Definition

Heavy expenditure of a revenue nature, the benefit of which is available for a period of two or three (or even more) years, is known as capitalized or deferred revenue expenditure.

Explanation

This expenditure is not written off from the profits of the year in which it was incurred; instead, it is spread over the number of years for which the benefit is expected to last.

To maintain steady growth, it is advisable to spread this expenditure equally over the number of years for which it is anticipated that the benefit will be enjoyed by the business.

Examples

Examples of capitalized or deferred revenue expenditure include:

  • Exceptional repairs of a non-recurring nature by way of overhauling of the plant and machinery
  • Advertising payments made under a contract extending over a period of more than one year
  • Large amount allocated to advertisements in one year to popularize a new product

Frequently Asked Questions

What is a deferred revenue expenditure?

Deferred revenue expenditure is an expenditure that is incurred today but will not provide benefits until a future accounting period. This type of expenditure is often associated with long-term projects, such as research and development projects, where the benefits of the project will only be realized over a number of years.

What are the benefits of deferring revenue expenditures?

The benefits of deferring revenue expenditures include: - Allowing for the realization of the full benefits of the expenditure over time - Allocating the costs of the expenditure more evenly over time - Minimizing distortions in company performance that can be caused by revenue expenditure timing

Are there any drawbacks to deferring revenue expenditures?

The main drawback of deferring revenue expenditures is that it can result in a higher tax bill in the short term. This is because, in most jurisdictions, taxes are paid on profits in the year in which they are earned. Thus, if a company defers a revenue expenditure, it will have lower profits in the year in which the expenditure is incurred and this could result in a higher tax bill.

How are deferred revenue expenditures accounted for?

Deferred revenue expenditures are generally accounted for by recording a liability on the balance sheet. This liability is then amortized over time, with the expense being recognized in the income statement in each period that the benefit is realized.

Are there any other considerations when accounting for deferred revenue expenditures?

Yes. In some cases, it may be necessary to adjust the carrying value of a deferred revenue expenditure if there is a change in the estimate of the future benefits to be received. For example, if a research and development project is expected to take longer to complete than originally thought, the carrying value of the deferred revenue expenditure would need to be increased. Conversely, if the project is completed sooner than expected, the carrying value would need to be decreased.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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