Treatment of Replacement of Assets - Electricity Companies, Advanced Corporate Accounting | Advanced Corporate Accounting - B Com PDF Download

Replacement of an asset under double entry system.

Under Single Account System, when a new asset is replaced in place of an old one, the old asset is written-off and the new one is capitalised.

But under Double Account System, the procedure is quite different. Under this method, there is no need to write-off loss when an asset is abandoned, i.e., depreciation is not charged to the asset account.

Instead, the amount is credited to Depreciation Reserve Account.

In other words, the asset will continue in the books at its book value (original cost). The value of the asset will increase as soon as extension or additions to the assets are made.

Therefore, allocation to the amount Spent is to be made between:

(i) Capital—the value of extension, and
(ii) Revenue — the actual current cost of replacement of the original asset.

The procedure is enumerated:

(i) The original cost of the asset will remain intact.
(ii) The estimated cost of replacement of the old asset is ascertained. At the same time, the estimated cost is reduced by the sale proceeds of old materials, if any, or by the value of materials reused in the new construction. The balance is charged to Revenue Account.
(iii) The difference between the total cost of the entire work and the estimated replacement cost of the old asset in original manner is charged to Capital Account, i.e., capitalised.

In addition to above, the additions and improvements are capitalised. Moreover, the auxiliary mains, subsidiary, subsidiary permanent ways, etc. are also to be capitalised. Improvement is the excess amount spent over the cost of replacement with asset of equal efficiency.

It may be mentioned, however, in this respect that current cost of the old assets may be determined either from the market or from the price index. That is, price index which is applicable to the type of asset with same efficiency after 20-30 years may be practically obsolete now. It may be applied simply to get the estimated current cost. If the asset is in the nature of Construction Works, separate indices have to be applied to different elements of cost. But if the estimate differs (between engineering data and price indices) the lesser amount may be capitalised just on the basis of conservatism.

Accounting Steps:

Illustration 1:

An electricity company laid down a main at a cost of Rs. 50,000. Some years later, the company laid down an auxiliary main for 1/5th of the length of the old main at a cost of Rs. 15,000. It also replaced the rest of the length of the old main at a cost of Rs. 60,000. The cost of materials and labour has gone up by 20%. Sale of old materials realised Rs. 800 only. Old materials valued at Rs. 1,000 were used in renewal and those valued at Rs. 500 were also used in the construction of the auxiliary main.

Show the entries.

Illustration 2:

Calcutta Electric Company Ltd. decides to replace its old plant with a modern one with a larger capacity. The plant was installed in 1940 at a cost of Rs. 40 lakhs. The components of materials, labour and overhead being in the ratio 5 : 3 : 2. It is ascertained that the costs of material and labour have gone up by 50% and 100%, respectively. The proportion of overheads to total costs is expected to remain the same as before.

The cost of the new plant as per improved design is Rs. 90 lakhs and in addition materials recovered from the old plant having value of Rs. 2,00,000 was used in the construction of the new plant. The old plant was scrapped and sold for Rs. 7,50,000.

The accounts of the company are maintained under Double Account System.

Show the entries in the books of Calcutta Electric Company.

Illustration 3:

The Oriental Gas Co. Ltd. incurred an expenditure of Rs. 23,10,000 to rebuild a part of their works. The relevant part of the old works had cost originally Rs. 9,00,000. The capacity of the new works is double the capacity of the old one. A sum of Rs. 1,80,000 is realised by the sale of old materials; and old materials of the value of Rs. 90,000 are further used in the construction of the new works. The cost of materials and labour has gone up by 30% and 20%, respectively, since the old works were built. The cost constitutes 3/5^th for materials and the balance for labour.

Show journal entries to record the above transactions.

Thus, according to the first one, improvement is Rs. 12,00,000 (i.e., Rs. 24,00,000 – Rs. 12,00,000). But under the second alternative, amount of improvement becomes Rs. 12,66,000 (i.e., Rs. 24,00,000 – Rs. 11,34,000). But it is better for us (i.e., to be of conservative point of view) to capitalise the smaller amount and greater amount should be charged by way of revenue one.

Illustration 4:

Wind Mill Ltd. supplying electricity maintains its accounts on double account basis. It incurred an expenditure of Rs. 25,00,000 to renovate its works. The relevant part of old works had cost Rs. 10,00,000. The capacity of new works will be double the capacity of old works. A sum of Rs. 5,00,000 is realised by the sale of old material. Old materials of the Value of Rs. 2,00,000 are used in the new works.

Cost escalation (since old works were built) is as follows:

Material 20%; Labour 25%

The cost constitutes 3/5th for materials and 2/5th labour.

Show:

(a) the amount of improvement to be capitalised
(b) the amount to be written-off to revenue; and
(c) Journal Entries to second the transactions.

Illustration 5:

An Electric Supply Co. rebuilds its Mains at the cost of Rs. 19,90,000. This includes value of Rs. 13,800 material old Main used for new one. The original Mains were constructed at a cost of Rs. 9,90,000. The ratio of material and labour there was 7 : 3. The increase in material prices is 12% and wage rates 15%. Materials worth Rs. 25,200 from old works were sold.

Show journal entries under Double Account System for the above and determine the net cost of replacement.