A business has to incur various expenses from time to time. Some expenses are regular in nature while some are one-time expenses.
The expenses whose benefits will be enjoyed over a long period of time are known as capital expenditures. Revenue expenditure refers to those expenses which are incurred for maintaining the day-to-day operations of the business.
Any transaction taken place within the business is to be classified under a category known as revenue nature or capital nature.
Receipt or expenditure transactions are to be classified as capital or revenue and further classified as capital expenditure, revenue expenditure, capital receipts or revenue receipts.
Expenditure transactions involve outflow of cash. Receipt transactions involve inflow of cash.
Capital transactions are further classified as capital expenditure and capital receipt and revenue transactions are classified as revenue expenditure and revenue receipt.
What Is Capital Expenditure?
Capital expenditure refers to any expenditure which has any one or all of the following:
- It is not a recurring expenditure.
- The benefit of such expenditure is seen for more than one accounting year.
- The expenditure increases the revenue earning capacity of the organisation.
- The amount of money involved is quite large.
- In simple terms, if the benefits of the expenditure are expected to accrue for a long term, then the expenditure is considered to be capital expenditure. Capital expenditure is that expenditure which generally results in the acquisition of an asset and further helps the business to improve its earning capacity and resource optimisation. Capital expenditure is the expenditure which is incurred to raise the earning capacity of an organisation.
Characteristics of Capital Expenditure:
- Usually a large amount is involved.
- Increases the cost of fixed asset.
- Increases life of fixed assets.
- Non-recurring in nature.
- Increases the future profitability and earning capacity of the business.
- Brings the fixed asset into working condition.
- Benefit of expenditure is not exhausted within 1 year but is enjoyed over several years and is long term in nature.
- Shown in the Assets side of Balance Sheet.
Examples of Capital Expenditure:
- Acquisition of An Asset: Any expenditure that is directly incidental to the purchase of an asset or has been incurred to put the asset into working condition, for example, installation charges or commission expenses directly incurred with reference to the acquisition of assets are to be treated as capital expenditure. The expenses incurred to put the machinery into use like installation expenses, repairs and maintenance is also considered as capital expenditure. All the expenses incurred on the assets till they yield income are capital in nature.
- Improvisation: Any expenditure that improves the standard of performance of an existing asset is considered to be a capital expenditure. Any expenditure which extends the useful life of the asset or improves the efficiency of the asset, thereby, improving the earning capacity of the business is to be capitalised and added to the cost of fixed assets.
- Addition or Extension To Assets: Any cost incurred in regards to a strategic addition or extension of an existing asset class is considered to be a capital expenditure.
- Investments: Investment in shares, debentures, immovable properties are also considered as capital expenditure.
- Intangible Assets: Intangible assets like Goodwill, Patents, Copyright, Trademarks at times are purchased when acquiring a business, so the cost of acquisition of those intangible assets come under the category of capital expenditure.
- Accounting of Capital Expenditure: The treatment of capital expenditure in terms of accounting is that the capital expenditures are shown in the Assets side of the Balance Sheet, as this expenditure is purely done to increase the assets and further improves and increases the earning capacity of the business.
What Is Revenue Expenditure?
Revenue expenditure is any expenditure which has any one or all of the following characteristics:
- The expenditure is incurred in the day-to-day functioning of the business and is necessary to maintain or carry out the business.
- The expenditure is recurring in nature. The benefit of such expenditure usually lasts for a short period of time.
- Revenue expenditure is an expenditure which is incurred to maintain the regular functioning of the business and has to be incurred quite frequently.
- Any expenditure which is not a capital expenditure and which is incurred for carrying out the day-to-day activities of the business is known as revenue expenditure.
- Revenue expenditure is the expenditure which is primarily, recurring in nature, incurred in connection with the day-to-day operations of an organisation and is seen as an expenditure necessary for maintaining the regular course of business.
- Revenue Expenditure: “It is an expenditure charged against operation: a term used to contrast with Capital Expenditure.” Any expenditure which is not a capital expenditure and which is incurred for carrying the day to day business activities is called revenue expenditure.
Kohler defines Revenue Expenditure, as an expenditure charged against operations.
Examples of Revenue Expenditure:
- Expenses related to operations and functioning of regular business activities.
- Expenses of Production- Purchase of Raw Materials.
- Expenses of Administration- Payment of office salaries.
- Expenses of Selling and Distribution- Finance expenses.
- Expenses incurred to earn income- Interest on loan taken for purchase of shares.
- Accounting of revenue expenditure- Revenue expenditures are shown on the debit side of Trading or Profit and Loss account.
- Expenditures primarily incurred to maintain the asset in a working condition, for example, repairs and maintenance expenses.
Note: Repairs and maintenance expenses, sometimes are treated as capital expenditures and at times treated as revenue expenditures. The key distinction here is, when a maintenance activity is taken place while acquiring the asset it is to be considered as capital expenditure and when a preliminary repairs and maintenance activity is taken place after a while of installation of the machinery it will be treated as revenue expenditure as it is incurred just to maintain the asset.
Characteristics of Revenue Expenditure:
- Usually a small amount is involved.
- Recurring in nature.
- Benefit is exhausted within the year and is usually short term oriented.
- Incurred for the maintenance and smooth running of the business.
- Shown in the debit side of the Trading or Profit and Loss Account.
Difference Between Capital And Revenue Expenditure:
Tests To Be Applied To Transactions:
To classify a transaction as capital or revenue, one may use the following tests as indicators:
For Capital/Revenue Expenditure:
- What is the period of benefit from the expenditure?
- What is the effect of expenditure?
- What is the amount of expenditure?
Period of Benefit From Expenditure: If the benefit is for the short term and recurring in nature, it is treated as Revenue Expenditure. The expenditure which will give benefit for a long period of time and which is non-recurring in nature will be classified as Capital Expenditure.
Effect of Expenditure: If the given expenditure gives rise to a tangible asset or a right, it is treated as capital expenditure.
Amount of Expenditure: Generally, the Capital Expenditure involve huge amounts but this cannot always be treated as a conclusive, reliable test for classification.
How Would You Treat The Following Transactions (Practical Examples):
- Carriage paid on purchase of Raw Materials- Revenue Expenditure, as these expenses are incurred in the normal course of business operations.
- Freight and carriage of a new machinery acquired- Capital Expenditure, as these expenses are directly incidental to the acquisition of the new machinery and needs to be further added to the cost of the asset.
- Paid to the government a duty of Rs. 50,000- Revenue Expenditure, as these expenses are incurred in the normal course of business operations.
- Purchased Land and Building- Capital Expenditure, as it created a real asset.
- Installation charges on Plant and Machinery- Capital Expenditure, as these expenses are directly incidental to the acquisition of the Plant and Machinery and needs to be further added to the cost of the asset.
- Repairs to furniture- Revenue Expenditure, as it is incurred to keep the furniture in a good condition.
- Legal expenses incurred in an action for infringement of trademarks- Revenue Expenditure, as these expenses are incurred in the normal course of business operations.
- Amount spent on air-conditioning the office- Capital Expenditure, as it gives a long term benefit and generally huge amount is associated.
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