Capital and Revenue Expenditure: Concept and Guidelines for Determining It

Here we detail about the concept and guidelines for determining capital and revenue expenditure.

Capital Expenditure:

A payment and/or incurrence of outlay for a purpose, other than the settlement of an existing liability are known as expenditure. It should be noted that expenditure is a wider term and includes expenses. A part of expenditure that has been consumed in the current year is known as an expense of the current year.

The amount incurred for acquiring or improving some assets, which would give benefit for more than one accounting year and not kept for resale in the ordinary course of business enterprise, is termed as capital expenditure. Capital expenditures are non-recurring in nature.

The basic aim and object of incurring capital expenditure is to increase the earning capacity of the business enterprise. Usually, the business enterprise incurs capital expenditure for acquiring some tangible or intangible assets.

Capital expenditure includes the following types of expenditures:

(i) Amount incurred on the purchase of some permanent or any fixed asset such as purchase of machinery or building etc.;

(ii) Amount incurred on the permanent improvement, addition or extension of an existing asset such as amount spent on construction of cycle and scooter shed in the business premises, installing air-conditioning in the chamber of General Manager etc.

Revenue Expenditure:

The amount incurred on maintaining the earning capacity of the business, benefit of which is direct and would be in the same accounting year itself in which such expenditure has been incurred is termed as revenue expenditure.

The most important point to remember here is that the benefit of revenue expenditure would exhaust in one year. Revenue expenditures are recurring in nature. Revenue expenditure should be matched with the revenue receipts of the business enterprise.

The basic aim and object of incurring revenue expenditure is to run and maintain the earning capacity of the business enterprise.

Revenue expenditure includes the following types of expenditures:

(i) Items of expense incurred for producing finished goods such as purchase of raw material and other direct expenses etc.;

(ii) Establishment cost such as rent, light, repairs etc.;

(iii) Administrative costs such as salaries of the staff, telephone expenses etc.;

(iv) Selling and distribution expenses such as advertisement expenses, commission etc.;

(v) Financial expenses such as discount allowed, interest on loans etc.;

(vi) Other miscellaneous expenses for maintaining the business enterprise such as repairs and renewals, insurance etc.

Guidelines for Determining Capital or Revenue Expenditure:

Basic criteria whether any expenditure shall be treated as capital expenditure or revenue expenditure are the aim and object with which such expenditure was incurred.

However, the following guidelines can be applied in judging whether a particular expenditure is a capital expenditure or revenue expenditure:

(i) When an expenditure is incurred for acquiring long term assets for use in the business enterprise itself and not for resale in the ordinary course of the business, it should be treated as capital expenditure.

Example:

Pal Ltd spent Rs. 45,000 on the purchase of furniture for its business enterprise.

(ii) When an expenditure is incurred which helps the business in being established and run smoothly, it should be treated as capital expenditure.

Example:

Preliminary expenses of Rs. 90,000 paid by Arun for setting up his business.

(iii) When an expenditure is incurred on purchase of consumable items, raw materials or any goods or services for the purpose of resale, it should be treated as revenue expenditure. It is worth mentioning here that selling of those goods or services in original or in improved manner does not hamper putting them into the category of revenue expenditure.

Example:

Jai Ltd spent Rs. 36,000 for the purchase of raw material for the production of its finished goods.

(iv) When an amount is incurred for putting any second-hand asset in working condition and for the use in business enterprise, it should be treated as capital expenditure.

Example:

Veer Ltd spent Rs. 18,000for the repair of its damaged machinery to put the same into use.

(v) When an amount is incurred for maintaining the fixed assets in working order, it should be treated as revenue expenditure.

Example:

Payal Ltd spent Rs. 27,000 on a machine for repairs and replacement of defective parts of a machine.

(vi) When an amount is incurred for increasing the earning capacity of the business enterprise, it should be treated as capital expenditure.

Example:

Mohan Ltd spent Rs. 90,000 for alteration of the plant to improve the production process.

(vii) When an amount is incurred which is non-recurring in nature and benefit of which would arise in more than one year, it should be treated as capital expenditure.

Example:

Legal expenses amounting to Rs. 72,000 paid by Ajit Ltd to acquire a building.

(viii) When an amount is incurred which is recurring in nature and benefit of which would arise in the same accounting year in which that expenditure has been incurred, it should be treated as revenue expenditure.

Example:

Salaries and wages of Rs. 90,000 paid by Ashwani Enterprises.