Question

Transaction takes place when one party exchanges or promise to exchange good or service with another party for money. Identify the difference between revenue expenditure and capital expenditure and provide the examples

Answer 1

As per law, transaction takes place when one party exchanges or promises to exchange goods or services with another party for a 'consideration'. Consideration need not be in the form of money.

However, as per Generally accepted Accounting principles (GAAPs) and money measurement concept, only those transactions are recorded in Books of Accounts which can be measured in terms of money.

Capital expenditure:

Capital expenditure is that expenditure which results in acquisition of an asset or which results in an increase in the earning capacity of a business. The benefit of such expenditure lasts for a long period of time.

Examples: Purchases of land, buildings, machinery, furniture, patents, etc. All these assets stay in business and are used again and again. Other examples are money paid for goodwill (like the right to use the established name of an outgoing firm) since it will attract the old firm’s customers and thus will result in higher sales and profits; money spent to reduce working expenses like conversion of hand-driven machinery to power-driven machinery and expenditure enabling a firm to produce a large quantity of goods. Expenditure which does not result in an increase in capacity or in reduction of day-to-day expenses is not capital expenditure, unless there is a tangible asset to show for it.

Revenue expenditure:

Expenses whose benefit expires within the year of expenditure and which are incurred to maintain the earning capacity of existing assets are termed as revenue expenditure. Amounts paid for wages, salary, carriage of goods, repairs, rent and interest, etc., are examples of revenue expenditure. Depreciation on fixed assets is also a revenue expenditure. To the extent the materials are used up, they will be revenue expenditure. Similarly, cost of goods sold is revenue expenditure. Costs incurred to acquire an asset are capital but costs incurred to keep them in working condition or to defend their ownership are revenue. Fee paid to a lawyer for checking whether all the papers are in order before land is purchased is capital expenditure. But if later a suit is filed against the purchaser, the legal costs will be of revenue type.

Differences:

The following are the points of distinction between capital expenditure and revenue expenditure:

(i) Capital expenditure is incurred in acquiring or improving permanent assets which are not meant for resale. But revenue expenditure is a routine expenditure incurred in the normal course of business and includes cost of sales as also the upkeep of fixed assets etc.

(ii) Capital expenditure seeks to improve the earning capacity of the business whereas revenue expenditure is incurred to maintain the earning capacity of the business.

(iii) Capital expenditure is normally a non-recurring outlay but revenue expenditure is usually a recurring features.

(iv) Capital expenditure produces benefits over several years. Hence, only a small part is charged as depreciation to income statement and the rest appears in the balance sheet. But revenue expenditure is consumed within an accounting year and the entire amount is charged to the (current year’s) income statement. Hence, it does not appear in the balance sheet. Deferred revenue expenditure is however an exception to this rule.