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Saturday, December 11, 2010

Difference between capital and revenue expenditures

Difference between capital and revenue expenditures affects the fundamental principle of correct accounting. Proper adjustments are necessary before preparation of the final accounts. All items of capital and expenditure will find place in the balance sheet whereas all items of revenue expenditure will be included in the profit and loss account. If any incorrect adjustment or allocation is made between these expenditures, this will falsify the final results as disclosed by the revenue account or the balance sheet.

Capital Expenditures:

Expenditure means the amount spent. Any expenditure incurred for the following purposes is capital expenditure:

For acquiring fixed assets such as land, building, plant and machinery, furniture and fitting and motor vehicles. These assets should not be acquired with a view to resell them at a profit but to retain in the business. The cost of fixed asset would include all expenditure up to the asset becomes ready for use.

For making improvement and extensions to the fixed asset e.g., additions to buildings.

For increasing the earning capacity of a business or for reducing the cost of manufacture, administration or distribution in a business e.g., expenditure incurred in removing the business to a central locality or compensation paid to retrenched employee.

For raising capital monies for the business such as brokerage paid for arranging loans, discount on issue of shares and debentures, underwriting commission etc.

All capital expenditures represent either an asset or liability and are shown in the balance sheet.

List of Capital Expenditures - (Examples of Capital Expenditures):
The following is a list of the usual items of capital expenditures:

Cost of goodwill.

Cost of freehold land and building and the legal charges incurred in this connection.

Cost of lease.

Cost of machineries, plants, tools, fixtures, etc.

Cost of trade marks, patents, copy rights, designs, etc.

Cost of car, lorry etc.

Cost of installation of lights and fans.

Cost of any other assets acquired by way of equipment.

Erection cost of plant and machinery.

Cost of addition to existing assets.

Structural improvements and alteration in the existing assets.

Expenses for developments in case of mines and plantations.

Expenses for administration incurred during construction and equipment of any industrial enterprise.

Expenses incurred in experimenting which finally result in the acquisition of a patent or other rights.

Revenue Expenditures:

Expenditures will be treated as revenue expenditures if it is incurred for the following purposes:

Expenditure for purchasing floating assets i.e., assets meant for resale at a profit or for being converted into saleable goods, such as the cost of goods, raw materials and stores.

Expenditures incurred by maintaining assets in proper working order e.g., repairs to plant and machinery, building furniture and fittings etc.

Expenditures incurred for meeting day to day expenses of carrying on a business e.g., salaries, rent, rates, taxes, stationery, postage etc.

All revenue expenditures have to be deducted from the income earned by the firm. That is to say, all revenue items will be taken to the profit and loss account.

List of Revenue Expenditures - (Examples of Revenue Expenditures):
The following is a list of the usual items of revenue expenditures:

Expenses incurred for the ordinary administration and carrying on the business.

Expenses for repairs, renewals and replacement of permanent assets.

Cost of goods for resale.

Cost of raw materials and stores acquired for consumption in course of manufacturing.

Wages paid for manufacture of products for sales.

Expenses for the manufacture and distribution of the finished goods.

Loss from wear and tear and obsolescence of assets.

Depreciation of lease.

Interest on loans borrowed for business.

Loss from sale of fixed assets.

Fees for renewal of patent rights, etc.

Up-keep and maintenance of motor car and van.

Maintenance of fan and lights.

Book value of assets discarded or totally damaged or destroyed by fire or other reasons.

Difference Between Capital and Revenue Expenditures:

Following is the difference between capital and revenue expenditures.

Capital Expenditures Revenue Expenditures
1 Its effect is long term i.e., it is not exhausted within the current account year. Its benefit is enjoyed in future year or years also. In a word, its effect is reduces gradually. 1 Its effect is temporary, i.e., it is exhausted within the current accounting year.

2 An asset is acquired or the value of an asset is increased as a result result of this expenditure. 2 Neither an asset is acquired nor the value of an asset is increased.

3 It does not occur again and again - it is non-recurring and irregular. 3 It occurs repeatedly - It is recurring and regular.

4 Generally, it has physical existence i.e., it can be seen with eyes. 4 It has no physical existence, i.e., it cannot be seen with eyes.

5 This expenditure improves the position of the concern 5 This expenditure helps to maintain the concern

6 A portion of this expenditure is shown in the trading and profit and loss account or income and expenditure account as depreciation. 6 The whole amount of this expenditure is shown in trading and profit and loss account or income and expense account. But deferred revenue expenditures and prepaid expenses are not shown.

