Rules for determining capital expenditure

If an expenditure is incurred for one of the following purposes it will be considered as Capital:

1. Purchase of fixed assets

Amount spent to purchase fixed assets on a long term basis. It means they are purchased to earn profit and not for resale. Such expenditure will be considered as Capital Expenditure.

Example

If electronics dealer purchases furniture for business, it will be termed as Capital expenditure. But if he buys any electronic items for resale purpose, it will be termed as Revenue expenditure.

2- Improvement of fixed assets

The amount spent on improving the condition of an existing fixed Asset, by which its value to the business enhances, will be treated as capital expenditure. Here, by increasing the value of fixed Assets to business means increase in its working capacity, effectiveness or life. If the expenditure is made to put an old asset into the working condition it will also be termed as Capital Expenditure. Last but not the least if expenditure is incurred to put an asset into working condition, will also be considered capital expenditure.

Also Check:  Capital and revenue profits

Example 1

If a land is purchased for $5,00,000 and  $3,000is spent on registration and stamp duty, the Capital Expenditure on the land will be $5,03,000.

Example 2

If furniture is purchased for $3,00,000 and $10,000 is paid as transportation and $15,000 is paid as installation, the total cost of the furniture will be $3,25,000.

3. Increase in earning capacity of fixed assets

If by incurring expenditure the earning capacity of the business is increased, it will be considered
as Capital Expenditure.

Example

Expenditure incurred on Shifting of the office near to factory for easy access of material will be Capital Expenditure.

4. Erection and construction of assets

If a firm’s employees are engaged in the process of erection of a machine or building extension, wages paid to them will be considered as Capital Expenditure and will be included in the cost of the asset.

Example

Wages paid to employees engaged for making extension in Premises of the factory.

5. Formation of Company

Preliminary Expenses incurred before the commencement of business will be considered Capital.

Example

Legal charges paid for drafting the Memorandum of Association of a company etc. To make easy recognition of Capital Expenditures to the students here a list is given.

  1. Purchase of Land, Building, Motor Vehicles, Office Equipments or Furniture etc
  2. Purchase of Factory.
  3. Cost of Lease-hold land and building.
  4. Cost of acquisition of long term rights and benefits e.g. patents, copyrights, Goodwill, designs, patents, patterns, trademarks etc.
  5. Preliminary expenditures.
  6. Cost of addition or extension to existing assets.
  7. Cost of overhauling second-hand machine.
  8. Expenditures incurred on putting an asset into working condition.
  9. Cost incurred for increasing the earning capacity of the business.
  10. Cost of issue of shares and debentures.
  11. Legal expenses on loans and mortgage
  12. Interest on capital during construction period.
  13. Development expenses in case of mines and & plantation.

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