CAPITAL EXPENDITURE VS.
REVENUE CAPITAL EXPENDITURE
EXPENDITURE
Generates enduring benefits and helps in
Introduction revenue generation over more than one
accounting period
For ascertaining the periodical business results, the
nature of transactions should be analyzed whether May represent acquisition of any tangible
they are of capital or revenue nature. or intangible fixed assets for enduring
future benefits
The Revenue Expense relates to the operations of the Are transferred to profit and loss account
business of an accounting period or to the revenue
of the year in which their benefits are
earned during the period or the items of expenditure,
utilized.
benefits of which do not extend beyond that period.
The expenses incurred in connection with
Capital Expenditure generates enduring benefits and the acquisition of asset also will be
helps in revenue generation over more than one considered as capital expenditure.
accounting period.
Some examples
REVENUE EXPENDITURE
Question: Wages paid for installation of fixed
Must be associated with a physical activity of assets.
the entity. Answer: Expenses incurred including wages
Therefore, whereas production and sales for installation of any fixed asset is capital
generate revenue in the earning process, use expenditure in nature.
of goods and services in support of those Question: Expenses of trial run of a newly
functions causes expenses to occur. installed machine.
Are recognized in the Profit & Loss Account
Answer: Expenses incurred for trial run of a
through matching principle which tells us
newly installed machinery is capital
when and how much of the expenses to be
expenditure in nature.
charged against revenue
Question: Money paid to Mahanagar
A part of the expenditure can be capitalized
Telephone Nigam Ltd. (MTNL) Rs. 8,000 for
only when these can be traced directly to
installing Telephone in the office.
definable streams of future benefits.
Answer: Money deposited with MTNL for
Some examples for revenue exp installation of telephone is not expenditure
item. This is treated as an asset.
Question: Rs. 1,000 paid for removal of Question: Expenses incurred in connection
Inventory to a new site.
with obtaining a license for starting the
Answer: Rs. 1,000 paid for removal of factory for Rs 10,000.
Inventory to a new site is revenue Answer: Money paid ` 10,000 for obtaining
expenditure. This is neither bringing enduring
license to start a factory is a capital
benefit nor enhancing the value of the asset. expenditure. This is an item of expenditure
Question: Amount spent for replacement of
incurred to acquire the right to carry on
worn out part of machine business.
Answer: Amount spent for replacement of
any worn out part of a machine is revenue Revenue expenditures are transferred to profit and
expense since it is part of its maintenance loss account in the year of spending while Capital
cost. expenditures are transferred to profit and loss
account of the year in which their benefits are
utilized. Therefore we can conclude that it is the time
factor, which is the main determinant for transferring
the expenditure to profit and loss account.
Expenses are recognized in profit and loss account PURPOSES OF EXPENSES
through matching concept which tells us when and
how much of the expenses to be charged against Expenses for repairs of machine may be incurred in
revenue. However, distinction between capital and course of normal maintenance of the asset. Such
revenue creates a considerable difficulty. In many expenses are revenue in nature. On the other hand,
cases borderline between the two is very thin. expenditure incurred for major repair of the asset
so as to increase its productive capacity is capital in
Basic consideration for distinction nature. However, determination of the cost of
Points to be considered for capital or revenue maintenance and ordinary repairs which should be
classification expensed, as opposed to a cost which ought to be
capitalized, is not always simple.
Nature of Business
Recurring nature of expenditure EFFECT ON REVENUE GENERATING CAPACITY OF
Purpose of expenses BUSINESS
Effect on revenue generating capacity of
The expenses which help to generate
business
Materiality of the amount involved income/revenue in the current period are revenue
in nature and should be matched against the
revenue earned in the current period. On the other
hand, if expenditure helps to generate revenue
Considerations in determining Capital &
over more than one accounting period, it is
Revenue Expenditure generally called capital expenditure.
