capital and revenue expenditure

Capital and Revenue Expenditure

Key Takeways: • define capital and revenue expenditure • distinguish between capital and revenue expenditure • classify accounting transactions as capital and revenue expenditure • analyse the effects of differences in classification and treatments of capital and revenue expenditure on profit/loss for the period and non-current assets Source: 7087_y22_sy Principles of Accounts O-Level for 2022 (seab.gov.sg) Definition and differences…

Key Takeways:

• define capital and revenue expenditure 
• distinguish between capital and revenue expenditure 
• classify accounting transactions as capital and revenue expenditure 
• analyse the effects of differences in classification and treatments of capital and revenue expenditure on profit/loss for the period and non-current assets

Source: 7087_y22_sy Principles of Accounts O-Level for 2022 (seab.gov.sg)

Definition and differences between capital and revenue expenditure

A business owner has many other items of expenditure for his business. These items can be classified into two categories:

Capital ExpenditureRevenue Expenditure
Definition:
Spending to purchase or improve
non- current assets 
Definition: Spending to operate or maintain the non-current assets (ongoing operating expenses)
Expenses to put non-current assets to usable conditionCosts to repair and maintain the non-current assets in working condition.
Benefits last more than one accounting period (1 year) Increase the operating efficiency or capacity during their useful life.Contributes to profit–earning and lasts less than one accounting period (1 year) Provides a temporary influence on the profit–making activity.
Shown as Non–Current Assets   Appears in the Statement of financial positionRecorded as Expenses (Income summary) Appears in the Statement of financial performance
Examples of capital expenditure: freight (delivery) charges, import taxes, legal expenses and installation costsExamples of revenue expenditures: Petrol, maintenance expense, insurance expense, car parking, machine oil, renewal expenses
Journal/Accounting Entry Dr Motor vehicle      Cr Cash at bank / other payableJournal/ Accounting Entry Dr Motor vehicle expenses      Cr Cash at bank

Distinction between Revenue and Capital Expenditure

Not every expenditure item is easily classified.

The Materiality concept states that expenditures should be treated as expenses if the value of the item is insignificant (immaterial). For example, although a stapler can last for more than a year, its value is insignificant and thus has little effect on decision making.


Therefore, instead of recording it as an asset, the accounting treatment  is to record it as “stationery expense” in the statement of financial performance.

EFFECTS OF WRONG CLASSIFICATION OF EXPENDITURE

Mis-classifying the category of capital or revenue expenses has consequences: 

 ProfitAssetsEquity
If capital expenditure wrongly allocated to revenue expenditureUnderstatedUnderstatedUnderstated
If revenue expenditure wrongly allocated to capital expenditureOverstatedOverstatedOverstated

TIP! Rather than thinking capital or revenue expenditure, think in examples. If a question asks, what is the effect of classifying capital expenditure as revenue expenditure – ask yourself instead:

“What happens if I classify petrol as motor vehicle”

EXAMPLE:

On 1 July 2020, Chi Huo Guo incurred the following expenditure in relation to his new delivery van.

REQUIRED 

1) Place a tick (✓) in the appropriate column to show whether each item should be treated as revenue or capital expenditure. Explain your answer.

ItemRevenue Expenditure Capital ExpenditureReason
i)Purchase of delivery van $40,000   
ii)COE incurred from the purchase of delivery van $35,000   
iii)Replacement of light bulbs $40   
iv)Refitting vehicle with shelves to increase storage capacity
$5,000
   
v)Maintenance and repairs $1,000   
vi)Vehicle Insurance $1,500   

2) Calculate the total cost of the van. Show your workingsSOLUTION

ItemRevenue Expenditure Capital ExpenditureReason
i)Purchase of delivery van $40,000 Spending to purchase or improve non- current assets
ii)COE incurred from the purchase of delivery van $35,000 Expenses to put assets to usable condition
iii)Replacement of light bulbs $40 Too immaterial to be recorded as capital expenditure
iv)Refitting vehicle with shelves to increase storage capacity
$5,000
 Increase the operating efficiency or capacity during their useful life
v)Maintenance and repairs $1,000 Spending to operate or run the non-current assets
vi)Vehicle Insurance $1,500 Recurring yearly expenses to operate the non-current asset

2) Cost of motor vehicle = $40,000 + $35,000 + $5,000 = $80,000 (all the capital expenditures)