Accounting For Capital And Revenue

Capital and Revenue Expenditure

Expenditure on fixed assets may be classified into Capital Expenditure and Revenue Expenditure. The distinction between the nature of capital and revenue expenditure is important as only capital expenditure is included in the cost of fixed asset.

Capital Expenditure

Capital expenditure includes costs incurred on the acquisition of a fixed asset and any subsequent expenditure that increases the earning capacity of an existing fixed asset.

The cost of acquisition not only includes the cost of purchases but also any additional costs incurred in bringing the fixed asset into its present location and condition (e.g. delivery costs).

Capital expenditure, as opposed to revenue expenditure, is generally of a one-off kind and its benefit is derived over several accounting periods.

 Capital Expenditure may include the following:

• Purchase costs (less any discount received)
• Delivery costs
• Legal charges
• Installation costs
• Up gradation costs
• Replacement costs

As capital expenditure results in increase in the fixed asset of the entity, the accounting entry is as follows:

• Debit
• Fixed Assets
• Credit 
• Cash/Payable

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What is a capital expenditure versus a revenue expenditure?

A capital expenditure is an amount spent to acquire or improve a long-term asset such as equipment or buildings. Usually the cost is recorded in an account classified as Property, Plant and Equipment. The cost (except for the cost of land) will then be charged to depreciation expense over the useful life of the asset.

A revenue expenditure is an amount that is expended immediately—thereby being matched with revenues of the current accounting period. Routine repairs are revenue expenditures because they are charged directly to an account such as Repairs and Maintenance Expense. Even significant repairs that do not extend the life of the asset or do not improve the asset (the repairs merely return the asset back to its previous condition) are revenue expenditures.

The difference between these two types of expenditure  is the difference between capital  expenditure and revenue  expenditure. It is of great importance in understanding Final Account it is the key that decides whether an  expenditure is considers as an expense loss or asset.

The chief difference between   the two types of expenditure is the length of time for which they benefit the business and since we have to draw a line somewhere so it is sense able to draw this line at one year. 

Timing: Capital expenditures are charged to expense gradually via depreciation, and over a long period of time. Revenue expenditures are charged to expense in the current period, or shortly thereafter.

Consumption: A capital expenditure is assumed to be consumed over the useful life of the related fixed asset. A revenue expenditure is assumed to be consumed within a very short period of time.

Size: A more questionable difference is that capital expenditures tend to involve larger monetary amounts than revenue expenditures. This is because an expenditure is only classified as a capital expenditure if it exceeds a certain threshold value; if not, it is automatically designated as a revenue expenditure. However, certain quite large expenditures can still be classified as revenue expenditures, as long they are directly associated with sale transactions or are period costs.

Examples of capital expenditures

A capital expenditure refers to the expenditure of funds for an asset that is expected to provide utility to a business for more than one reporting period.

Examples of capital expenditures are as follows:

1. Buildings 
2. Capital leases
3. Computer equipment
4. Office equipment
5. Furniture and fixtures
6. Intangible assets 
7. Land 
8. Software
9. Vehicles

An expenditure is otherwise recorded as an expense if either of the following two rules apply:

The expenditure is for an amount less than the designated capitalization limit of a business. The capitalization limit is established to keep a company from wasting time tracking assets that have little value, such as computer keyboards.

The expenditure relates to an item that is expected to be fully consumed within the current reporting period.

Examples of revenue expenditure

All the expenditures which are incurred in the day to day conduct and administration of a business and the effect-of which is completely exhausted within the current accounting year are known as "revenue expenditures". These expenditures are recurring by nature i.e. which are incurred for meeting day today requirements of a business and the effect of these expenditures is always short-lived i.e. the benefit thereof is enjoyed by the business within the current accounting year. These expenditures are also known as "expenses or expired costs." e.g. Purchase of goods, salaries paid, postage, rent, traveling expenses, stationery purchased, wages paid on goods purchased etc.

Following are the examples of revenue expenditure.

1. Wages paid to factory workers.
2. Oil to lubricate machines.
3. Power required to run machine or motor.
4. Expenditure incurred in the ordinary conduct and administration of business, i.e. rent, , carriage on saleable goods, salaries, wages manufacturing expenses, commission, legal expenses, insurance, advertisement, free samples, postage, printing charges etc.
5. Repair and maintenance expenses incurred on fixed assets.
6. Cost of saleable goods.
7. Depreciation of fixed assets used in the business.
8. Interest on borrowed money.
9. Freight, cartage, octroi duty, transportation, insurance paid on saleable goods.
10. Petrol consumed in motor vehicles.
11. Service charges to motor vehicles.
12. Bad debts.

This expenditure is incurred on items or services which are useful to the business but are used up in less than one year and, therefore, only temporarily increase the profit-making capacity of the business.

Revenue expenditure also includes the expenditure incurred for the purchase of raw material and stores required for manufacturing saleable goods and the expenditure incurred to maintain the- fixed assets in proper working conditions i.e. repair of machinery, building, furniture etc