The basic considerations in distinction between
When expenditure on improvements and repair of
capital and revenue expenditures are:
a fixed asset is done, it has to be charged to Profit
NATURE OF BUSINESS and Loss Account if the expected future benefits
from fixed assets do not change, and it will be
For a trader dealing in furniture, purchase of included in book value of fixed asset, where the
furniture is revenue expenditure but for any expected future benefits from assets increase.
other trade, the purchase of furniture should be
treated as capital expenditure and shown in the MATERIALITY OF THE AMOUNT INVOLVED
balance sheet as asset. Therefore, the nature of Relative proportion of the amount involved is
business is a very important criteria in separating another important consideration in distinction
an expenditure between capital and revenue. between revenue and capital. Even, if expenditure
does not increase the productive capacity of an
RECURRING NATURE OF EXPENDITURE
asset, it may be capitalized because the amount is
If the frequency of an expense is quite often in an material or expenditure may increase the asset
accounting year then it is said to be an expenditure value and yet to be expensed because the amount
of revenue nature while non-recurring expenditure is immaterial.
is infrequent in nature and do not occur often in an
accounting year. Monthly salary or rent is the
example of revenue expenditure as they are
incurred every month while purchase of assets is
not the transaction done regularly therefore,
classified as capital expenditure unless materiality
criteria defines it as revenue expenditure.
DEFERRED REVENUE EXPENDITURES
Is that expenditure for which payment has been REVENUE RECEIPTS
made or a liability incurred but which is carried
Receipts which are obtained in course of normal
forward on the presumption that it will be of
business activities are revenue receipts (e.g.
benefit over a subsequent period or periods.
receipts from sale of goods or services, interest
In short, it refers to that expenditure that is, for
income etc.)
the time being, deferred from being charged
against income. Such suspension of ‘charging of’ Revenue and capital receipts are recognized on
operation may be due to the nature of accrual basis as soon as the right of receipt is
expenses and the benefits expected there from. established. Revenue receipts should not be
It should be revenue expenditure by nature in equated with the actual cash receipts. Revenue
the first instance. But its matching with revenue receipts are credited to the Profit and Loss Account.
may be deferred considering the benefits to be
accrued in future. CAPITAL RECEIPTS
A thin line of difference exists between deferred Receipts which are not revenue in nature are
revenue expenses and prepaid expenses. The capital receipts (e.g. receipts from sale of fixed
benefits available from prepaid expenses can be assets or investments, secured or unsecured loans,
precisely estimated but that is not so in case of owners’ contributions etc.).
deferred revenue expenses.
As per para 56 of AS 26 “Intangible Assets”, in some
Capital receipts are not directly credited to Profit
cases expenditure is incurred to provide future
and Loss Account
economic benefits (for more than one accounting
period) which does not create an asset to be For example, when a fixed asset is sold for 92,000
recognized in the books of an entity. Such expenses (cost 90,000), the capital receipts 92,000 is not
should be charged to profit and loss account in the credited to Profit and Loss Account. Profit/Loss on
year the amount is incurred. sale of fixed assets is calculated and credited to
Profit and Loss Account as follows:
However, it may be noted that accounting issues of
specialised nature such as accounting for discount Sale Proceeds Rs. 92,000
or premium relating to borrowings and ancillary Cost (Rs. 90,000)
costs incurred in connection with the arrangement Profit Rs. 2,000
of borrowings, share issue expenses and discount
allowed on the issue of shares may be deferred for
CLASSIFY THE FOLLOWING EXPENDITURES AND
more than one accounting period.
RECEIPTS AS CAPITAL OR REVENUE
For example, insurance premium paid say, for the
year ending 30th June, 2011 when the accounting Question: ₹.10,000 spent as travelling expenses
year ends on 31st March, 2011 will be an example of the directors on trips abroad for purchase of
of prepaid expense to the extent of premium capital assets.
relating to three months’ period i.e. from 1st April,
Answer: Capital expenditure.
2011 to 30th June, 2011. Thus the insurance
protection will be available precisely for three Question: Amount received from Trade
months after the close of the Year and the amount receivables during the year.
of the premium to be carried forward can be
calculated exactly. Answer: Revenue receipt.
CAPITAL RECEIPTS & REVENUE RECEIPTS
Question: Amount spent on demolition of
building to construct a bigger building on the
same site.
