What will be your views on the following issues/statements? (4 Marks each December 2005)
a) Mr. RJ Thapa, Chief Accountant booked the expenses of Rs.5,00,000/- incurred in structural modification in the construction of building of factory premises. He charged this expense in building repairs account.
Any subsequent expenditure on fixed assets, which increases future benefits arising from them beyond their previously assessed standards of performance amounts to capital expenditure and thus, must form part of the cost of the asset. The words “structural alteration” would generally signify that some significant changes have been taken place in the design of building to provide more strength to the building or expansion in the capacity of the building. Therefore, cost of Rs.5,00,000/- represents the cost of expansion or may increase the life span of premises, it is hence a capital expenditure, and an adjustment entry debiting building Account and crediting Building Repair Account should be made and depreciation should be provided accordingly.
b) M/s ABC Ltd. sold a plot of land at Rs. 15,00,000/- as the same is not required for use whose cost to the company is Rs.8,00,000/- resulting therea profit of Rs.7,00,000/- on this sale. M/s ABC Ltd. credited entire profit of Rs.7,00,000/- to the profit and Loss Account. The boards of directors are planning to propose a dividend out of profit made from this sale.
Profit of Rs.7,00,000/- on the sale of plot of land is a capital profit i.e. it represents the excess of sale value over the original cost of the asset. The question whether such a profit can be distributed as dividend has
been considered in legal cases viz. Lubbock v. The British Bank of South America Ltd. and foster v. the News Trinidad Lake Asphalte Co. Ltd. Based on the court Judgments, it is argued that capital profits can be distributed a company only if certain conditions are fulfilled. However,
As per ” Property, Plant and Equipment”, the gain or loss arising from the derecognition of an item of property, plant and equipment shall be included in the profit or loss when the item is derecognized.
Thus, all profits, which can properly be taken to the profit and loss account are distributable profits. Therefore, in the given case, the directors can declare dividend out of the above profit.
c) A company commenced production on Magh 1, 2061 after a construction period of 3 years. No profit and loss were drawn-up during the construction period. Now, the company proposes to capitalize all the expenditure incurred during that period. Just before the end of the construction period, some scrap was sold. The sale proceeds are proposed to be credited to miscellaneous income.
The entire expenditure cannot be capitalized. The expenditure should be properly analyzed and classified into capital, deferred revenue and revenue expenditure. The proceeds from sale of scrap may be deducted from the related expenditure or shown as miscellaneous income.