Capital and revenue expenditures
The business expenditures are of two types:-
- Capital expenditures
- Revenue expenditures
Definition and explanation of capital expenditures:
An expenditure is a capital expenditure if the benefit of the expenditure extends to several trading years. Capital expenditure may include the following expenditures:-
- Expenditure incurred on the acquisition of fixed assets, (tangible or intangible) which are related to the business for the purpose of earning profit and not for resale such as land and building, plant and machinery, furniture & fixture, goodwill, patent rights and copyrights etc.
- The cost of fixed assets would include all expenditures necessary up to the time the asset is ready for use, for instance, cost of all building purchased would include the price paid to the seller, legal charges and broker’s commission. Similarly, the cost of machinery would include the purchase price, freight, import duty, cartage, octroi duty, erection and installation charges.
- Expenditure which results in an increase in the earning capacity of a business. For instance, expenditure incurred in removing the business to a certain locality or better Situation premises and money paid for goodwill (the right to use the established name of outgoing firm) since it will attract the old firm’s customers and thus resulting in higher sales and profits.
- Money spent on the improvement of existing assets so as to increase their life or reduce the cost of production, for example, conversion of hand driven machine to power-driven machine.
- Expenditure incurred on the extension and addition of existing fixed assets, for instance, the cost of making additions to the building, furniture, machinery, motor vehicles etc.
- Any expenditure which is incurred for raising capital money for business, such as commission and brokerage paid to agent for arranging long term loans, discount on issue of shares and debentures.
Capital expenditure is shown as an asset in the balance sheet.
Examples of capital expenditures
Following are the most important items of capital expenditure:-
- Purchase of factory and building.
- Purchase of machine, furniture, motor vehicle, office equipment etc.
- Cost of goodwill, trademarks, patents, copyright, patterns and designs.
- Expenditure on installation of plant and machinery and other office equipment.
- Additions or extension of existing fixed assets.
- Structural improvement or alterations as to fixed assets which increase their life or earning capacity.
- Preliminary expenses of a limited company.
- Cost of issue of shares and debentures.
- Legal expenses on loans and mortgage.
- Interest on capital during construction period.
- Development expenses in case of mines and plantations.
Definition and explanation of revenue expenditures:
An item of expenditure whose benefit expires within the year is revenue expenditure. Revenue expenditure does not increase the efficiency of the firm.
The expenditure incurred for the following purposes will be treated as revenue expenditure.
- Expenditure incurred for the purpose of floating assets i.e., asset for resale purpose such as cost of merchandise, raw-material and stores required for manufacturing process.
- All establishment and other day-to-day expenses incurred in the conduct and administration of the business such as salaries, rent, taxes, postage, stationery, bank chårges, insurance, advertisement charges etc.
- Expenditure incurred to maintain the fixed assets in proper working condition such as repair, replacement and renewals of building, furniture, machinery etc.
Examples of Revenue expenditures
Following are the important Items of revenue expenditure:
- All expenses incurred in the ordinary conduct of business, such as rent, salaries, wages, manufacturing expenses, carriage, commission, legal charges, insurance and advertisement, free samples, salaries, postage expenses etc.
- Expenses incurred by way of repairs, renewals and replacement for the purpose of maintaining the existing fixed assets of the business in working order.
- Cost of merchandise bought for resale.
- Cost of raw-material and stores purchased for manufacturing process.
- Wages paid for manufacture of products for sale.
- Depreciation of assets used in business.
- Interest on loan borrowed for business.
- Freight and cartage paid on merchandise purchased.
- Cost of oil to lubricate machinery.
- Service to vehicle.
- Any kind of expenditure incurred in defending lawsuit regarding sale or purchase of merchandise.