In this topic, we would try to distinguish capital expenditure from revenue expenditures and try to elucidate some other related terms. Differentiation between capital and revenue is necessary to come up with the true and fair financial view of an entity since capital expenditures are shown in balance sheet while revenue expenditures are presented in income statement
Amount of money spent on either buying fixed assets or improving the earning capacity of these assets
Therefore, all expenditures are capital expenditures if they are incurred in connection with:
• Purchasing a new fixed asset. Or
• Improving the earning capacity of existing fixed assets / Adding value to existing fixed assets
The cost of purchasing a new fixed asset includes not only the purchase price of fixed asset but also all costs necessary to bring a new fixed asset into business location and workable condition
Examples of a new fixed asset costs include:
- Purchase price of fixed asset itself
- Legal costs in the case of property, land etc.
- Cost related to delivery of fixed asset to business location
- Installation costs of fixed asset at business place
- Demolition costs necessary to remove unwanted things before the installation of a fixed asset
- Inspection and testing fees before a new fixed asset can be used
- Demurrage charges
- All non-refundable tax charges related to the new fixed asset
In addition to the cost of a new fixed asset, capital expenditure could include business money spending on adding value to existing fixed assets which would benefit business for a longer period of time such as more than a year.
Examples of costs incurred on adding value to existing fixed assets:
- Installing an additional motor in machinery to help increase its capacity
- Adding a new fuel tank to existing plant and machinery
- Putting a new engine into an existing vehicle
- Replacing interior wall of the business building
All expenditures other than capital expenditures are referred to as revenue expenditures and they are also known as expenses
Revenue expenditures are day to day expenses of a running business that don’t provide benefits for a long period of time, for example they benefit business financially for less than a year.
Revenue expenditures are incurred either on the following:
• Ordinary course of business for example selling expenses, administrative expenses, financial charges etc. Or
• Maintaining existing value or earning capacity of fixed assets for example repair and maintenance cost of machinery, painting the existing factory building, repair expenses of vehicle etc.