Capital Expenditure and Revenue Expenditure Examples

 

Capital Expenditure and Revenue Expenditure

Introduction

Capital Expenditure and Revenue Expenditure: Accounting aims in ascertaining and presenting the results of the business for an accounting period. For ascertaining the periodical business results, the nature of transactions should be analyzed whether they are of capital or revenue nature. The Revenue Expense relates to the operations of the business of an accounting period or to the revenue earned during the period or the items of expenditure, benefits of which do not extend beyond that period. Capital Expenditure, on the other hand, generates enduring benefits and helps in revenue generation over more than one accounting period. Revenue Expenses must be associated with the physical activity of the entity. Therefore, whereas production and sales generate revenue in the earning process, the use of goods and services in support of those functions causes expenses to occur. Expenses are recognised in the Profit & Loss Account through matching principle which tells us when and how much of the expenses to be charged against revenue. A part of the expenditure can be capitalised only when these can be traced directly to definable streams of future benefits.

The distinction of the transaction into revenue and capital is done for the purpose of placing them in the Profit and Loss account or in the Balance Sheet. For example, revenue expenditures are shown in the profit and loss account as their benefits are for one accounting period i.e. in which they are incurred while capital expenditures are placed on the asset side of the balance sheet as they will generate benefits for more than one accounting period and will be transferred to profit and loss account of the year on the basis of utilisation of that benefit in particular accounting year. 

Example (A)

State with reasons whether the following are Capital or Revenue Expenditure

(l) Expenses Incurred in connection with obtaining a license for starting the Company?

(2) 50,000 paid for the removal of Inventory to a new site.

(3) Rings and Pistons of an engine were changed at a cost of 25,000 to get fuel efficiency.

(4) Money paid to Reliance JIO 1,00,000 for installing Wi-Fi Connection in the office.

(5) A Company Building constructed at a cost of 10,00,000. A sum of 15,000 had been incurred in the construction of temporary huts for staying the guards.

SOLUTION

(1) Money paid 30,000 for obtaining a license to start a Company is a capital expenditure. This is an item of expenditure incurred to acquire the right to carry on business.

(2) 50,000 paid for the removal of Inventory to a new site is revenue expenditure. This is neither bringing enduring benefit nor enhancing the value of the asset.

(3) 25,000 spent in changing Rings and Pistons of an engine to get fuel efficiency is capital expenditure.
This is an item of expenditure on the improvement of a fixed asset. It results in increasing the profit-earning capacity of the business by cost reduction.

(4) Money deposited with JIO for installation of Wi-Fi Connection in the office is not expenditure. This is treated as an asset and the same is adjusted over a period of time against actual Internet bills.

(5) Cost of construction of the building including the cost of temporary huts is capital expenditure. The building is a fixed asset that will generate enduring benefits to the business over more than one accounting period. The construction of temporary huts is incidental to the main construction. Such cost is also capitalised with the cost of building.

Difference Between Capital Expenditure and Revenue Expenditure 

Capital Expenditure	Revenue Expenditure
For any other trade, the purchase of furniture should be treated as capital expenditure	But for a trader dealing in furniture, purchase of furniture is revenue expenditure
If non-recurring expenditure is infrequent in nature and do not occur often in an accounting year.	While the frequency of an expense is quite often in an accounting year than it is said to be an expenditure of revenue nature
Expenditure incurred for major repair of the asset so as to increase its productive capacity is capital in nature.	On the other hand, expenses for repairs of the machine may be incurred in the course of normal maintenance of the asset. Such expenses are revenue in nature.
If expenditure helps to generate revenue over more than one  accounting period, it is generally called capital expenditure.	On the other hand, the expenses which help to generate income/ revenue in the current period is revenue in nature and should be matched against the revenue earned in the current period.
The value of the existing assets is to be added under the Capital Expenditure.	But the value of the existing assets is to be added under the Revenue Expenditure.

