What is the difference between capital and revenue expenditure?

Capital expenditures represent money spent to purchase, improve, or extend the life of a long-term asset. Revenue expenditures are incurred in the normal course of business for supplies, repairs, and other operating costs that do not add value to an asset.

When should capital expenditure be accounted for?

Capital expenditure should be recorded as an asset on the balance sheet when it meets certain criteria such as having a useful life of more than one year and being something that can depreciate over time.

How are capital and revenue expenditure treated differently by businesses?

Businesses often treat capital expenditures differently than revenue expenditures, as the former are considered investments into the business that may yield future benefits. Revenue expenditures, on the other hand, do not result in long-term benefits and are treated as operating expenses.

What is capitalization of expenditure?

Capitalization of expenditure is the process of converting an expense to an asset by recording it as capitalized cost on the balance sheet instead of expensing it immediately. This allows businesses to spread out costs associated with significant purchases over time rather than having to pay for them all upfront.

What are some examples of capital expenditure?

Examples of capital expenditure include purchasing or improving the property, buying new equipment or technology, and investing in research and development.

Capital and Revenue Expenditures | Definition & Example

There are two main types of expenditures in business:

Capital expenditures

Revenue expenditures

Capital Expenditures

Definition and Explanation of Capital Expenditures

An expenditure is a capital expenditure if the benefit of the expenditure extends to several trading years.

Capital expenditure may include different types of expenditures, each of which is shown as an asset in the balance sheet.

First, expenditures incurred on the acquisition of fixed assets (tangible or intangible), which the business uses to earn profit and not for resale (e.g., land and buildings, plant and machinery, furniture and fixtures, goodwill, patent right, and copyrights).

Second, the cost of fixed assets would include all expenditures necessary up to the time the asset is ready for use.

For instance, the cost of all buildings purchased would include the price paid to the seller, legal charges, and the broker’s commission.

Similarly, the cost of machinery would include the purchase price, freight, import duty, cartage, octroi duty, and erection and installation charges.

Third, expenditures that result in an increase in the earning capacity of a business.

Examples include expenditures incurred in relocating the business and money paid for goodwill (e.g., the right to use the established name of an outgoing firm).

This is because it will attract the old firm’s customers and, in this way, lead to higher sales and profits.

Fourth, money is spent on improving existing assets so as to increase their life or reduce the cost of production (e.g., converting hand-driven machines into power-driven machines).

Fifth, expenditures incurred on the extension and addition of existing fixed assets.

Examples include the cost of making additions to the building, furniture, machinery, or motor vehicles.

Finally, any expenditure that is incurred to raise capital for the business (e.g., commission and brokerage paid to an agent to arrange long-term loans, or discounts on the issue of shares and debentures).

Examples of Capital Expenditures

The following are the most important items of capital expenditure:

Purchase of factories and buildings

Purchase of machines, furniture, motor vehicles, or office equipment

Cost of goodwill, trademarks, patents, copyrights, and designs

Expenditure on installation of plant and machinery and other office equipment

Additions or extension of existing fixed assets

Structural improvement or alterations to fixed assets that increase their lifetime or earning capacity

Preliminary expenses of a limited company

Cost of issue of shares and debentures

Legal expenses on loans and mortgages

Interest on capital during construction periods

Development expenses (e.g., for mines and plantations)

Revenue Expenditures

Definition and Explanation of Revenue Expenditures

An item of expenditure for which the benefit expires within the year is classed as revenue expenditure.

Revenue expenditure does not increase the efficiency of the firm.

Expenditures incurred for the following purposes are treated as revenue expenditures:

Expenditures incurred for the purpose of floating assets (i.e., asset for resale purposes such as cost of merchandise, raw materials, and stores required for manufacturing process).

All establishment and other day-to-day expenses incurred in the operation and administration of the business (e.g., salaries, rent, taxes, postage, stationery, bank charges, insurance, and advertisement charges).

Expenditures incurred to maintain fixed assets in proper working condition (e.g., repairs, replacement, and renewals for buildings, furniture, and machinery)