Home News FORM THREE BOOK KEEPING STUDY NOTES TOPIC 4-6.

FORM THREE BOOK KEEPING STUDY NOTES TOPIC 4-6.

TOPIC 4: Capital Expenditure And Revenue Expenditure

Meaning of Capital Expenditure and Revenue Expenditure
Give the meaning of capital expenditure and revenue expenditure
Capital Expenditure
Payments
made in cash or cash equivalents over a period of more than one year.
Capital expenditures are used to acquire assets or improve the useful
life of existing assets. An example of a capital expenditure is the
funding to construct a factory. In accounting, capital expenditures must
be capitalized; that is, the expenditure is recognized on a balance
sheet gradually over the course of an asset’s useful life. Capital
expenditures are recorded as liabilities on a balance sheet. They are
also called capital outlays..
Funds
used to acquire a long-term asset. A capital expenditure results in
depreciation deductions over the life of the acquired asset. Also called
capital outlay. Expenditure on the acquisition or
improvement of FIXED ASSETS that is subsequently written off against
profits over several ACCOUNTING PERIODS. Contrast with REVENUE
EXPENDITURE. See INVESTMENT, CAPITAL BUDGETING.
Revenue Expenditure
Revenue
expenditure is a cost that is charged to expense as soon as the cost is
incurred. By doing so, a business is using the matching principle to
link the expense incurred to revenues generated in the same accounting
period. This yields the most accurate income statement results.
There are two types of revenue expenditure:
  • Maintaining a revenue generating asset.
    This includes repair and maintenance expenses, because they are
    incurred to support current operations, and do not extend the life of an
    asset or improve it.
  • Generating revenue. This is all day-to-day expenses needed to operate a business, such as sales salaries, rent, office supplies, and utilities.
Other types of costs are not considered to be revenue expenditures, because they relate to the generation of future
revenues. For example, the purchase of a fixed asset is categorized as
an asset and charged to expense over multiple periods, to match the cost
of the asset against multiple future periods of revenue generation.
These expenditures are known as capital expenditures.
Difference between Capital Expenditure and Revenue Expenditure
Distinguish capital expenditure items from revenue expenditure items
February 12, 2015 By Surbhi S Leave a Comment
In
business, it is very common to spend money in order to make profit. A
large amount of expenditure is incurred by the company for various
purposes to get high returns. The expenditure has been broadly divided
into two categories – Capital and Revenue. Prima facie, these two terms
seem alike, but they are not similar. Capital Expenditure is an expense generally made to acquire an asset or improve the capacity of the asset. Unlike Revenue Expenditure, which
is an expense made for operating day-today activities of the business.
The difference between Capital and Revenue is explained here.
Content: Capital Expenditure Vs Revenue Expenditure
  1. Comparison Chart
  2. Definition
  3. Key Differences
  4. Example
  5. Conclusion
Comparison Chart
Basis for Comparison Capital Expenditure Revenue Expenditure
Meaning The
expenditure incurred in acquiring a capital asset or improving the
capacity of an existing one, resulting in the extension in its life
years.
Expenses incurred in regulating day to day activities of the business.
Term Long Term Short Term
Capitalization Yes No
Shown in Income Statement & Balance Sheet Income Statement
Nature Non-recurring Recurring
Benefit More than one year Only in current accounting year
Definition of Capital Expenditure
The
amount spent by the company for possessing any long term capital asset
or to enhance the working capacity of any existing capital asset, or to
increase its lifespan in order to generate future cash flows or to
decrease the cost of production, is known as Capital expenditure. As a
huge amount is spent on it, the expenditure is capitalized, i.e. the
amount of expenditure is spread over the remaining useful life of the
asset.
In
a nutshell, the expenditure which is done for initiate current as well
as future economic benefit, is capital expenditure. It is like a long
term investment done by the entity, in the name of assets, to create
financial gain for the years to come. For example – Purchase of
Machinery or installation of an equipment to the machinery which will
improve its productivity capacity or life years.
Definition of Revenue Expenditure
The
expenditure which is incurred on a regular basis for conducting the
