Term 1 Theory 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. It is depreciated. For example, Purchase Price and installation costs.
Whereas Revenue Expenditure is any cost relating to a non-current asset that is incurred to maintain, but not to extend, the useful life of the asset. It is not depreciated. For example insurance and repairs.
How is Capital Expenditure accounted for in the accounting reports of a business?
As an asset, Capital Expenditure is recorded on the Balance Sheet.
How is Revenue Expenditure accounted for in the accounting reports of a business?
As an expense, Revenue Expenditure is recorded on the Income Statement
Define the terms depreciation and amortization and explain the difference
Depreciation is the allocation of the cost of an asset to the accounting periods in which it is expected the asset will contribute to the earning of revenue. Usually used in relation to physical assets, such as furniture.
Whereas amortization, refers to the gradual writing off of the costs of certain assets through the passing of time or depletion. Usually used in relation to intangible assets, such as patents
List the different methods of calculating depreciation and their associated formulas
Straight Line
Annual Depreciation = (Original Cost -Residual Value)/(Useful Life)
Diminishing Balance
Annual Depreciation = Rate of Depreciation x Diminished Value of Asset
Explain why depreciation is taken into consideration within the accounting system. (Hint: Two accounting concepts – Historical Cost Assumption and Matching Principle)
Depreciation is taken into consideration within the accounting system, because over time some non-current assets decrease in value, due to: wear and tear, obsolescence or depletion.
The historical cost assumption and the matching principle are two significant concepts that relate to non-current assets.
The historical cost Assumption states that non-currents assets are recorded in the financial records of an enterprise at their original cost. However, the historical cost of some non-current assets decrease overtime, as their service potential or future economic benefits decrease. Therefore, historical cost of the non-current asset as recorded in the Balance Sheet may prove misleading.
The Matching Principle, matches the cost of an asset to the periods in which the asset contributes to the earning of revenue. Depreciation is created as the expense incurred to be matched against the revenues earned by the business.
Therefore, the depreciation expense is created to allow for this allocation of cost and resolve the two accounting concepts.
State the factors that need to be know to calculate the annual depreciation expense of an asset
Orginal Cost of the Asset
Useful Life of the Asset
Residual Value
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 costs of an asset as being constant over the life of the asset. This applies to assets that have low obsolescence. E.g Buildings and Furniture.
Alternatively, Diminishing Depreciation is the allocation of the cost of an asset using the diminishing balance, resulting in a decreased depreciation expense over time. It is used for assets that give most of their service potential in their early life. E.g Machinery and Equipment.
1) Depreciation is taken into consideration within the accounting system because…………………………………..
Depreciation is taken into consideration within the accounting system, because over time some non-current assets decrease in value, due to: wear and tear, obsolescence or depletion
2) The historical cost and matching principle are…………..
The historical cost assumption and matching principle are two significant concepts that relate to non-current assets
3) The Historical Cost Assumption states…….
The historical cost assumption states that non-current assets are to be recorded in the financial records of an enterprise at their original cost. However the historical cost of some non-current assets decrease over time, as their service potential or future economic benefits decrease. Therefore, the historical cost of the non-current asset as recorded in the Balance Sheet may prove misleading
4) The Matching Principle, matches…..
The Matching Principle, matches the cost of an asset to the periods in which the asset contributes to the earning of revenue. Depreciation is created as the expense incurred to be matched against the revenues earned by the business.
5) Therefore, the depreciating expense……………..
Therefore, the depreciating expense is created to allow for this allocation of cost and resolve the two accounting concepts.