7 It appears in balance sheet until its benefit is fully exhausted. 7 It does not appear in balance sheet. Deferred revenue expenditure, outstanding expenditure, outstanding expenses and prepaid expenses, however, temporarily shown in the balance sheet.

8 It does not reduce the revenue of the concern. Purchase of fixed assets does not effect revenue. 8 It reduces revenue. Payment of salaries to employees decreases revenue.

Capital and Revenue Receipts, Payments, Profits and Losses:

Capitalized and Revenue Receipts:
Receipts refer to the actual amounts of cash received. They can be either of capital nature or revenue nature.

Capital receipts include the following:

Capital brought in by the proprietor at the commencement and any additions made subsequently.

Money borrowed from partners, bankers, private individuals etc.

Money received by the sale of fixed assets.

Money received on account of capital profit.

Revenue receipts include the following:

Money received by the sale of floating assets - by sale of goods.

Money received on account of some revenue profit.

Capital and Revenue Payments:
Definition and Explanation:
Capital payment is an amount paid on account of some capital expenditure and a revenue payment is an amount actually paid on account of some revenue expenditure. Expenditure is the full amount incurred whether paid or not, whilst payments refer to the amount actually paid.

If a building is purchased for $20,000 from X and $10,000 is paid in cash and the remaining sum to be paid after six months; $20,000 is capital expenditure, but $10,000 is only capital payment. Similarly if goods are purchased from X for 30,000 and $15,000 is paid in cash; $30,000 is revenue expenditure but only $15,000 is revenue payment.

Capital and Revenue Profits:
Definition and Explanation:
Capital profit means a profit made on the sale of a fixed asset or profit earned on raising monies for the business. For example a building purchased for $20,000 is sold for $25,000 the profit $5,000 thus made is a capital profit.

Revenue profit on the other hand is a profit made by the business e.g., profit on the sale of goods, income from investments, commission earned etc.

Whenever, capital profit is made it should either be transferred to the capital account of the proprietor or credited to capital reserve account which would appear as a liability on the balance sheet. But capital profits should in no case be transferred to profit and loss account because it is non-trading profit. Revenue profits on the other hand should be transferred to profit and loss account because they arise out of regular trading operation.

Capital and Revenue Losses:
Definition and Explanation:
Capital loss means a loss made on the sale of a fixed asset or a loss incurred in connection with the raising of money for business. Capital loss may be shown as an asset in the balance sheet. But as this asset is a fictitious nature, it would would advisable to write off it.

Revenue loss, on the other hand, is the loss incurred in trading operations such as loss on the sale of goods. Revenue losses are charged to profit and loss account of the year in which they occur.

More About Capital and Revenue Expenditures:

Capitalized or Deferred Revenue Expenditures:
Where a certain revenue expenditure incurred is of such a nature that its benefit is likely to be spread over a certain number of years, or where it is of non-recurring and special nature and large in amount, in such circumstances, instead of debiting the entire amount to the profit and loss account of the year in which it has been incurred, it may be spread over a number of years, a proportionate amount being charged to each year's profit and loss account. The remaining portion of the expenditure is carried forward and is known as capital expenditure or or deferred revenue expenditure and is shown as an asset in the balance sheet. Item such as preliminary expenses, cost of issue of debentures are examples that may be classified under this head.

Exceptions to General rules:
There are certain expenses which are usually of a revenue in nature but under certain circumstances they become capital expenditures. The following are the examples of expenses which are usually revenue but under certain circumstances become capital.

Legal Charges:
These are, as a rule, revenue charges, but legal charges incurred in connection with the purchase of a fixed asset are capital expenditures as they form an additional cost of the asset acquired.

Wages are ordinary a revenue expenditure. But in a manufacturing business where the firm's own men are employed in making of fixed asset, the wages paid for such purpose would be capitalized. For example if the firm's own men are employed in making extension to the factory building or in erection of plant or manufacturing tools for own requirements. the wages and salaries paid to the persons are not revenue but capital expenditures.

Brokerage and Stamp Duty:
Normally these are revenue expenditures, but brokerage paid on acquisition of a property and stamp duty involved thereon can be capitalized.

Freight and Carriage:
This is revenue charge, but freight and carriage paid on newly acquired plant or fixed assets are capital expenditures.

Ordinarily amount expended on advertising is revenue charge but the cost of special advertising undertaken for the purpose of introducing a new line of goods may be capitalized.

Development Expense:
In concern like collieries, mines, tea, rubber etc., all expenses incurred during the period of development are treated as capital.

Preliminary Expenses:
These are the expenses incurred in connection with the formation of a public company. These expenses although are revenue in nature but are allowed to be capitalized and can be shown as an asset in the balance sheet.







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