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Item5

Item 5 5 points

Exercise 8-16A Distinguishing between revenue expenditures and capital expenditures LO 8-8

Bill’s Wrecker Service has just completed a minor repair on a tow truck. The repair cost was $1,070, and the book value prior to the repair was $5,320. In addition, the company spent $6,500 to replace the roof on a building. The new roof extended the life of the building by five years. Prior to the roof replacement, the general ledger reflected the Building account at $86,300 and related Accumulated Depreciation account at $40,900.

Required
After the work was completed, what book value should appear on the balance sheet for the tow truck and the building?

Answer 1

Capital expenditure means the cost incurred on acquisition of an asset or any subsequent expenditure that has the effect of increasing the productivity of an existing fixed asset. However revenue expenditures are incurred to maintain rather than improve the productivity of the fixed asset. The benefits of capital expenditures can be reaped by the business entity for more than one accounting period and hence the frequency of capital expenditures is less compared to revenue expenditures. However, the benefits of revenue expenditure is available for one accounting period or less and the frequency of such expenditure is high as compared to capital expenditure. Capital expenditures are capitalized, i.e, they are added to the value of the fixed asset thereby increasing the value of the fixed asset while revenue expenditures are charged to the income statement as expenses relating to that period in which they were incurred.

In light of the above concepts, the expenditure incurred on minor repair of a tow truck shall be treated as a revenue expenditure as it does not increase the productivity of the tow truck and is rather aimed at "maintaining" it. Therefore the repair cost of $1070 will be charged to income statement as an expense and thereby has no effect on the value of the tow truck which will continue to remain at $5320.

The expenditure incurred to replace the roof on a building amounting to $6500 has increased the life of the building by five years. Since this expenditure results in an increase in the productive life of the building it should be treated as a capital expenditure. Therefore $6500 should be capitalized and added to the value of the building(as before such expenditure was made). The new value of the building will be $92800 (86300+6500). From now on, depreciation will be charged on this value. The net value of the building will be $51900 (92800-40900), right after the expenditure is incurred.