: sundry standards (IAS 16, IAS 23, IAS 20 and IAS 40)

This question requires an explanation of the accounting treatment of government grants relating to capital expenditure under IAS 20.

IAS 20: Accounting for Government Grants and Disclosure of Government Assistance sets out the requirements for recognizing as income any grants received from government agencies, together with any repayments of such grants.

Required:
Detail the requirements of IAS 20 with respect to government grants to aid capital expenditure. (3 marks)

IAS 20 provides two methods for accounting for government grants relating to capital expenditure:

  1. Reduction of Carrying Amount of the Asset:
    Under this method, the grant is deducted from the carrying amount of the asset on the balance sheet. The asset is then depreciated based on the net amount after deducting the grant. This method reduces the depreciation expense over the life of the asset and ultimately reduces profit in each reporting period.
  2. Deferred Income Approach:
    Alternatively, the grant may be credited to a deferred income account on the balance sheet. The deferred income is then amortized to the profit or loss over the useful life of the related asset, typically in line with the depreciation of the asset. This method recognizes the benefit of the grant over time in a systematic manner.

Key requirements for government grants relating to capital expenditure:

  • The grant should be recognized in profit or loss over the periods in which the asset is depreciated.
  • It should not be recognized as income immediately, but rather in a manner that matches the grant’s benefit with the expense of the related asset over time.
  • 10 Marks

AT – Nov 2023 – L3 – Q5c – Tax planning

Explain the residual deduction rule and state four conditions under which repairs and improvements are considered allowable deductions.

Repairs and improvements are not mutually exclusive in tax administration because one leads to the other, and one cannot happen without the other. The Commissioner-General ensures that certain conditions are met before an amount of repairs and improvements is taken as an allowable deduction under the deductibility principles in tax administration.

You are the Tax Manager for Akwaaba and Associates, a firm of tax consultants. The Finance Manager of APC Ltd, a client of your firm, is contemplating how to treat major repair works being undertaken on their warehouse.

Required:
Write a memo to the Finance Manager of APC Ltd explaining what constitutes the residual deduction rule and state FOUR (4) conditions under which repairs and improvements are considered allowable deductions. (10 marks)

Memo
To: Finance Manager, APC Ltd
From: Tax Manager, Akwaaba and Associates
Date: November 8, 2023
Subject: Residual Deduction Rule and Allowable Deductions for Repairs and Improvements

Introduction:
In response to your inquiry regarding the treatment of major repair works on your warehouse, I would like to clarify the residual deduction rule and outline the conditions under which repairs and improvements may be considered allowable deductions.

1. Residual Deduction Rule:
The residual deduction rule is a principle in tax administration that allows for the deduction of expenses that are:

  • Wholly,
  • Exclusively, and
  • Necessarily incurred in the production of income.
    This rule applies to expenses that do not fall into any specific deduction category but are essential for the business operations. It ensures that all necessary and reasonable business expenses are deductible, provided they meet the criteria of being non-capital in nature.

2. Conditions for Allowable Deductions for Repairs and Improvements:
The following conditions must be met for repairs and improvements to be considered allowable deductions under the residual deduction rule:

  • a. Identification of the Asset or Pool:
    • The specific depreciable asset or pool of assets related to the repair or improvement must be clearly identified. This is crucial for determining whether the expense is capital in nature or qualifies as a repair.
  • b. Written Down Value (WDV):
    • The Written Down Value (WDV) of the asset or pool of assets at the close of the tax year must be calculated. This value is used to assess whether the repair and improvement expenses exceed a certain percentage of the WDV.
  • c. Expense Limitation:
    • Repairs and improvements that exceed 5% of the WDV of the asset or pool of assets at the close of the tax year may not be fully deductible and could be subject to capitalization.
  • d. Non-Capital Nature:
    • The expenditure must not result in the creation of a new asset or the enhancement of an existing asset’s life beyond its original condition. If the expenditure is deemed to be capital in nature, it must be capitalized and depreciated accordingly.

Conclusion:
By ensuring that the repair and improvement expenses meet the above conditions, APC Ltd can maximize its allowable deductions while remaining compliant with tax regulations.

Please feel free to contact me if you require any further clarification or assistance.

Best regards,
[Your Name]
Tax Manager, Akwaaba and Associates

(10 marks)

  • 4 Marks

PSAF – May 2019 – L2 – Q2b -Public sector fiscal planning and budgeting

Outline the procedures for payment of works procured by an MDA.

b) Funds are released from the consolidated fund to the Ministries, Departments, and Agencies (MDAs) for use only when an appropriation bill has been passed into an appropriation act. However, when the Appropriation Act is issued, there are certain procedures usually followed in making payments for Capital Expenditure.