CAPITAL RECEIPTS AND REVENUE RECEIPTS

Just as a clear distinction between Capital and Revenue expenditure is necessary, in the same manner,

Capital Receipts must be distinguished from Revenue Receipts. Receipts that are obtained in course of normal business activities are revenue receipts (e.g., receipts from the sale of goods or services, interest income, etc.). On the other hand, receipts that are not revenue in nature are capital receipts (e.g., receipts from the sale of fixed assets or investments, secured or unsecured loans, owners' contributions, etc.). Revenue and capital receipts are recognised on an accrual basis as soon as the right of receipt is established. Revenue receipts should not be equated with actual cash receipts. Revenue receipts are credited to the Profit and Loss Account.

On the other hand, Capital receipts are not directly credited to the Profit and Loss Account. For example, when

a fixed asset is sold for 1,00,000 (cost 95,000), the capital receipts 95,000 is not credited to Profit and Loss Account. only Profit or Loss on sale of fixed assets is calculated and credited to Profit and Loss Account as follows:

Particular	Amount
Sale Proceeds Less: Cost   Profit	1,00,000 (95,000)
	5,000

 

 

 

 

Example (B)

Good Pictures Ltd., constructs a cinema house and incurs the following expenditure during the first year ending 31^st March 2021.

(i)   Second-hand furniture worth 15,000 was purchased; repainting of the furniture costs (5,000. The furniture was installed by own workmen, wages for this being 500.

(ii)   Expenses in connection with obtaining a license for running the Auditorium worth 25,000. During the course of the year, the company was fined 3,000, for contravening rules. Renewal fee 4,000 for next year also paid.

(iii)  Fire insurance, 2,500 was paid on 1^st October 2020 for one year.

(iv)  Temporary huts were constructed costing 3,200. They were necessary for the construction of the cinema. They were demolished when the cinema was ready.

SOLUTION

(i)         The total cost of the furniture should be treated as 20,500 i.e., all the amounts mentioned should be capitalised since without such expenditure, the furniture would not be available for use. If e 5,000 and 500 have been respectively debited to the Repairs Account and the Wages Account, these accounts will be credited to the Furniture Account.

(ii)     License for running the Auditorium house is necessary, hence its cost should be capitalised. But the fine of 3,000 is revenue expenditure. The renewal fee for the next year is also revenue expenditure but pertains to the next year; hence, it is a prepaid expense.

(iii)     Half of the insurance premium pertains to the year beginning on 1st April 2021. Hence such an amount should be treated as a prepaid expense. The remaining amount is revenue expense for the current year.

(iv)     Since the temporary huts were necessary for the construction, their cost should be added to the cost of the cinema hall and thus capitalised.

Some Other Example

Classify the following expenditures and receipts as capital or revenue:

(i)        20,000 spent as travelling expenses of the directors on trips abroad for the purchase of capital assets.

(ii)      Amount received from Trade receivables during the year.

(iii)    Amount spent on the demolition of building to construct a bigger building on the same site.

(iv)    Insurance claim received on account of machinery damaged by fire.

SOLUTION

(i) Capital expenditure.

(ii) Revenue receipt.

(iii) Capital expenditure.

(iv) Capital receipt.

Are the following expenditures capita/ in nature?

(I)             Sunsing &Co. run a restaurant. They renovate some of the old cabins. Because of this renovation, some space was made free and the number of cabins was increased from 10 to 13. The total expenditure was 20,000.

(ii)      M/S Kolkata Mart Co. sold certain goods on an instalment payment basis. Five customers did not pay instalments. To recover such outstanding instalments, the firm spent e 20,000 on account of legal expenses.

(iii)     M/S Jaiswal & Co. of Durgapur purchased machinery from M/S Agarwal & Co. of Gujrat. M/S Jaiswal & Co. spent 50,000 for transportation of such machinery. The year-end is 31st Dec 2021.

SOLUTION

(i)           Renovation of cabins increased the number of cabins. This has an effect on the future revenue-generating capability of the business. Thus, the renovation expense is capital expenditure in nature.

(ii)      An expense incurred to recover instalments due from customers does not increase the revenue-generating capability in the future. It is a normal recurring expense of the business. Thus, the legal expenses incurred in this case are revenue expenditure in nature.

(iii)     Expenses incurred on account of transportation of fixed asset is capital expenditure in nature.