Answer to Question #157949 in Financial Math for M Junaid Saleem

Question

Question no 1

HnH Solutions acquired a machine by making the following payments:

Net cash price Rs. 116,000 including 16% Sales tax; Carriage in Rs. 6,000; Insurance in transit Rs. 5,000; Fire insurance for the next 4 years Rs. 8,000; Installation charges Rs. 20,000; Overhauling Charges (Before Use); Charges to repair the damage caused during installation Rs. 2,000.

REQUIRED:

1)     Classify the above payments into capital expenditures and revenue expenditures.

2)     Give and entry to record acquisition of machine, and another entry to record expenditures by Debiting General Expenses Account.

Answer 1

All the expenditures incurred to bring the machinery into working condition up to the time of put to use is treated as capital expenditures and are capitalized along with the cost of machinery.

All the expenditures, that are incurred after the machinery is put to use is treated as revenue expenditure, if it does not increase the efficiency of the machinery.

Based on the above statements, the expenditure incurred above is classified as follows :

Capital expenditure :

1) Net cash price Rs. 116,000 including 16% Sales tax

2) Carriage incurred Rs. 6,000

3) Insurance in transit Rs. 5,000

4) Installation charges Rs. 20,000

5) Overhauling Charges (Before Use)

6) Charges to repair the damage caused during installation Rs. 2,000.

Revenue Expenditure :

Fire insurance for the next 4 years Rs. 8,000 - Will be amortized over the 4 years time - Rs.2000 per year.

Journal entry :

Machinery a/c Dr Rs. 149,000

To Bank 149,000

(Being the capital expenditure on acquisition of machinery capitalised)

General expenses Rs.2,000

To cash Rs.2,000

(Being the fire insurance for the year 1, expenses off)    

Note : The amount for overhaul expenses is not given in the question, hence the same is not added in Rs.149,000. However as per the requirement stated, it will be classified as capital expenditure.