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CMA Foundation · Fundamentals of Financial and Cost Accounting · Capital and Revenue Transactions

Iyer Pharma incurred Rs 90,000 on legal fees for defending a case about the title of its factory land and Rs 30,000 on legal fees for recovering overdue amounts from customers. Further, it spent Rs 15,000 on legal fees for drafting a routine sales agreement. Assuming the land title defence is needed to protect ownership of the asset, what is the total amount to be charged to the Profit and Loss Account, and what is capitalised?

Rs 45,000 is charged to the Profit and Loss Account and Rs 90,000 is capitalised. Legal costs of defending title to land are capital, while debt-recovery fees of Rs 30,000 and routine agreement drafting of Rs 15,000 are revenue expenses of the trading activity.

  1. ACharged Rs 1,35,000; capitalised nil
  2. BCharged Rs 45,000; capitalised Rs 90,000Correct
  3. CCharged Rs 30,000; capitalised Rs 1,05,000
  4. DCharged Rs 90,000; capitalised Rs 45,000

Explanation

Legal costs of defending title to a capital asset are capitalised (Rs 90,000). Legal fees for debt recovery and routine sales agreements are revenue: 30,000 + 15,000 = Rs 45,000. Charging everything to profit ignores the capital nature of title defence, and the other options misclassify the routine agreement or the title costs.

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