Required:
Outline the procedures for payment of works procured by an MDA.
(4 marks)

The general rule is that all covered entities shall use GIFMIS from the commencement of the procurement process through to payment. The procedures for payment of works procured by an MDA include the following:

i) Inspection for the purpose of certification: The Principal Spending Officer (PSO) inspects the physical output of the works and supplies to certify their completion. This inspection can be done before progress payment or when the work is fully completed.

ii) Certification of completion: Upon completion of works or supply of goods and services, the PSO prepares a certificate statement, including details such as the quantity and particulars of the works, method and result of the inspection, and any necessary remedial actions.

iii) Recording invoices and supporting documents: After certification, the PSO records the details of the invoices in the GIFMIS and uploads the certification statement and other supporting documents onto the system.

iv) Approval of payment voucher: The head of accounts and the PSO ensure the validity, accuracy, and legality of the claims for payment before approving the payment voucher on GIFMIS.

v) Payment: The Controller and Accountant General releases cash to the covered entities using GIFMIS. Payments are made through electronic fund transfer (EFT) for third-party transactions, system checks or electronic means for internal payments, and physical cash disbursement only from imprest or for allowances.

  • 6 Marks

PSAF – May 2019 – L2 – Q2a – Public Procurement

Analyze internal control measures for public assets, outline payment procedures for capital expenditure, explain procurement offenses, and suggest ways to improve IGF in local governments.

a) The backward development in the public sector has been attributed to weaknesses in the Internal Control Systems in the public sector. Proper systems for the effective control over the custody and management of assets in public institutions are critical for Public Sector Accounting.

Required:
Analyze FOUR (4) key control measures required to be put in place to ensure effective management of Public Assets.
(6 marks)

The following controls are necessary for effective management of public assets:

Fixed assets:
i) Proper use of the fixed assets: Ensure that systems exist to prevent wrongful use of public assets by both authorized and unauthorized persons. For example, institute tracking systems over vehicles and other assets. Physical restrictions such as locks and security systems are also important to safeguard the use of assets.

ii) Establishing a Fixed Asset Coordinating Unit: The principal spending officer should establish a coordinating unit within the entity to take responsibility for fixed asset management.

iii) Keep proper records on fixed assets: The entity should maintain and update a fixed asset register to ensure accurate records for effective checks and decision-making.

Investment of Excess Moneys:
i) Establish an investment policy: The entity should establish an investment policy in accordance with the PFM Act and regulations to ensure lawful and prudent investment activities.

ii) Accurate accounting and reporting: Ensure that all investments made from public monies are accurately accounted for and reported.

Advances and Loans:
i) Establish appropriate schemes: Implement appropriate advance and loan schemes with the approval of the Minister of Finance and Parliament, where necessary.

ii) Institute effective recovery systems: Ensure effective recovery systems for advances and loans made under the scheme.

iii) Proper accounting and reporting: Follow proper accounting and reporting practices for advances and loans.

Cash management:
i) Cash planning and forecasting: Implement an effective cash planning and forecasting system to ensure efficient management of cash resources.

ii) Custody of cash resources: Ensure that all cash is deposited gross in designated bank accounts.

iii) Approval of bank accounts: Open bank accounts under the approval of the Controller and Accountant General as part of the Treasury Single Account system.

iv) Bank reconciliation: Regularly perform bank reconciliations to ensure accurate records of cash transactions.

  • 20 Marks

FA – Mar 2023 – L1 – Q5 – Interpretation of financial statements (Financial Ratios)

Distinguishes between capital and revenue expenditure and calculates financial ratios to assess the performance of a business.

a) Distinguish between capital expenditure and revenue expenditure. (5 marks)

b) Banky is the owner of a business supplying goods to other traders. He has just received the financial statement for his business for the year ended 31 December 2022 from his accountant. Below are the summarized financial statements:

Required:

i) Calculate for Banky each of the following ratios for the year ended 31 December 2022 (where appropriate, calculations should be approximated to two decimal places):

  • Net profit margin. (2 marks)
  • Return on capital employed (using the closing year-end value for capital employed) (2 marks)
  • Current ratio. (2 marks)
  • Liquid (acid test) ratio. (2 marks)
  • Rate of inventory turnover. (2 marks)

ii) Based on the ratios calculated in i) above, and all other information provided, assess the performance (profitability) of Banky’s business. (5 marks)

a) Distinction between Capital Expenditure and Revenue Expenditure:

Capital Expenditure:

  • It is expenditure which results in the acquisition of non-current assets or an improvement in their earning capacity.
  • Capital expenditure is not charged as an expense in the statement of profit or loss at one go but rather a depreciation or amortization charge will usually be made to write off the capital expenditure gradually over time.
  • Capital expenditure on non-current assets is the recognition of a non-current asset (e.g., vehicles, land, and buildings) in the statement of financial position of the business.