Answer: Capital expenditure.
Question: Insurance claim received on account of
a machinery damaged by fire.
Answer: Capital receipt.
Example
Question: M/s Dogra & Co. installed machinery
for ₹. 500,000 on 1.1.2005. They were charging
deprecation on straight line basis taking useful
life of the machine as 10 years In December, 2011
they found that the machine became obsolete
which could not be used. The machine can fetch
only ₹. 50,000. Compute the Obsolete loss.
Answer: Loss arising out of obsolescence of
machinery is revenue expenditure. This loss is to
be charged against revenue of the year in which
such loss is recognized. In this case, loss due to
obsolescence is:
Cost 500,000
Less: Depreciation 2005- 2011 (350,000)
Written down value at the end of 150,000
2011
Less: Estimates scrap value (50,000)
This loss is revenue loss in nature 100,000
1. Money spent ₹.10,000 as traveling expenses of
the directors on trips abroad for purchase of
capital assets is
A. Capital expenditures
B. Revenue expenditures
C. Deferred revenue expenditures
D. None of the above
2. Amount of ₹.5,000 spent as lawyers’ fee to
defend a suit claiming that the firm’s factory site
belonged to the plaintiff’s land is
A. Capital expenditures
B. Revenue expenditures
C. Deferred Revenue expenditures
D. None of the above
3. Entrance fee of ₹.2,000 received by Ram and wiring system is ₹. 19,000; the amount to be
Shyam Social Club is expensed is
A. Capital receipt A. ₹. 299,000
B. Revenue receipt B. ₹. 44,000
C. Capital expenditures C. ₹. 30,000
D. Revenue expenditures D. ₹. 49,000
4. Subsidy of ₹. 40,000 received from the 11. ₹.1,200 spent on the repairs of machine is
government for working capital by a A. Capital expenditures
manufacturing concern is B. Revenue expenditures
A. Capital receipt C. Deferred Revenue expenditures
B. Revenue receipt D. None of the above
C. Capital expenditures 12. ₹.2,500 spent on the overhaul of machines
D. Revenue expenditures purchased second-hand is
5. Insurance claim received on account of A. Capital expenditures
machinery damaged completely by fire is B. Revenue expenditures
A. Capital receipt C. Deferred Revenue expenditures
B. Revenue receipt D. None of the above
C. Capital expenditures 13. Whitewashing expenses are
D. Revenue expenditures A. Capital expenditures
6. Interest on investments received from UTI is B. Revenue expenditures
A. Capital receipt C. Deferred Revenue expenditures
B. Revenue receipt D. None of the above
C. Capital expenditures 14. Paper purchased for use as stationery is
D. Revenue expenditures A. Capital expenditures
7. Amount received from IDBI as a medium term B. Revenue expenditures
loan for augmenting working capital is C. Deferred Revenue expenditures
A. Capital expenditures D. None of the above
B. Revenue expenditures 15. Which of the following is false?
C. Capital receipt A. The capital expenditure incurred leads to
D. Revenue receipt tangible or intangible assets and hence,
8. A second hand car is purchased for ₹. 10,000, the posted to the assets side of Balance sheet.
amount of ₹. 1,000 is spent on its repairs, ₹. 500 is B. The obsolescence of machinery (loss) is
incurred to get the car registered in owner’s name generally considered as revenue
and ₹. 1,200 is paid as dealer’s commission. The expenditure
amount debited to car account will be C. Capital Expenditure generates enduring
A. ₹. 10,000 benefits and helps in revenue generation
B. ₹. 10,500 over more than one accounting period.
C. ₹. 11,500 D. When an expenditure increases the
D. ₹. 12,700 previously assessed standard of
9. Revenue from sale of products, ordinarily, is performance of an asset, then it is
reported as part of the earning in the period in considered as revenue expenditure
which
A. The sale is made.
B. The cash is collected.
C. The products are manufactured.
D. The planning takes place.
10. If repair cost is ₹. 25,000, whitewash expenses are
₹. 5,000, cost of extension of building is ₹.
250,000 and cost of improvement in electrical
