In part one we started looking at the cycle of buying, owning and disposing of non-current assets.
We discussed IAS 1 and how the application of materiality allows organisations to tailor accounting policies to make them appropriate for individual business needs. We also looked at the Standard’s fundamental accounting concepts and set objectives, with which organisations must be compliant.
Here is the invoice for the machine LMO Ltd decided to buy at the end of its acquisition of non-current assets process:
The invoice shows us that not only did LMO purchase a new machine but that the purchase price was reduced by a part-exchange allowance of £1,500 as an old machine must have been sold to Clever Engineering Solutions in part exchange for the new one. We can also see that the supplier provided training on operating the new machine and cover against breakdowns.
There are a number of elements to the transaction that LMO has made so we’re going to look at each individually.
Capital or revenue?
As we are interested in the non-current asset cycle we first need to decide which items on the invoice are relevant to it, in other words, which are capital expenditure and which revenue.
Capital expenditure is defined as:
Expenditure on the purchase or improvement of non-current assets.
Revenue expenditure is defined as:
All other expenditure incurred by a business that is not capital expenditure.
Therefore, looking at the three items of expenditure on the invoice, the machine is capital expenditure and the training and breakdown cover are revenue. Simple, right? Unfortunately not, it would be correct if the training and breakdown cover were not related to the new machine and is in fact correct for the breakdown cover. But how can two items of revenue expenditure be treated differently?
The answer is contained within IAS 16 Property, Plant and Equipment, which says that any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management, can be capitalised. The key to identifying which items of revenue expenditure can be capitalised and which cannot, is applying the words ‘directly attributable costs’.
When we apply them to the training and breakdown cover, we can reason that the machine will not be operational unless someone is initially trained to use it, however, it will be perfectly functional regardless of whether breakdown cover is in place or not.*
We need to be really careful when analysing capital expenditure documents as often revenue expenditure is often made at the same time and therefore on the same invoice. The revenue cost must be identified and posted to the appropriate account(s) in the general ledger so that it will be written off at the end of the year on the statement of profit or loss (SoPL) and only the capital expenditure, and any other directly attributable costs, are included as the cost of the non-current asset.
Double-entry bookkeeping for acquisitions
Now let’s look at how we should record the cost of the new machine in our accounting records. We’ll assume that LMO Ltd is VAT registered.
The cost of the capital expenditure is £9,810, the net value of the machine and the training:
The revenue expenditure is £200 for the breakdown cover:
The VAT is recoverable:
This gives us £11,712 worth of debits but the total amount due to the supplier is £10,212:
As they stand the postings do not fulfil the accounting concept of duality because the total debits do not match the total credits. This is because an old asset has been sold in the same transaction as a new one being bought and the resultant part-exchange allowance has reduced the amount owed to the supplier. In reality a part-exchange allowance is both the sales proceeds from the disposal of an asset as well as part of the value of a new asset.
As the total value/cost of the new asset has already been debited to the machinery at cost account, the acquisition function of the part-exchange allowance has already been fulfilled. Therefore, the disposal function needs to be completed and this means posting £1,500 to the disposal account:
Now the total debits match the total credits and the invoice has been processed correctly.
Recording capital expenditure in the non-current asset register
Now we have entered all the postings from the invoice into the accounting records we also need to record the acquisition of the machine in the non-current asset register. It is important to note that the register is not part of the double entry system but is used by businesses to organise key information about non-current assets and keep it all in one place.
Below is an extract from LMO Ltd’s non-current asset register:
We already have a lot of the information we need in order to add the new acquisition. The date and machine details are on the invoice, the cost is the full amount of the capital expenditure we posted to the machinery at cost account and the funding method is cash, as there is nothing to indicate that payment will be paid in any other way, than in line with the terms on the invoice.
In the final part of this series we will focus on the middle of the non-current asset cycle by looking at what accounting treatment will be applied to the new machine with regards to depreciation. We will also consider what needs to happen to complete the process for disposing of the old machine that has been part-exchanged.
* Please note that subsequent or wider staff training is not capital expenditure – only the initial training.
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.