Reinvesting income in assets

Gary1089

Good afternoon,

I hope everyone is well.

I have a tendency to consider hypotheticals long before I will ever need to use them but here goes; how would you treat non-current assets purchased directly from revenue income within the accounting system? Would it be necessary to take the money out of the business in the form of drawings/dividends, reintroduce as capital and then make a capital purchase? Or is it possible to treat this as profit not removed from the company and transfer the money to the capital account then to equipment at cost?

Sorry to head off at a slight tangent but when deciding whether an item of equipment should be capitalised, would you look solely at how long the item is likely to be used in a business or is there an approved/widely used ‘cut-off’ value below which it isn’t really worthwhile capitalising (e.g. I have a printer which cost £100 and will probably be used for 3 years, as the value is fairly low I can claim this as a sundry/office expense)?

Thank you in advance for your help!
Gary

Pian32

Hi Gary

I'm assuming in the 1st part that the person never sees the revenue in the bank or on a customer ledger. In which case it'd be a journal between the Revenue (credit) and the appropiate non-current asset (debit). This means the revenue would still be accounted for and you get the appropiate amount in the NC assets. If it was in a debtors ledger then the journal would be against that.

The second part is a bit harder the captilising amount depends on the company and the materiality. If the company you are looking at only makes about £10k then £100 is much more significant than if the company makes £1 million. It has to be discussed and agreed with the client.

Hope this helps.

Gary1089

Thank you very much for your help. In creating this journal entry I assume the revenue figure for the year remains unchanged and it would instead simply be: credit the bank, debit the non-current asset cost account?

With regards to capitalising assets, should a client wish to set a cut off point which we may consider significant, would you ever be inclined to advise them against that or continue working for them with their adopted policies? Part of the reason that this hypothetical came to mind is that I have a friend who has recently started up as a tree surgeon (private limited company) and their plan is to reinvest the first year’s revenue into various items of equipment; few I would imagine would cost large amounts of money (likely average purchase I would assume to be in the region of £100-200). If they were to do this would it be in breach of any laws or standards to record these all as a one off expense, effectively offsetting tax in the first year? On the assumption that moving forward there won’t be any depreciation charges for these assets in subsequent years.

Thanks again.
Gary

Pian32

If they are investing what has already been paid then it would just be added directly from the bank to the non-current asset account when it's bought. In the example above from what you said I'd assumed they had never seen the revenue that was invested.

It would depend on the business. You will have come across the concept of materiality if an asset is going to be used over multiple years and is a significant amount to the business then it wants to be capitalised to give the most realistic position of the business. In this case you could advise capitalsing the items especially if significant. It might be there are reasons for not doing so which would be worth asking about.

Anything not capitalized effectively becomes an expense which reduces the profit, if the amount is large it would distort the figures in the accounts. By capitalizing the assets are accounted for over mulitple years and effectively smooths out the purchase.

Depreciation doesn't alter tax as it is added back onto the P/L before tax is calculated. If it was an expense it would either be reducing corporation tax or income tax (sole trade + partnership) by reducing the profit. If capitalized then the tax is reduced through capital allowances instead, this has a set of rules which would effectively reduce the tax liability for the year by a set amount per year based on the type of asset.

I'm not 100% on the law so wouldn't want to comment incorrectly on this.

Gary1089

Thank you very much, you’ve been a great help!