Capital, Revenue and Depreciation in a Haulage Business
Kofi Adeyemi runs a haulage business. At 1 January 2024 his motor vehicles account showed cost of ₦12,000,000 and accumulated depreciation of ₦4,800,000. Depreciation is 20% per annum straight line with no residual value; a full year is charged in the year of acquisition and none in the year of disposal. On 1 April 2024 he bought a vehicle for ₦3,600,000, paid ₦180,000 to have the company name and logo painted on it, and paid ₦90,000 for twelve months' insurance from that date. His accountant debited all ₦3,870,000 to motor vehicles. On 30 September 2024 a vehicle that had cost ₦2,000,000 and had accumulated depreciation of ₦1,200,000 at 1 January 2024 was sold for ₦850,000; the proceeds were credited to sales revenue. The draft accounts show gross profit of ₦5,400,000, depreciation of ₦2,400,000 and no profit or loss on disposal.
1. Compute the corrected depreciation charge for 2024 and the carrying amount of motor vehicles at 31 December 2024.
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Cost of the fleet
| ₦ | |
|---|---|
| Cost at 1 January 2024 | 12,000,000 |
| Add: vehicle purchased | 3,600,000 |
| Add: logo painting (capital - it is part of the asset's cost) | 180,000 |
| Less: vehicle disposed of | (2,000,000) |
| Cost at 31 December 2024 | 13,780,000 |
Insurance of ₦90,000 is excluded: it is a running expense, not part of the asset's cost.
Depreciation charge
| Asset group | Cost ₦ | Rate | Charge ₦ |
|---|---|---|---|
| Original fleet retained (12,000,000 − 2,000,000) | 10,000,000 | 20% | 2,000,000 |
| Vehicle bought 1 April (3,600,000 + 180,000) | 3,780,000 | 20% (full year) | 756,000 |
| Disposed vehicle | - | nil in year of disposal | - |
| Total | 2,756,000 |
Carrying amount
Accumulated depreciation: 4,800,000 − 1,200,000 (removed on disposal) + 2,756,000 = 6,356,000. Carrying amount = 13,780,000 − 6,356,000 = ₦7,424,000.
The draft figure of ₦2,400,000 is simply 20% of the opening cost; it ignores both the addition and the disposal and is understated by ₦356,000.
2. Compute the profit or loss on disposal and restate gross profit.
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| ₦ | |
|---|---|
| Proceeds | 850,000 |
| Cost | 2,000,000 |
| Less accumulated depreciation to date of disposal | (1,200,000) |
| Carrying amount | (800,000) |
| Profit on disposal | 50,000 |
No depreciation is charged on the vehicle in 2024 under the stated policy, so the ₦1,200,000 brought forward is the full accumulated depreciation.
Restated gross profit: the ₦850,000 was credited to sales revenue, so revenue is overstated by ₦850,000 with no matching cost of sale. Gross profit = 5,400,000 − 850,000 = ₦4,550,000. The ₦50,000 profit on disposal is presented separately and is not part of gross profit.
Effect on profit for the year: −850,000 (remove proceeds from revenue) + 50,000 (record disposal profit) − 356,000 (extra depreciation) − 67,500 (insurance expense for 1 April to 31 December, currently sitting in motor vehicles) = net reduction of ₦1,223,500. The remaining ₦22,500 of insurance is a prepayment at 31 December 2024.
3. Justify treating the ₦180,000 logo painting as capital expenditure while treating the ₦90,000 insurance as revenue expenditure.
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The test is whether the spend becomes part of the asset that will generate benefits over several periods, or is consumed in running the business.
The logo painting is capital: it is applied to the vehicle itself, it is not deductible in computing taxable profit in the same way as a running cost, and it will remain on the vehicle for years, helping to win contracts. It is directly attributable to bringing the asset into the condition and use intended, so it is added to cost and depreciated with the vehicle. Note the practical consequence: capitalising it increases the annual depreciation charge by ₦36,000 (20% of ₦180,000).
The insurance is revenue: it buys twelve months of cover, it is consumed month by month, it does not enhance the vehicle's capacity, and if the vehicle were sold the cover would simply lapse or transfer. Only the portion relating to 2024 (₦67,500) is an expense; the rest is a prepayment.
Judgement traps: a repair that restores the asset to its previous condition is revenue, but a replacement that upgrades or extends useful life is capital; and the fact that a payment is large or is paid at the same time as the purchase does not make it capital. Misclassifying the insurance would overstate both profit and non-current assets by ₦90,000 and would never be corrected while the vehicle is held.