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Capital and revenue expenditure

Capital and revenue expenditure

Capital expenditure is expenditure which forms part of the cost of non-current assets.
Revenue expenditure is expenditure incurred for the purpose of the trade or to maintain non-current
assets.

The distinction between capital and revenue expenditure

Capital expenditure
is expenditure which results in the acquisition of non-current assets, or improvements to
existing non-current assets.
-Capital expenditure is not charged as an expense in the statement of profit or loss,
although a depreciation charge will usually be made to write off the capital expenditure
gradually over time.
- Depreciation charges are expenses in the statement of profit or loss.
-Capital expenditure on non-current assets results in the recognition of a non-current asset
in the statement of financial position of the business.

Revenue expenditure
is expenditure which is incurred for either of the following reasons.
-For the purpose of the trade of the business. This includes expenditure classified as
selling and distribution expenses, administration expenses and finance charges.
-To maintain the existing earning capacity of non-current assets.

NB capital expenditure as expenditure that provides long-term benefits (eg a building, item of
machinery) and revenue expenditure as trading costs relating to the short-term (eg electricity, wages).
- the term 'capital' in capital expenditure should not be confused with the capital invested in a
business.

and must be expensed in the statement of profit or loss

Example: capital and revenue expenditure
A business purchases a building for $30,000. It then adds an extension to the building at a cost
of $10,000. The building needs to have a few broken windows mended, its floors polished and
some missing roof tiles replaced. These cleaning and maintenance jobs cost $900.
In this example, the original purchase ($30,000) and the cost of the extension ($10,000) are
capital expenditure, because they are incurred to acquire and then improve a non-current asset
and so can be capitalized as part of it. The other costs of $900 are revenue expenditure, because
these merely maintain the building and thus the 'earning capacity' of the building.

Capital income and revenue income

Capital income is the proceeds from the sale of non-trading assets (ie proceeds from the sale
of non-current assets, including long-term investments). The profits (or losses) from the sale of non-
current assets are included in the statement of profit or loss of a business, for the accounting period
in which the sale takes place. For instance, the business may sell vehicles or machinery which it no
longer needs – the proceeds will be capital income.

Revenue income is income derived from the following sources.

-The sale of trading assets, such as goods held in inventory

-The provision of services
-Interest and dividends received from investments held by the business
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Capital transactions

The categorization of capital and revenue items given above does not mention raising additional
capital from the owner(s) of the business, or raising and repaying loans.
These transactions add to the cash assets of the business, thereby creating a
corresponding liability (capital or loan)
When a loan is repaid, it reduces the liabilities (loan) and the assets (cash)
None of these transactions would be reported through the statement of profit or loss.

Why is the distinction between capital and revenue items important?

Revenue expenditure results from the purchase of goods and services for one of the following
reasons.

-To be used fully in the accounting period in which they are purchased, and so be a
cost or expense in the statement of profit or loss.
-To result in a current asset as at the end of the accounting period because the goods or
services have not yet been consumed or used.

Capital expenditure results in the purchase or improvement of non-current assets, which

are assets that will provide benefits to the business in more than one accounting period, and which
are not acquired with a view to being resold in the normal course of trade. The cost of purchased
non-current assets is not charged in full to the statement of profit or loss of the period in which the
purchase occurs. Instead, the non-current asset is gradually depreciated over a number of
accounting periods in accordance with the accruals concept.

Since revenue items and capital items are accounted for in different ways, the correct and
consistent calculation of profit for any accounting period depends on the correct and consistent
classification of items as revenue or capital.

QUESTION Capital or revenue

State whether each of the following items should be classified as 'capital' or 'revenue'
expenditure or income for the purpose of preparing the statement of profit or loss and the
statement of financial position of the business.
The purchase of a property (e.g. an office building)
The annual depreciation of such a property
Solicitors' fees in connection with the purchase of such a property
The costs of adding extra storage capacity to a computer used by the business
Computer repairs and maintenance costs
Profit on the sale of an office building
Revenue from sales by credit card
The cost of new plant
Customs duty charged on the plant when imported into the country
The 'carriage' costs of transporting the new plant from the supplier's factory to the premises of
the business purchasing the plant
The cost of installing the new plant in the premises of the business
The wages of the machine operators
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ANSWER

Capital expenditure
Depreciation of a non-current asset is revenue expenditure
The legal fees associated with the purchase of a property may be added to the purchase
price and classified as capital expenditure. The cost of the property in the statement of
financial position of the business will then include the legal fees
Capital expenditure (enhancing an existing non-current asset)
Revenue expenditure
Capital income (net of the costs of sale)
Revenue income
Capital expenditure
If customs duties are borne by the purchaser of the non-current asset, they may be added to
the cost of the machinery and classified as capital expenditure
Similarly, if carriage costs are paid for by the purchaser of the non-current asset, they may
be included in the cost of the non-current asset and classified as capital expenditure
Installation costs of a non-current asset are also added to the non-current asset's cost
and classified as capital expenditure
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