Management Accounting For Capital Expenditure

Income and Expenses for the Year Ended on December 31, 2016

For the year ended on December 31, 2016

(Amount in $)

WN-1 Calculation of Depreciation 

There are many errors which are not revealed by a Trial Balance, even if the trial balance matches. Some of these errors are as below:

Error of Principle – Preparation of financials needs to follow certain rules of accounting, these are commonly known as fundamental of accounting. According to these rules, a transaction must be posted to the correct class of accounts. In the error of principle, the transaction is not posted to the correct account or is posted to a wrong chart, class of account. Revenue expenditure if recorded as a capital expenditure and vice versa, results in error of principle. For example, purchase of furniture is debited to the purchase account instead of furniture account, another example is repairs to vehicle debited to vehicle account instead of repairs expense account. Hence, in this error the trail balance agrees, in spite of the error.

Errors of Omission – This error means that a transaction is completed omitted to be recorded in the books of account. If a transaction is not recorded at all, then it will have no impact on the trail balance as the both legs of the transaction are not recorded. For example, Purchase of material on credit, if these transaction is omitted from recording, then entries in both the accounts purchases as well as suppliers account is not recorded, hence it will not impact trial balance. Both the sides of Trial Balance will tally as neither the debit side nor the credit side has been recorded in the books.

Error of commission – In this error, the amount is posted on the correct side but in the wrong ledger but of same category. For instance, goods sold to Ramu is recorded in the Raman account. Since, Ramu and Raman both are debtors of the company, so the entry will not be having any impact on trial but the independent ledgers of Ramu and Raman will reflect the wrong balance. Hence, this type of error is not reflected by the trial balance. Error of commissioning also includes when entry in the books of account is recorded with the wrong amount. It means if a transaction is recorded in the correct ledgers but amount mentioned is wrong. For example, consider that there is a purchase of goods by the company for $500 on credit on Sam. This purchase of $500, when recorded in the books of account, gets recorded with the amount of $400 on debit as well as on credit side according to the double entry system. Since both sides of the entry have equal amount, trial balance will not show any difference.

Calculation of Depreciation

Compensating Errors – These errors are those errors in which two errors are done in such a way that it compensates one another and will have no impact. For instance, if a totaling error is done in which purchases account is recorded less by $500 and similarly, a totaling error is done in Sales account in which sales account is recorded less by $500, then these both errors will compensate each other. Since these error nullifies the impact of wrong transactions, it will not get reflected in trial balance and both sides of trial balance will have equal balance. Another example of compensating error is when there is mistake in recording of two or more transactions in books of account in such a way that these errors compensate one another completely. For example, consider that there is purchase of goods of $500 on credit from Sam and there is purchase of stationery of $800. In these cases, first transaction is recorded with the amount $400 in purchase account as debit and $500 as credit to the Sam. Second transaction is recorded with the amount $900 in stationery expenses as debit and $800 as credit to cash. In these cases, debit side of both transactions have been recorded wrongly but these transactions have been recorded in such a way that total of trial balance will tally on both sides. Errors in these two transactions are compensating each other and hence trial balance will not show any difference.

Error of duplication – In this error, an entry is recorded two times in the books of account, hence double entry is recorded. But it will not impact the trial balance and the trial balance will not reflect such error. For instance, sale of goods is recorded twice, debtors debit and sales credit. In this error, the sales account and debtors account will have twice the value from the original amount, but in spite the error, the correct entry is passed, so the trial balance will remain unaffected.

Normally the expenses are of two types, i.e. capital expense and revenue expense. These both expenses differ from each other in terms of their accounting treatment and there proper treatment is very important. The difference between these two are as follows:

Capital expenditure are those expenditure which are incurred on or for purchase of fixed assets whereas revenue expenditure is those which are incurred in normal course of business or for running of business. For example, purchase of land (which is a fixed asset) is a capital expenditure whereas expenses on purchase of stationery items is a revenue expenditure.

Revenue expenses are expensed off or charged to profit and loss account in the year in which they are incurred whereas capital expenditure are not charged to profit and loss instead they are added to the value of the fixed assets are depreciated over the life of the asset. Some examples of revenue expenses are includes wages expenses, purchase of material, maintenance etc. and the examples of capital expense include freight paid for importing the machinery, this will be added to the cost of the machinery.

Capital expenses are consumed over the life of the assets whereas revenue expenses are consumed within the period in which they are incurred. Generally the life of capital expenditure is more than one year whereas life of revenue expenditure is one year or less.

Normally, capital expenses are larger in size in terms of monetary amount whereas the revenue expenses involves less monetary amount as compared to capital expenses. Purchase of land will involve large amount of money whereas purchase of stationery items will involve less amount of money.

Capital expenditure are generally non-recurring in nature and are incurred once in a life time of the asset and revenue expenses are recurring in nature and occur normally in every period. Since, life of capital expenditure is larger, there are generally of non-recurring nature. Purchase of land is of non-recurring in nature. On the other hand, purchase of stationery is of recurring nature and may be incurred more than once in a year.

Capital expenditure is incurred to improve the capacity of the assets, hence it helps in increasing the revenue of the company whereas revenue expenses are related to carrying of business and does not improve or enhance the capacity of the assets or business. Thus, capital expenses increases the future economic benefits whereas revenue expenses generated benefit for current year only.

Capital expenses are added to the cost of the fixed assets and are shown on the asset side of the balance sheet whereas revenue expenses are charged to the profit and loss account.