CAPITAL Financing

Capital Financing
• The relationship between capital expenditure and
method by which it is financed is the crux of capital
financing. This is double accounting system.
• Double accounting is a process whereby capital
transactions are separated from all types of
transactions. Such capital transactions are apart
from the initial recording of the purchase of the
fixed asset also record the way in which the asset
was financed.
 CAPITAL FINANCING
• Students should always know the difference
between the double entry accounting system
and the double accounting system.
• There is need to show how assets which have
not been written off have been financed.
 Ways of financing capital expenditure
• External loans or advances from consolidated
loans fund or individual specific funds.
- The majority of capital schemes in municipal
councils are financed from borrowed money.
- Loans may be repayable in equal annual
installments or installments calculated by the
annuity method or on maturity of the loan.
 Ways of financing capital expenditure

• Advances from a Capital Development Fund

Local authorities in Zimbabwe are required by
statute to establish Capital Development
Funds. The funds may be financed from the
sale of assets and subject to limitations from
annual surplus of the General Fund or revenue
contributions.
Ways of financing capital expenditure
Advances may be made from the Capital
Development Fund to finance capital projects and in
the majority of cases these advances are repayable
to the fund over a period of years. Interest is charged
on the advances and also accrues to the fund.
The loan repayments and interest paid on the
outstanding loans are called capital charges and they
constitute an expenditure item to the relevant
income expenditure account of the asset financed by
that loan.
 Ways of financing capital expenditure

The sources discussed above require

repayments and therefore represent a liability.
The following do not;
• Revenue contributions
• Grants
• Reserve funds
• Gifts, gratuities
 Ways of financing capital expenditure

• The total of these sources of finance, together

with the total of loans redeemed and
advances repaid in respect of assets not
written off represent the total of capital
discharged.
 Basic Bookkeeping entries
• Financing capital expenditure from loan.
For the purposes of this example it is assumed
that the capital expenditure is financed from a
loan specifically earmarked for the purpose.
Example
Assuming that a loan is raised for $50 000,
repayable by annual installments over 20 years,
the entries are to debit the cash account
 Basic Bookkeeping entries
And to credit a loans outstanding account
Journal entries;
Debit: Cash account $50 000
Credit: Loans outstanding account $50 000
Being loan raised to finance expenditure on
project.
 Basic Bookkeeping entries
Each year in terms of the loan, a repayment of
$2 500 is made to the lender which reduces
the liability ($50 000 divided by 20 =$2 500)
The journal entries on repayment;
Debit :Loans outstanding account $2 500
Credit : Cash account $2 500
Being annual repayment of loan.
 Basic Bookkeeping entries
• The transactions shows the reduction of the outstanding
liability by the repayment of cash. It does not deal with
the provision of funds to make this repayment
• The next part of the transaction therefore is to find this
repayment out of revenue for revenue cash has been paid
out to reduce the loan. Consequently the revenue
accounts must be debited with the repayments and a
corresponding credit must show that the revenue charge
has been used to repay a capital loan. The account
credited is therefore termed “Capital discharged – loans
repaid account”
 Basic Bookkeeping entries
• Debit :Revenue account $2 500
Credit : Capital Discharged
– loans repaid account $2 500
Being charge to revenue for repayment of loan
 Basic Bookkeeping entries
• On the assumption that all the $50 000 was
spent on capital assets, the capital entries in
the statement form financial position form
would now be
• Loans outstanding $47 500
Capital discharged – loans repaid $2 500
$50 000
 Basic Bookkeeping entries
• Capital Outlay $50 000
$50 000
 Basic Bookkeeping entries
• This shows that the loan outstanding is now less
than the original cost of the assets to the extent
that repayments have been made.
• The two fold nature of the transactions must be
stressed, which we are calling double
accounting.
• If no charge has been made to the revenue
account for the repayment, no funds would
have been available to meet the repayment.
 Basic Bookkeeping entries
• At the end of the 20 year loan period, the loan
will be repaid and the Capital Discharged-
Loans repaid account will be $50 000 equalling
the original cost of the asset.
Financing Capital Expenditure from Revenue

• Most authorities finance a proportion of

capital expenditure direct from revenue. It
differs from financing from loan for obvious
reasons. In that the whole of the expenditure
is met from revenue in the year in which it is
incurred, instead of over a period. This source
of financing is called revenue contributions.
Financing Capital Expenditure from Revenue

