Capital And Revenue Expenditure PDF

Capital and Revenue Expenditure Objectives:  Distinguish between expenditure that is capital in nature and that which is revenue  Understand that some expenditure is part capital and part revenue expenditure  Understand that if revenue expenditure is incorrectly treated as...

Capital and Revenue Expenditure Objectives:  Distinguish between expenditure that is capital in nature and that which is revenue  Understand that some expenditure is part capital and part revenue expenditure  Understand that if revenue expenditure is incorrectly treated as capital expenditure, or vice versa, both the final accounts and profit will be affected. Capital Expenditure Capital expenditure is incurred when a business spends money to either:  Buy fixed assets; or  Add to the value of an existing fixed asset. Included in such amounts should be the cost of:  Acquiring fixed assets  Bringing them into the business  Legal cost of buying buildings  Carriage inwards on machinery bought  Any other cost needed to get the fixed asset ready for use. Revenue Expenditure Revenue expenditure is expenditure that does not increase the value of fixed assets but is incurred in the day- to- day running expenses of the business. The difference from capital expenditure can be seen when considering the cost of running a motor vehicle for a business. The expenditure incurred in acquiring the motor vehicle is classified as capital expenditure, while the cost of the petrol used to run the vehicle is revenue expenditure. This is because the revenue expenditure is used up in a few days and does not add to the value of the fixed asset. Difference between Capital and revenue expenditure The difference between capital and revenue expenditure can be seen more generally in the following table. Revenue expenditure is the day to day running expense of the business and, as such, is chargeable to the trading and profit and loss account. Capital expenditure, in contrast, results in an increase in the fixed assets shown in the balance sheet. 1  Capital Expenditure Revenue Expenditure Premises purchased Rent of premises Legal charges for conveyancing Legal charges for debt collection New machinery Repairs to machinery Installations of machinery Electricity costs of using machinery Additions to assets Maintenance of assets Motor vehicles Petrol Delivery charges on new assets Carriage on purchases and sales Extension costs of new offices Redecorating existing offices Cost of adding air-conditioning to room Interest on loan to purchase air- conditioning Joint expenditure In certain cases, an item of expenditure will need dividing between capital and revenue expenditure. Suppose a builder was engaged to carry out some work on your premises, the total bill being $30,000. If one-third of this was for repair work and two-thirds for improvements, then $10,000 should be charged to the profit and loss account as revenue expenditure, and $20,000 should be identified as capital expenditure and added to the value of the firm’s premises and shown as such in the balance sheet. Exhibit 13.2 Total cost of $30,000 for repairs and improvements Repairs to premises $10,000 Repairs Account Profit and Loss Account Improvements to premises Premises Balance Sheet $20,000 2  Account Incorrect treatment of expenditure If one of the following occurs:  Capital expenditure is incorrectly treated as revenue expenditure, or  Revenue expenditure is incorrectly treated as capital expenditure, then both the balance sheet figures and trading and profit and loss account figures will be incorrect, this means that the net profit figure will also be incorrect. If capital expenditure is incorrectly posted to revenue expenditure- for example, if the purchase of a photocopier is posted in error to the stationery account instead of the office equipment account – then: Net profit would be understated, and Balance sheet values would not include the value of the asset. If revenue expenditure is incorrectly posted to capital expenditure – for example if stationery is posted to office equipment instead of the stationery account – then: Net profit would be overstated, and Balance sheet values would be over-valued. If the expenditure affects items in the trading account, then the gross profit figure will also be incorrect. Treatment of loan interest If money is borrowed to finance the purchase of a fixed asset, then interest will have to be paid on the loan. The loan interest, however, is not a cost of acquiring the asset but is simply a cost of financing its acquisition. This means that loan interest is revenue expenditure and not capital expenditure and should be charged to the profit and loss account. Capital and revenue receipts When an item of capital expenditure is sold, the receipt is called a capital receipt. Suppose a motor van is bought for $ 5,000 and sold five years later for $750. The $5000 was treated as capital expenditure. The $750 received is treated as a capital receipt. 3 Revenue receipts are sales and other revenue items, such as rent receivable or commissions receivable. 4 Summary  The distinction between capital and revenue expenditure is explained and how important it is to classify items carefully since this can ultimately affect the recording of profits and the balance sheet valuations of a business.  Capital expenditure is money spent on the purchase of fixed assets or additions to existing assets. They are usually purchased to be retained in the business to enable it to generate profits.  Revenue expenditure is money spent to day-to-day running expenses of the business.  Some items are both capital and revenue expenditure and the costs involved need to be apportioned carefully.  If capital expenditure or revenue expenditure is mistaken one for the other, then either gross or net profit (or both) will be incorrectly stated. The value of the assets in the balance sheet will also be affected.  It is also important to classify capital receipts, i.e. the sale of a fixed asset, from revenue receipts, which are accounted for from sales or other revenue items. 5