Question

As an auditor, a common task is to verify that expenditures of a company are properly classified as capital or revenue expenditures. Discuss the determinants of such classifications. If an expenditure is capitalized, is such expenditure ever expensed? If so, how?

Answer 1

There are some basic determinants for classification of expenses into Revenue and Capital Expenditure.

Revenue expenditures are basically the expenses that are required for day to day running of business. It can be expenses to generate revenue like COGS and other operating expenses or, it can be the regular repairs and maintenance expenses for maintaining revenue generating assets . Revenue expenses are short term , generally recurring in nature and accounted in Income Statement.

Capital Expenditures on the other hand are the expenditures to acquired Long term assets that add to the Income generation capacity of the organization over a long period. Land , Building, Equipments, etc are the examples of such Long term assets and the costs associated to bring those assets into operating conditio are treated as Capital Expenditure. If any major non recurring overhaul or improvement of the Capital Asset is undertaken later in the life of the Asset that enhances its capacity or productivity , such costs will also be treated as Capital Expenditure. Capital Assets are presented at its net value (less accumulated depreciation ) in the Balance sheet.

Capitalized expenditure is expensed out in the form of Depreciation or amortization expense over the useful life of the Asset. As the Capital Asset in used over a long period , its cost also is consumed over the useful life of the asset in the form of depreciation or amortization. Depreciation /Amortization expense in debited to income statement as expense and credited to Accumulated depreciation account in Balance Sheet as contra entry to Fixed Asset Cost.