• Projects are sometimes financed from a combination of

sources. For example, it is common for local authorities
to finance small overspendings on projects from
revenue.
• Example 1
Assuming a project for $1000 to be financed from
revenue, the journal entry would be to Debit the
revenue account to show that capital expenditure of
$1000 had been discharged by a contribution from
revenue account the account would therefore be termed
Financing Capital Expenditure from Revenue

• Termed “Capital discharged – Revenue

Contributions to Capital outlay”
Debit Revenue Account $1000
Capital Discharged Revenue
Contributions to capital outlay $1000
Being contribution in respect of capital project
Financing Capital Expenditure from Revenue
• After the project has been completed the
account in the balance sheet form would be
simply;
Capital Discharged – Revenue
Contribution to capital outlay $1000

Capital outlay $1000

 Financing of overspending
• The treatment in respect of financing from the
revenue of the overspending on a project partly
financed from loans follows the same procedure.
• If we assume that there was $3000 overspending
in respect of the project estimated to cost $50
000 in the loan example, the journal entry would
be similar to the above example and the balance
sheet at the end of the first year of the project
would show;
 Financing of overspending
• Loans outstanding $47500
Capital Discharged:
Loans repaid $2500
RCCO $3000 $5500
$53000

Capital Outlay $53000

FINANCING CAPITAL EXPENDITURE FROM RESERVES AND RENEWALS
FUNDS

• Reserves and renewals funds may be financed

by contributions from revenue, investment
income, or miscellaneous receipts.
• As funds they stand apart from the revenue
and capital accounts of the local authority.
• A normal use of a renewals fund would be for
a trading undertaking to make provision for
the replacement of assets, which occur at
irregular intervals by regular by annual
contributions
• The main difference therefore between
financing capital expenditure direct from
revenue as distinct from financing it from a
reserve or renewals fund is that the making of
the contributions from revenue is not directly
related to the use of the money to meet the
expenditure.
 Example
• Assume that a liquor undertaking has a plant
and vehicles renewals fund with a balance of
$50 000 and annual contributions from
revenue of $10 000 and that expenditure to
be met from the fund during the year will be
$8 000.
Prepare the relevant journal entries
 Journal entries
• Debit Revenue account $10 000
Credit Renewals fund $10 000
Being annual contributions

Debit Cash assets Liquor undertakings $10000

Credit Cash account $10000
 Journal entries
• Debit Renewals fund $8000
Credit Capital Discharged- $8000
Renewals fund contribution
Being contribution to meet cost of plant and
vehicles

*** What would be that balance of the renewals

fund
 Financing Capital Expenditure from capital
development fund
• If capital expenditure is financed from the capital
development fund without an obligation to make
repayment to the fund then the transactions are
similar to those for the Renewals or Reserve
funds. The Capital discharged will of course
relate to Capital Development funds applied.
Where an obligation to repay the fund does exist,
the transactions are similar to those in respect
of loan finance.
 Financing Capital Expenditure from capital
development fund
• In the borrowing account an advance from
capital development fund account is opened
to record the indebtedness to the fund.
Example
A project for $30000 is financed by an advance
from Capital Development Fund
Debit cash $30000
Credit Advances from CDF $30000
 General illustration
• The general fund Statement of Financial
position of a local authority showed the
following balances as at 31 December

$
Loans outstanding 1 040 000
Advances from CDF 60 000
Loans repaid 320 000
 General illustration
• RCCO 85000
Capital receipts unapplied 5000
Capital Outlay 1000000
Other long term outlay 500000
Cash 10000

These transactions took place the following year

 General illustration
(a) A capital receipt of $10 000 was received.
(b) Capital expenditure during the year was
Capital outlay $180 000
Other long term outlay $130 000
© Capital expenditure includes expenditure on
projects totaling $17000 met by revenue
contributions.
(d) Loans raised amounted to $280 000
(e) Loans repaid amounted to $ 80 000
(f) Repayment of Advances from CDF $5000
(g) Capital receipts totaling $12 000 were used
to finance a capital outlay project.
 Journal entries
• (a) Debit Cash $10 000
Credit Capital receipts unapplied $10 000
Being capital receipts received
(b) Debit Capital Outlay $180 000
Credit Creditors $180 000
Debit OLTO $130 000
Credit Creditors $130 000
• Debit creditors $310 000
Credit Cash $310 000
© Debit revenue $17 000
Credit capital discharged RCCO $17 000

