In accounting it is important to distinguish between items of capital and revenue expenditure as their treatment in the financial statements differs.
Capital expenditure relates to expenditure on non-current assets which are held for use within the business and not for resale as part of the trade of the business.
For example, a business might purchase a property in which to house a new production facility or an item of plant and machinery to be used in the manufacture of its products. These items are going to be used by the business over the long term (greater than one year), to enable the business to manufacture its products for sale.
It should be noted that expenditure which extends the life of the asset or improves the asset beyond its earlier condition, is also treated as capital expenditure.
As capital expenditure is spent on items which are used over more than one accounting period, the expenditure is not treated as an expense in the income statement, but is included in the balance sheet as a non-current asset of the business, usually under the heading of property, plant, and equipment.
As most non-current assets have a defined useful life (for example a computer might be expected to last for 3 years), in order to match the cost of an asset to the revenue it helps to generate over its useful life, a proportion of the asset is treated as an expense in each accounting period and shown in the income statement under the heading of depreciation.
Revenue expenditure is expenditure which is related to the trade of the business or spent on repairing and maintaining non-current assets in order that they can continue to be used in the business.
For example a business might incur wage costs, pay rent on its premises, or carry out repairs on its plant and machinery. All of these expenditures are incurred for the purposes of the trade and are expected to be consumed within one year. Revenue expenditure is included in the income statement as an expense of the business for the accounting period.
Expenditure on non-current assets which does not increase the life of the asset or improve the asset beyond returning it to its earlier condition, is treated as revenue and not capital expenditure.
Expenditure on inventory is revenue expenditure as inventory is as current asset. When a business purchases inventory the amount consumed is transferred to the income statement as an expense under the heading cost of sales. The remaining expenditure is held under the heading of inventory as a current asset on the balance sheet, until it is consumed in the next accounting period.
Capital and Revenue Expenditure Example
Suppose a business buys a new production machine costing 45,000. The machine is delivered and installed at an additional cost of 2,500. At a later stage the business improves the machine with the addition of a more advanced motor costing 4,000, and carries out minor repairs and maintenance costing 1,100.
The original purchase cost of 45,000 is capital expenditure as it is expenditure on a non-current asset to be used within the business for more than one year. The delivery and installation costs of 2,500 can also be treated as capital expenditure as they are necessary costs of bringing the machine to its present location and condition.
The journal to post the expenditure, assuming it was funded by a bank loan, is as follows.
In this capital and revenue expenditure example, the addition of the new motor improves the machine and the expenditure of 4,000 can also be treated as capital expenditure.
The expenditure on the minor repairs does not improve the machine beyond its previous condition and does not extend the life of the machine, so is treated as revenue expenditure.
The revenue expenditure is posted with the following journal.
In summary, capital expenditure is expenditure on acquiring or improving non-current assets. The expenditure is for the long term (more than one year) and tends to be non-recurring, and is included in the balance sheet of the business.
Revenue expenditure is usually recurring expenditure on the day to day trading activities of the business. The expenditure is short term and is included in the income statement for the current accounting period.
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