Capital Expenditure and Revenue Expenditure

Q. What do you mean by Capital Expenditure and Revenue Expenditure?

In fact every expense is expenditure, but each expenditure is not necessarily an expense. They are definitely not synonyms. Those business expenses, which affect directly the profits for the accounting period, are called Revenue Expenditure. Those which do not directly affect the profit, but the benefits of which result over longer periods of life of the business (say five to ten years) are called Capital Expenditure. The revenue expenditure or expense is shown in P & L A/c while the capital expenditure is shown in Balance Sheet.

Capital Expenditure

All expenditure incurred in acquiring fixed assets, or improving the existing ones by increasing its efficiency (e.g. by providing substitution, alteration or renovation), or effecting economy in operation of existing assets (e.g. by attaching power motor to hand driven machine) are called capital expenditure. These expenditures are intended to be permanently used in business and they increase the earning capacity of the enterprise. They mayor may not reduce the existing expenses. The following types of expenditures fall under this category:

1. Expenditure incurred on any tangible or intangible asset, which can be sold or converted into Cash in future.
2. Expenditure incurred on improving an existing asset so as to increase its earning capacity.
3. Expenditure incurred on a new asset to bring it to workable condition.
4. Expenditure for acquiring a capital asset.

Some examples:

1. Payment for Goodwill.
2. Cost of freehold Land & Building.
3. Cost of Leasehold Land.
4. Payment for acquiring Trademark, Patents, Copyright, Pattern & Design etc.
5. Plant and Machinery and Furniture purchased for the use in business.
6. Motor Car, Truck, etc. for the use in business.
7. Installation expenses of Plant & Machinery.
8. Expenses of Electric Fittings.
9. Addition to the value of present assets.
10. Expenditure on extension of mines and gardens.
11. Acquiring an asset and spending on its erection, etc.

It must be remembered that the benefits of the capital expenditure are spread over several years. Hence only a portion of these expenditure is included in the income statement of each year, Such an expenditure when incurred is called Capital outlay and the portion which is earmarked for a particular accounting period is called Depreciation. This depreciation goes to the Profit and Loss A/c (and is reduced from the total capital outlay), while the rest which is called cost residue is transferred to balance sheet. Since capital expenditure are transferred to balance sheet they are also called balance sheet expenditure.

Revenue Expenditure

They are all such expenses, which are incurred on the organisation and for running the business. The benefits of such expenses are limited to the accounting period only. They are incurred to maintain the earning capacity of the business, whereas capital expenditure are incurred to improving the earning capacity of the business. The following types of expenditures are usually called revenue expenditure.

1. Expenditure incurred on acquiring raw material and business goods.
2. Such expenditure whose advantage does not last for more than a year.
3. Expenditure incurred for the maintenance of an asset.
4. Expenses to run the business efficiently e.g. office expenses. Financial expenses, selling expenses, distribution expenses etc.

The list given under can be quoted as examples:

1. Cost of Raw material.
2. Goods purchased for re-sale.
3. Wages paid.
4. Administrative Expenses wages, salaries, insurance, rent and advertisement etc.
5. Repairs and upkeep of fixed assets.
6. Annual rent of Leasehold Land.
7. Loss due to fire
8. Distribution expenses.
9. Selling expenses.
10. Interest on Loans.
11. Depreciation, etc.

It must, however, be remembered that the examples as has been shown above are not universally accepted. These _e the heads of expenditures which by and large, are classified as such. But in actual practice, whether an item of expenditure is a capital or revenue expenditure will depend on its purpose and nature of the business concern. It may vary at different times also. For example, expenditure on plant and machinery is a capital expenditure, but for engineering concern it may be revenue expenditure, if the plant is meant for resale. Similar is the case of furniture. It is generally a capital expenditure, but it may be revenue expenditure for a dealer in furniture. Likewise some items, generally of revenue nature may have to be capitalized under certain situations. They may be considered as exceptions to the general rules. Some examples can be given as under:

Exceptions to the General Rules

1. Raw Materials: When raw material is used for the manufacture, of an asset it is treated as Capital expenditure.
2. Wages and Salaries: This is revenue expenditure. But when wages and salaries are spent for the construction of a building or for installation of a machine then it is treated as Capital expenditure.
3. Carriage and Freight: These are also revenue expenditures but Carriage and Freight paid for bringing the machine to the godown, then it is treated as Capital expenditure.
4. Repairs and Renewals: These are revenue expenditures but when an old machine is purchased and some amount is spent to bring it to a workable condition then it is called Capital expenditure.

Capital Expenditure vs Revenue Expenditure

1. Capital expenditure is the capital outlay on acquiring new assets, improving the existing ones, not with the intention of reselling them. Revenue expenditure is the routine types of recurring expenses, which are incurred for running the business. Besides, they include expenses for maintaining the upkeep of the existing assets.
2. Capital expenditure increases the earning capacity of the business, whereas, Revenue expenses do not.
3. The benefits of the capital expenditure are always spread over several years, whereas the revenue expenditure provides benefit only for the accounting period. That is the reason why only a part of the capital expenditure is accounted for in the accounting period and the balance is shown as an asset in the balance sheet. On the other hand, the entire amount of the revenue expenditure is accounted for in the accounting period.

Q. Distinguish between Capital Expenditure and Revenue Expenditure.