Debit capital Outlay $17 000

Credit Cash $17 000
(d) Debit cash $280 000
Credit Loans outstanding $280 000
Debit Loans outstanding $80 000
Credit cash $80 000
Debit Revenue $80 000
Credit Capital discharged Loans repaid $80000
(e) Debit advances from the CDF $5000
Credit cash $5000
Debit Revenue 5000
Credit capital discharged adva.cdf repaid 5000
Debit capital receipts unapplied 12000
Credit capital receipts unapplied 12000
 Extract statement of financial position
Capital Outlay $1 180 000
Other Long Term outlay $630 000 1810 000
Cash 7 000
Totals 1 817 000

Loans outstanding $1 240 000

Advances from CDF $55 000 $ 1 295 000
Capital discharged:
Loans repaid $400 000
Revenue contributions $102 000
Capital receipts applied $12 000
CDF advances repaid $5 000 $519000
Capital receipts unapplied $3 000
Totals 1 817 000
 Writing off capital expenditure
• Assets are written off from the books when they
cease to exist. They are sold or scrapped.
• We obviously have to credit the asset account of the
asset which have ceased to exist.
• The amount will be the cost of the asset classified as
Capital Outlay or Other long term outlay. Generally
the asset account will show how the asset was
financed. If no liability exists, then the corresponding
amount of the asset will be shown in a capital
discharged account.
 Writing off capital expenditure
• Generally a separate Capital discharged
account is maintained for each source of
finance; loans repaid, RCCO, Capital receipts
applied etc and if an asset was originally
financed in several ways then several accounts
will need to be debited.
Example- No loan debt outstanding
In the example of a project costing
$53000.$50000 was financed from aloan
repayable over 20 years and $3000 from
revenue contributions. If the asset is scrapped
after the loan has been entirely repaid, the
entries to write off the asset would be as
follows;
Debit Capital Discharged loans repaid $50 000
Debit Capital Discharged RCCO $3 000
Credit Capital Expenditure $53 000
Being write off of asset scrapped
If the asset is sold after 20 years and not scrapped,
the transaction is exactly the same. However the
proceeds from the sale would require a separate
bookkeeping transaction. Assuming $2000 was
received, the receipt would be recorded as
follows;
Dr cash $2000
Capital Development Fund $2000
Being income on sale of asset.
 Example – Loan Debt outstanding
• In the first example there was no loan debt
outstanding and the Capital Discharged account,
which was written off by a debit entry, existed to
reflect how the asset was financed.
• If however there is a loan outstanding in respect of
an asset which is to be written off by a credit entry,
the loan account cannot obviously be written off by
a corresponding debit entry. It is a liability which
exist irrespective of what happens to the asset.
• When the asset is disposed of, the account
must reflect that the debt remaining is in the
nature of a deferred charge.
• Deferred charge- include the balance of
undischarged capital on an asset, which has
been disposed of.
• A deferred charge account must therefore be
debited with the amount of the loan
outstanding.
 Illustration
• Assume that a capital asset costing $10 000
financed from loan of which $2 000 is
outstanding is scrapped.
• The account in statement of financial position
form before the asset is scrapped would be;
Capital Outlay $10 000
Loans outstanding $2 000
Capital discharged
Loans repaid $8 000
10 000
When scrapped the journal entries would be ;
Dr Capital Discharged – Loans repaid 8 000
Dr Deferred charges 2 000
Cr Capital Asset $10 000
Being write off of a capital asset scrapped and
raising of deferred charge in respect of
outstanding loan
The statement of financial position extract
would be as follows;
Loans outstanding $2 000

Deferred charge $2000

Example 3
Loan outstanding of asset
Capital receipt exceed cost
In this example an asset costing $4 000 is sold
$5000. A Loan of $2000 is outstanding at the
time of the sale.
Debit Cash $5000
Credit Capital Development Fund $5 000.
Dr Capital Discharged – Loans repaid $2000
Dr deferred charge account $2000
Cr capital asset $4000
Being write off of capital assets sold and raising
of deferred charge in respect of outstanding
loan
 Writing off deferred charge
Review the following;
Loans outstanding $2000

Deferred charges $2000

As loan repayments are made the procedure is
to debit the revenue account the repayment
and to credit the Deferred charges account to
reduce the balance.
Dr. Loans outstanding account $100
Credit Cash $100
Being installment of loan repaid in the year.
Debit revenue account $100
Cr Deferred charges account $100
Being provision for repayment of an installment
of loan on a deferred charge.
The statement of financial position will be as
follows;
Loans outstanding $1 900

Deferred charges $1 900