Grade 12 test 2, term 1 Flashcards
Define capital and revenue expenditure and explain the difference between the two.
Capital expenditure is any significant cost that increases the value of a non-current asset. For example, purchase price, installation costs and freight. Whereas, revenue expenditure is any cost relating to non-current assets that are incurred to maintain, but not to extend, the useful life of the asset. For example, insurance, repairs and maintenance costs.
How is capital expenditure accounted for in the accounting reports of a business?
Capital expenditure is an asset, shown in the balance sheet.
How is revenue expenditure accounted for in the accounting reports of a business?
Revenue expenditure is an expense, shown in the income statement.
Define the terms depreciation and amortisation and explain the difference.
Depreciation is the allocation of the cost of the asset to the accounting periods in which it is expected that the asset will contribute to the production of revenue. Usually used in relation to physical assets such as machinery and computer equipment. Whereas, amortisation refers to the gradual writing off of the cost of certain assets through the passing of time or depletion. It usually refers to the writing off of intangible assets and natural resources; such as copyright.
List the different methods of calculating depreciation and their associated formulas.
Straight line: original cost - residual value / useful life.
Diminishing: rate of depreciation x diminished value of asset.
Explain why depreciation is taken into consideration within the accounting system. INTRO
Depreciation is taken into consideration within the the accounting system due to the declining value of non-current assets of their time of use. Two significant concepts relating to non-current assets are the historical cost assumption and the matching principle
Explain why depreciation is taken into consideration within the accounting system. HISTORICAL COST ASSUMPTION
The Historical Cost Assumption states that non-current assets are recorded in the financial records of an enterprise at their original cost. However, over time, the service potential or future economic benefits of some non-current assets decreases over time. The historical cost of the non-current assets as recorded in the balance sheet may be misleading to some users of the information.
Explain why depreciation is taken into consideration within the accounting system. MATCHING PRINCIPLE
The Matching Principle refers to allocating the cost of the asset being matched to the periods on which the asset contributes to earning revenue. Depreciation is created as the expense incurred to be matched against the revenues earned by the business.
Therefore, depreciation expense is created to allow for this allocation of cost and resolve the two accounting concepts.
State the factors that need to be known to calculate the annual depreciation expense of an asset.
To be able to calculate depreciation, the following four factors need to be known: original cost of the asset, useful life of the asset, residual value and the method of depreciation.
State the different methods of calculating the depreciation charge. Give an example of an asset for each method of depreciation and justify your response.
Straight line depreciation is the allocation of the cost of an asset as being constant over the life of the asset. This applies to assets that have a low obsolescence such as buildings and furniture.
Diminishing balance is the allocation of the cost of an asset using the reducing balance that will result in a decreased depreciation expense over time. It’s suitable for assets that give most of their service potential in their early life, such as machinery and equipment.
First Journal Entry
Asset - Dr
GST clearing - Dr
Method of payment (A/R or Bank) - Cr
Second journal entry
Asset (Capital Expenditure) - Dr
GST Clearing - Dr
Method of payment - Cr
Third journal entry
Asset expense (Revenue expenditure) - Dr
GST Clearing - Dr
Method of payment - Cr`
Fourth journal entry
Depreciation of asset - Dr
Acc depreciation of asset - Cr
(balance day adjustment)
Fifth journal entry
Profit and Loss - Dr
Depreciation of machinery - Cr
Asset expense - Cr
(Closing entry)