operational activities of the business are known as Revenue expenditure
like purchase of stock, carriage, freight etc.. As per the accrual
accounting assumption, the recognition of revenues is done when they are
earned, while expenditure are recognized when they are incurred.
Therefore the revenue expenditure is charged in the Income Statement as
and when they occur. This satisfies the basic principle of Accounting
i.e. Matching Principle in which the expenses are recorded in the period
of their incurrence.
The
benefit generated by the revenue expenditure is for the current
accounting year. The examples of revenue expenditure is as under – Wages
& Salary, Printing &Stationery, Electricity Expenses, Repairs
and Maintenance Expenses, Inventory, Postage, Insurance, taxes etc.
Key Differences Between Capital and Revenue Expenditure
  1. Capital expenditure generates future economic benefits, but the Revenue expenditure generates benefit for the current year only.
  2. The
    major difference between the two is that, the Capital expenditure is a
    one time investment of money. On the contrary, revenue expenditure
    occurs frequently.
  3. Capital expenditure is shown in the Balance
    Sheet, in asset side, and in the Income Statement (depreciation), but
    Revenue Expenditure is shown only in the Income Statement.
  4. Capital Expenditure is capitalized as opposed to Revenue Expenditure which is not capitalized.
  5. Capital Expenditure is a long term expenditure. Conversely, Revenue Expenditure is a short term expenditure.
Example 1
Example
If
a company deals in computers and opens a new branch at different
location for which it acquires a building. The acquisition of the
building will be a capital expenditure, while the purchase of computers
will be a revenue expenditure. Let’s look it another way, If a company
is involved in property dealing business the purchase of the buildings
willbe a revenue expenditure, while the purchase of machinery would be a
capital expenditure.
Note: Here you must focus on the intention of expenditure.
Importance of Distinguishing Capital Expenditure from Revenue Expenditure
Explain the importance of distinguishing capital expenditure from revenue expenditure
Capital
Expenditure and Revenue Expenditure both are important for business for
earning a profit in the present as well as in subsequent years. Both
have its own merits and demerits. In case of a capital expenditure an
asset has been purchased by the company which generates revenue for
upcoming years. On the other hand, no asset is acquired as such in case
of a Revenue Expenditure.
The difference between capital expenditures and revenue expenditures is essentially the same as the difference between capital expenditures and operating expenses.
Capital
expenditures represent major investments of capital that a company
makes to maintain or, more often, to expand its business and generate
additional profits. Capital expenses are for the acquisition of
long-term assets, such as facilities or manufacturing equipment. Because
such assets provide income-generating value for a company for a period
of years, companies are not allowed to deduct the full cost of the asset
in the year the expense is incurred; they must recover the cost through
year-by-year depreciation over the useful life of the asset. Companies
often use debt financing or equity financing to cover the substantial
costs involved in acquiring major assets for expanding their business.
Revenue
expenses are shorter-term expenses required to meet the ongoing
operational costs of running a business, and thus are essentially the
same as operating expenses. Unlike capital expenditures, revenue
expenses can be fully tax-deducted in the same year the expenses occur.
In relation to the major asset purchases that qualify as capital
expenditures, revenue expenditures include the ordinary repair and
maintenance costs that are necessary to keep the asset in working order
without substantially improving or extending the useful life of the
asset. Revenue expenses related to existing assets include repairs and
regular maintenance as well as repainting and renewal expenses. Revenue
expenditures can be considered to be recurring expenses in contrast to
the one-off nature of most capital expenditures.
The
purpose of capital expenditures is commonly to expand a company’s
ability to generate earnings, whereas revenue expenditures are more
commonly for the purpose of maintaining a company’s ability to operate.
Capital expenditures appear as an asset on a company’s balance sheet;
revenue expenses are listed with liabilities. 
 
