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Capital and Revenue Expenditure

Expenditure which is an amount of money spent is either capital expenditure or revenue expenditure. It is important to distinguish between the two so that it can be decided to capitalize the expenditure or to treat it as an expense item. Adjustments can then be made before the final accounts are prepared. If there is no proper treatment of the expenditures, it will adversely affect the financial statement.

Capital expenditures are sums spent to add value to an asset by improving it, but not revenue expenditures which do not add value to the asset. Capital expenditures increase the productive life and capacity of the asset to increase output and reduce the cost of production. The amount spent for the capital expenditure is therefore added (debited as assets are debit accounts) to the asset, and increases its value.

Revenue expenditures are for the routine maintenance and repair work of the asset. They are expenses that the company spends on to run its business, and to generate revenue. They are normal operating expenses and so are debit items in the expense accounts such as repair and maintenance account. Other revenue expenditures include office supplies, salaries and wages, lighting and heating, telephone and stationery, etc.

The costs incurred in the purchase of an asset can be both capital expenditure and revenue expenditure. For example, the capital expenditures of the vehicle are the purchase price and taxes such as sales tax. Revenue expenditures such as insurance, repair and petrol for a vehicle do not increase its value. They are in fact operational expenses. For other assets, the capital expenditures include transportation, delivery, and installation charges which are necessary to locate the asset and make it operational.

Capital expenditure is non-recurring. The returns last a long period of time and are only felt in the future. This is unlike revenue expenditure whose benefit is enjoyed only in the period in which it is incurred. Revenue expenditure is a recurring expense which does not improve or extend the life of an asset. A portion of the capital expenditure is charged in the income statement such as profit and loss account as depreciation. The asset appears on the balance sheet and is gradually written off over a specified period of time. All revenue expenditures are charged against the income earned in the profit and loss account of the period within which they are incurred.

When a capital expenditure is treated as revenue expenditure, it is described as an error of principle. This results in incorrect figures and net profit in the profit and loss account, and incorrect figures on the balance sheet. The error is best avoided by being able to distinguish the difference between capital expenditure and revenue expenditure. It’s important to remember that all capital expenditures go onto the balance sheet and all revenue expenditures are entered in the profit and loss account.

Summary of capital expenditure to get the fixed assets operational
Acquisition of fixed assets
Increasing the value of the assets by improving, overhauling, etc.
Transportation, delivery and installation of the assets
Insurance covering the shipment of the assets
Legal costs involved in the purchase of the assets
Inspection and testing of the assets prior to using them
Professional fees, e.g. for surveying report, plans for erection or alteration of buildings, etc.

Last Updated (Friday, 03 September 2010 20:00)