Unit -3

Revenue ,Capital Expenditure and Audit of a company Accounts

Q1) Define Revenue.

A1)

• Revenue expenditure means an expenditure from which no future benefit is expected.
• Eric Kohler has defined revenue expenditure as "an expenditure charged against operation, a term used to contrast with capital expenditure." Revenue expenditure, as opposed to capital expenditure, has no future benefits. The items of expenditure having immediate or short term benefits ( less than 1 year) are treated as revenue expenditure.

Examples –

1) Costs relating to the business activities during the accounting year are treated as revenue expenditure.

a) Cost of production.

b) Cost of administration.

c) Cost of selling and distribution.

d) Cost of finance.

2) Costs relating to the income earned during the accounting year are treated as revenue expenditure e.g. Interest paid on loans taken for investing in shares.

3) Costs whose benefits do not extend beyond the accounting year are treated as revenue expenditure e.g. Purchase of tools having useful life of 6 months.

4) Expenditure on repairs which maintains the standard of performance of an existing fixed asset (i.e. maintains the assets in working condition)

Q2) Give a short note on Capital Expenditure.

A2)

Capital expenditure means expenditure carrying probable future benefits.

Eric Kohler has defined capital expenditure as "an expenditure intended to benefit future periods; an addition to fixed assets.

Examples –

1) Acquisition of a fixed asset is the most common type of capital expenditure.

All expenses incurred on the assets till they are capable of yielding income are capital expenses.

Q3) What are the Different Types Of Reserves?

A3)

There are broadly three types of Reserves –Capital Reserves, Revenue Reserves ad Statutory Reserves.

Capital Reserve:

A capital reserve is taken out of the capital profit and is not shared as a dividend to the shareholder. This reserve cannot be created out of the profit earned from the core operation.

Few examples of capital reserves are:

1)     Cash received by selling current assets

2)     Premium earned on the issue of share and debentures

3)     Excess on revaluation of assets and liabilities

Revenue Reserve:

Revenue reserve is a portion of profit owned by the company and is kept aside for the use of other multiple purposes. This reserve is recorded in the profit and loss account and can be used the following way:

1)     Dividend to shareholder

2)     Expand the business

3)     Stabilise the dividend rate

In other words, Revenue reserves are portions of profits earned by a company’s normal operations which are then set aside.

Revenue reserves are divided into two types:

1)     General Reserve and

2)     Specific Reserve

Statutory Reserve:

Statutory Reserve is the amount of money, securities or assets that need to be set aside as a legal requirement by financial institutions to cover its claims or obligations which are due in the near future. This is a mandatory reserve.

It is a legal reserve that is required to be maintained in accordance with the standards that are set by the regulating body for the sector which may vary from country to country.

The primary aim for maintaining a statutory reserve is for the organization to meet its obligations promised to its customers even if it is running into losses.

Q4) Write the Methods Of Charging Depreciation?

A4)

Before understanding the methods, let us understand the meaning of Depreciation.

Depreciation means the reduction in the value of an asset due to its use, leading its wear and tear, or due to obsolescence or due to general market trend. The prescribed rules state that the amount of depreciation of a depreciable asset must be allocated in every accounting period throughout the life of the asset.

Depreciable assets are those assets that are used for the purpose of business which can be depreciated. That is, the value of the asset is considered as a business expense over the useful life of the asset. A company can depreciate most of the tangible assets like Building, Machinery, Vehicles, Furniture and Fixtures, Computers and Equipment and intangible assets like Patents, Copyrights and Computer Software.

Purposes of Providing Depreciation:

Types:

Depreciation is allowable as expense in Income Tax Act, 1961 on basis of block of assets on Written Down Value (WDV) method. Depreciation on Straight Line Method (SLM) is not allowed.

Companies Act prescribes two methods for calculating depreciation:

-         Straight Line Method (SLM) and

-         Written Down Value Method (WDV)

Straight Line Method (SLM):

Straight line basis is calculated by dividing the difference between an asset's cost and its expected salvage value by the number of years it is expected to be used.

In other words, to calculate depreciation on straight line basis, company take the purchase price of an asset and then subtract the salvage value, its estimated sell on value when it is no longer expected to be needed. The resulting figure is then divided by the total number of years the asset is expected to be useful, referred to as the useful life.

Symbolically, the formula is –

Depreciation on Straight Line Basis = Purchase Price of Asset - Salvage Value

Estimated Useful Life of Asset

Advantages and Disadvantages of Straight Line Basis:

-         Straight line basis is popular because it is easy to calculate.(ADVANTAGE)

-         Accountants like the straight line method because it is easy to use, renders fewer errors over the life of the asset, and expenses the same amount every accounting period.(ADVANTAGE)

-         One of the most obvious drawbacks of using this method is that the useful life calculation is based on guesswork.(DISADVANTAGE)

For example, there is always a risk that technological advancements could potentially render the asset obsolete earlier than expected.

Written Down Value Method (WDV):

Under this method, the depreciation is calculated at a certain fixed percentage each year on the decreasing book value commonly known as WDV of the asset

WDV is calculated as Book value less Depreciation.

It is also known as Reducing Balance or Reducing Instalment Method or Diminishing Balance Method.

Q5) What are the aspects of Verification And Valuation Of Assests?

A5)

• Under this method higher depreciation is charged in early years it takes into account that asset is more efficient in early years and therefore it is more realistic way of depreciation. (ADVANTAGE)
• The amount of annual depreciation reduces with the reducing balance of the asset.(ADVANTAGE)
• This method takes care of the obsolescence problem related to the assets as the major part of depreciation is charged in the earlier years. Due to this feature replacement of the assets before the end of its estimated useful life becomes easy and feasible.(ADVANTAGE)
• The value of asset will never be zero in books of account under this even if asset is of no use to company.(DISADVANTAGE)
• This method is not suitable for an asset having a very short life. The calculation of the rate of the depreciation becomes very difficult and creates problems in this case.(DISADVANTAGE)

Q6) What do you mean by Audit Of A Company Accounts?

A6)

• An Audit of Financial Statements is the examination of an organisation’s financial statements and the accompanying disclosures by an independent auditor. The Auditor submits his opinion to the concerned authorities in form of his Audit Report.
• The purpose of an audit of financial statements is to add trustworthiness and credibility to the reported financial position and performance of a business apart from the legal obligations.
• The Companies Act, 2013 requires that all entities that are publicly held, must file annual reports with it, after being audited with a qualified auditor.
• Also, different users of the financial statements requires them to be audited. For instance, Lenders require an audit of the financial statements of any entity to which they lend funds. Similarly, Suppliers may also require audited financial statements before they opt to extend trade credit.

Q7) What are the Duties of Audit Of A Company Accounts?

A7)

1)     Planning and risk assessment –

This involves gaining an understanding of the business and the business environment in which it operates.

2)     Internal controls testing –

Involves the assessment of Internal Control practised by the client regarding authorization for expenses, payments for fixed assets, credit sales authorization, segregation of duties, etc.

3)     Conduct of Substantive procedures –

Substantive procedure involves a broad range of procedures. Some of them are explained as under:

a)     Cash - Review of Bank Reconciliations, Cash in Hand, Confirming Bank Balances, etc.

b)    Accounts receivable (Bills Receivables) - Confirming Account Balances from balance confirmation certificates and investigating subsequent collections.

c)     Inventory- Observing the physical inventories, obtaining confirmation of inventories held at other locations, reviewing current production costs, etc.

d)    Revenue - Examiningdocuments supporting sales on random sampling basis, review of subsequent transactions, reviewing the history of sales returns and allowances.