TOPIC 5:Depreciation
Cost of a Fixed Asset
Determine the cost of a fixed asset
Depreciation
is the systematic reduction in the recorded cost of a fixed asset.
Examples of fixed assets that can be depreciated are buildings,
furniture, leasehold improvements, and office equipment. The only
exception is land, which is not depreciated (since land is not depleted
over time, with the exception of natural resources).
An Asset Account
Write up an asset account
Provision for Depreciation Account
Write up a provision for depreciation account
The causes of depreciation are:
  • Wear and tear.
    Any asset will gradually break down over a certain usage period, as
    parts wear out and need to be replaced. Eventually, the asset can no
    longer be repaired, and must be disposed of. This cause is most common
    for production equipment, which typically has a manufacturer’s
    recommended life span that is based on a certain number of units
    produced. Other assets, such as buildings, can be repaired and upgraded
    for long periods of time.
  • Perish ability. Some assets have an extremely short life span. This condition is most applicable to inventory, rather than fixed assets.
  • Usage rights.
    A fixed asset may actually be a right to use something (such as
    software or a database) for a certain period of time. If so, its life
    span terminates when the usage rights expire, so depreciation must be
    completed by the end of the usage period.
  • Natural resource usage.
    If an asset is natural resources, such as an oil reservoir, the
    depletion of the resource causes depreciation (in this case, it is
    called depletion, rather than depreciation). The pace of depletion may
    change if a company subsequently alters its estimate of reserves
    remaining.
  • Inefficiency/obsolescence. Some equipment will be rendered obsolete by more efficient equipment, which reduces the usability of the original equipment.
Difference between Capital and Revenue Expenditure
Distinguish between copula and revenue expenditure
Capital
expenditures represent major investments of capital that a company
makes to maintain or, more often, to expand its business and generate
additional profits. Capital expenses are for the acquisition oflong-term
assets, such as facilities or manufacturing equipment. Because such
assets provide income-generating value for a company for a period of
years, companies are not allowed to deduct the full cost of the asset in
the year the expense is incurred; they must recover the cost through
year-by-yeardepreciationover theuseful lifeof the asset. Companies often
usedebt financingorequity financingto cover the substantial costs
involved in acquiring major assets for expanding their business.
Revenue
expenses are shorter-term expenses required to meet the ongoing
operational costs of running a business, and thus are essentially the
same as operating expenses. Unlike capital expenditures, revenue
expenses can be fully tax-deducted in the same year the expenses occur.
In relation to the major asset purchases that qualify as capital
expenditures, revenue expenditures include the ordinary repair and
maintenance costs that are necessary to keep the asset in working order
without substantially improving or extending the useful life of the
asset. Revenue expenses related to existing assets include repairs and
regular maintenance as well as repainting and renewal expenses. Revenue
expenditures can be considered to be recurring expenses in contrast to
the one-off nature of most capital expenditures.
The
purpose of capital expenditures is commonly to expand a company’s
ability to generate earnings, whereas revenue expenditures are more
commonly for the purpose of maintaining a company’s ability to operate.
Capital expenditures appear as an asseton a company’s balance sheet;
revenue expenses are listed with liabilities.
Relationship between Depreciation and the Matching Principle
Explain the relationship between depreciation and the matching principle
The
reason for using depreciation is to match a portion of the cost of a
fixed asset to the revenue that it generates; this is mandated under the
matching principle, where you record revenues with their associated
expenses in the same reporting period in order to give a complete
picture of the results of a revenue-generating transaction. The net
effect of depreciation is a gradual decline in the reported carrying
amount of fixed assets on the balance sheet. It is very difficult to
directly link a fixed asset with a revenue-generating activity, so we do
not try – instead, we incur a steady amount of depreciation over the
useful life of each fixed asset, so that the remaining cost of the asset
on the company’s records at the end of its useful life is only its
salvage value.

 

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