Revenue Expenditure:

  • It is expenditure which is incurred for either:
    • The purpose of the trade/service of the business. This includes selling & distribution expenses, administration expenses, and finance charges.
    • To maintain the existing earning capacity of non-current assets (such as repair expenses).
    • To ensure the smooth running of the day-to-day activities of the company/business.

(5 marks)

b)
i) Computed ratios
Net Profit As A Percentage Of Sales (14,880/324,000) = 4.65%
Return On Capital Employed (24,000/158,880) = 15.11%
Current Ratio (53,680/6,800) = 7.89:1
Liquid (Acid Test) Ratio (12,080/6,800) = 1.78:1
Rate Of Inventory Turnover (240,000/41,600) = 6 times
(2 marks each = 10 marks)

ii) Assessment of Banky’s Business Performance:

  • Net Profit Margin: The net profit margin of 4.65% is lower than the competitor’s 6%. This may indicate that Banky’s costs are higher or that he is not marking up his purchases as much as the competitor.
  • Return on Capital Employed (ROCE): Banky’s ROCE of 15.11% is better than the competitor’s 10.50%, meaning that Banky is making more profit per cedi of investment in the company.
  • Current Ratio: Banky’s current ratio of 7.89:1 is extremely high, indicating excessive liquidity, which might suggest inefficient use of resources. The competitor’s ratio is also high, but closer to the accepted standard.
  • Acid Test Ratio: Banky’s acid test ratio of 1.78:1 is within acceptable limits, indicating good liquidity management, whereas the competitor’s ratio of 0.3:1 suggests potential liquidity issues.
  • Inventory Turnover: Banky’s inventory turnover rate of 6 times is better than the competitor’s, indicating that Banky is selling inventory more frequently, which contributes positively to profitability.

(5 marks)

  • 20 Marks

FA – Nov 2015 – L1 – Q7 – Capital structure and finance costs | Preparation of financial statements of a sole trader

Differentiate between capital and revenue expenditure and prepare financial statements for Danfo Enterprise.

a) Distinguish between Capital Expenditure and Revenue Expenditure. (5 marks)

(b) The following Trial Balance was extracted from the books of Danfo Enterprise, a second-hand bags dealer, as at 31st December 2014:

Description DR (GH¢) CR (GH¢)
Stock in Trade 120,000
Vehicle (Cost) 150,000
Trade Receivables 80,000
Accumulated Depreciation: Vehicle 30,000
Accumulated Depreciation: Furniture & Fittings 10,120
Trade Payables 100,000
Drawings 120,000
General Expenses 65,000
Provision for Doubtful Debts 2,500
Rate & Rent 14,000
Insurance 5,000
Bad Debt 7,000
Discount Received 25,150
Discount Allowed 15,160
Bank Balance 165,240
Wages & Salaries 250,000
Sundry Expenses 6,150
Vehicle Running Expenses 15,650
Furniture & Fittings 50,600
Repairs to the Shop 6,500
Purchases 650,120
Sales 1,079,130
Capital 473,520
Total 1,720,420 1,720,420

Additional Information:
i. Provision for doubtful debts is to be reduced by 10%.
ii. Rate and Rent has been paid in advance by two (2) months. Note that Danfo Enterprise pays GH¢1,000 each month.
iii. Stock in trade as at 31st December, 2014 GH¢80,150.
iv. A bill of GH¢6,150 for vehicle running was outstanding as at 31st December, 2014.
v. The Enterprise provides depreciation as follows:

  • Vehicle: 20% per annum on straight line basis.
  • Furniture and Fittings: 20% per annum on straight line basis.

You are required to:
i. Prepare Income statement for the year ending 31st December 2014. (8 marks)
ii. Prepare Statement of Financial Position as at 31st December 2014. (7 marks)

(a) Capital Expenditure:

  • Capital expenditure results in the acquisition of fixed assets or an improvement in their earning capacity.
  • It is not charged as an expense in the income statement in one go; instead, a depreciation or amortization charge is usually made to write off the capital expenditure gradually over time.
  • Capital expenditure on fixed assets is the recognition of a fixed asset (e.g., vehicles, land, and buildings) in the statement of financial position of the business.

Revenue Expenditure:

  • Revenue expenditure is incurred for the purpose of trade/service of the business, including selling & distribution expenses, administration expenses, and finance charges.
  • It is also for maintaining the existing earning capacity of fixed assets, such as repair expenses.
  • It ensures the smooth running of the day-to-day activities of the company/business.

(b) i. Danfo Enterprise Income Statement for the year ended 31st December, 2014

ii. Danfo Enterprise Statement of Financial Position as at 31st December 2014

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