A capital expenditure is one which increases the value at which a fixed or capital asset may properly be carried on in the books. All expenditure which results in the acquisition of permanent assets which are intended to be continually used in the business for the purpose of earning revenue is capital expenditure.
The term capital expenditure is generally used to signify that expenditure which
(i) Increases quantity of fixed assets;
(ii) Increases quality of fixed assets; or
(iii) Results in the replacement of fixed assets.
An addition increases the quantity of fixed asset. Hence amount spent on the purchase of fixed asset is treated as capital expenditure.
• Expenditure resulting in the acquisition of long-lived (fixed) assets, e.g., land, building, machinery, furniture, motor car, trademarks.
• Legal charges and stamp duty paid for conveyancing on acquisition of a property.
• Architect fees paid for supervising construction of a property.
• Cost of stand-by equipment and servicing equipment.
• Cost of experimenting when the same results ultimately in acquisition of a patent.
• Money spent on reducing working capital requirement.
The quality of a fixed asset is said to have increased when expenditure results in any or some of the following events:
(a) When probable useful life of the fixed asset increases;
(b) When capacity of the fixed asset increases;
(c) When efficiency of the fixed asset increases;
(d) When operating economy is achieved;
(e) When quantity of its output increases beyond that originally anticipated.
• Expenditure resulting in extension or improvement of fixed assets, e.g., amount spent on increasing the seating accommodation in the picture hall.
• Expenditure in connection with the purchase, receipt or erection of a fixed asset, e.g., wages paid or expenses on the erection of plant and machinery, expenses on cartage, insurance of a fixed asset.
• Major repairs and replacement of parts resulting in increased efficiency of a fixed asset.
• Expenditure incurred or acquiring the right to carry on a business e.g., patent rights, copyright, goodwill.
This involves a substitution of a new asset or asset component for part or all of an existing asset. .
AN EXPENDITURE CANNOT BE SAID TO BE A CAPITAL EXPENDITURE ONLY BECAUSE:
(i) The amount is large;
(ii) The amount is paid in lump-sum. A capital expenditure can be paid either in lump-sum or instalment;
(iii) The amount is paid out of that fund which has been received out of the sale of fixed asset;
(iv) The receiver of the amount is going to treat it for the purchase of fixed asset.
An amount spent for earning or providing revenue is called revenue expenditure. Revenue expenditure is one which constitutes a proper deduction from income or revenue. It is an expense. In other words, all establishment and other expenses incurred in the conduct and administration of the business come under the heading of revenue expenditure. All expenses incurred by way of repairs, replacement of existing assets, which do not in any way add to their earning capacity but simply serve to maintain the original equipment in an efficient working order are charged to revenue. Examples are:
a) Expenses incurred in the normal course of business, e.g., expenses of administration, expenses incurred in manufacturing and selling products. Examples of such expenses are salaries, rent, insurance, postage, stationery and repairs to assets.
b) Expenses incurred to maintain the business, e.g., replacements for maintaining the existing permanent assets, cost of stores consumed in the course of manufacturing, e.g., oil, cotton-waste, machinery spares consumed and amount spent on replacement of worn-out parts of a machine
c) Cost of goods purchased for resale.
d) Depreciation on fixed assets, interest on loans for business, loss from sale of fixed asset.
DEFERRED REVENUE EXPENDITURE
A heavy expenditure of revenue nature incurred for getting benefit over a number of years is classified as deferred revenue expenditure.
Characteristics of Deferred Revenue Expenses are
(i) the benefit of which is not exhausted in the same year, or
(ii) is applicable either wholly or in part of the future years, or
(iii) is accidental with heavy amount and it is not prudent to charge against the profit of one year.
Preliminary expenses, brokerage on issue of shares and debentures, discount on issue of shares or debentures, exceptional repairs, heavy advertisement, expenses incurred in removing the business to more convenient premises, are examples of such expenses which are essential for carrying on the business and thus revenue in nature.
Capital receipts includes
• Payments or contributions into the business by the proprietor, partners or shareholders towards the capital of the firm
• Any sum received from debenture-holders, any loans
• Any sum Received by the business as a result of Non Current Assets or a source of Income.
Revenue receipts is the outcome of a firm’s activity in the accounting period, part of its rewards for offering goods or services to the public e.g. sales, commission, fees received for services, interest on investment, etc.
Revenue receipts must be set off against the revenue expenses in order to calculate the profit or loss of the business in an accounting period.