Ibrahim Sameer (MBA - Specialized in Finance, B.Com Specialized in Accounting & Marketing)

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1 Ibrahim Sameer (MBA - Specialized in Finance, B.Com Specialized in Accounting & Marketing)

2 Introduction Capital expenditure often represents a significant investment by a company.

3 What is Capital Expenditure? Capital expenditure results in the acquisition of non current assets or an improvement in their earning capacity. Revenue expenditure which is incurred for the purpose of the trade of the business or to maintain the existing earning capacity of non current asset.

4 Non Current Asset A non current asset is an asset which is acquired and retained in the business with a view to earning profits and not merely turning into cash. It is normally used over more than one accounting period. Eg: motor vehicle (except for motor trade), plant and machinery, fixture and fitting, land and building.

5 Capital & Revenue Expenditure Capital expenditure is not charged as an expense in the income statement of a business enterprise, although a depreciation charge will usually be made to write off the capital expenditure gradually over time. Depreciation charges are expenses in the income statement.

6 Capital & Revenue Expenditure Revenue expenditure is charged to the income statement of a period, provided that it relates to the trading activity and sales of that particular period.

7 Capital & Revenue Expenditure Suppose that a business purchases building for $30,000. It then adds an extension to the building at a cost of $10,000. The building needs to have a few broken windows mended, its floors polished and some missing roof tiles replaced. These cleaning and maintenance job cost $900.

8 Capital & Revenue Expenditure The original purchase ($30,000) and the cost of the extension ($10,000) are capital expenditures, because they are incurred to acquire and then improve a noncurrent assets. The other costs of $900 are revenue expenditure, because these merely maintain the building and thus the earning capacity of the building.

9 Preparing Capital Expenditure Budgets Recurring and minor non-current asset purchases may be covered by an annual allowance provided for in the capital expenditure budget. Major projects will need to be considered individually and will need to fully appraised.

10 Relevant costs are future incremental cash flow. Avoidable costs, differential costs and opportunity costs are all relevant costs. Non relevant costs include sunk costs, committed costs and notional (imputed) costs. Directly attributable fixed costs are relevant costs, general fixed overheads are not.

11 Avoidable cost Avoidable cost are cost which would not be incurred if the activity to which they relate did not exist.

12 Differential cost Differential cost is the difference in relevant cost between alternatives.

13 The term differential cost is used to compare the differences in cost between two alternative course of action. For eg: if option A will cost an extra $300 and option B will cost an extra $360 the differential cost is $30.

14 Opportunity cost Opportunity cost is the benefit which has been given up, by choosing one option instead of another.

15 Suppose for example that there are three mutually exclusive option, A, B & C. The N/P from each would be $80, $100 $70 respectively. Since only one option can be selected option B would be chose because it offer biggest benefit.

16 Non Relevant cost A number of terms are used to describe costs that are irrelevant for decision making.

17 Sunk cost A sunk cost is a cost which has already been incurred and hence should not be taken account of in decision making.

18 For eg: if the non-current asset has been purchased, depreciation may be charged for several years but the cost is sunk cost, about which nothing can now be done.

19 Committed Cost A committed cost is a future cash outflow that will be incurred anyway, whatever decision is taken now about alternative opportunities. Eg: committed costs may exist because of contracts already entered into by the organization, which it cannot get out of.

20 Notional Cost A notional cost is a hypothetical accounting cost to reflect the use of a benefit for which no actual cash expenses is incurred. Eg: notional rent, such as that charged to a subsidiary, cost centre or profit centre of an organization for the use of accommodation which the organization owns.

21 Q & A

Ibrahim Sameer (MBA - Specialized in Finance, B.Com Specialized in Accounting & Marketing)

Ibrahim Sameer (MBA - Specialized in Finance, B.Com Specialized in Accounting & Marketing) Responsibility A responsibility centre is a function or department of an organization that is headed by a manager