Capital and Revenue Expenditure

In an earlier context, the difference between "expense" and "expenditure" has been explained. It is emphasised that every expense is an expenditure, but every expenditure is not necessarily an expense. In accounting parlance, the two words are not synonyms. Business expenses which affect directly the profits for the accounting period are called REVENUE expenditure. Expenditure items which do not directly affected the profit (of the accounting period) but the benefits of which are available over longer periods of business (ordinarily at least for, say, four to five years) are called CAPITAL expenditure. Another way of saying these is as under. Payments in respect of which service has already been obtained and no further service will be available unless further payment is made are REVENUE expenditures. Telephone bills on a running basis, wages/salaries, rents paid - are all examples of revenue expenditure. Payments in respect of which service will be available for many years to come are CAPITAL expenditures. Installation charges for a telephone, a machine, electrical fittings, equipment erection - are all examples of capital expenditure. 

Revenue expenses (or expenditure) are to be charged off to the P & L A/c as an expense relating to the year. Only that portion for which payment is made in advance for the next year will be shown in the BS. 

Capital expenditure is really (the means or transaction of acquiring) an asset. It has to be shown in the BS after a proper portion out of it, because of wear and tear, is charged as revenue expense to the P & L A/c. 

Capital expenditure is characterised by two features. Firstly, barring a few exceptions, cash may be realised through the disposal of the asset concerned, though short of (occasionally in excess of, e.g. in case of land) the amount originally spent on acquiring the asset. However, the intention in the acquisition is not for resale. That is to say, all tangible things (or assets) (and intangible ones too) acquired and kept for use (though also capable of being sold off) are capital expenditure. Secondly, they increase the earning capacity of the organisation. This may be by larger production of goods or lower cost of production. (Note that reducing existing expenses is not the sole result; existing expenses may or may not be reduced). Put differently, an existing assist may be improved by increasing its efficiency (by addition, substitution, renovation); or there may result economy in operation of existing assets (e.g. attaching a power-driven motor to a hand-driven machine). 

An extension of the second feature involves an expenditure incurred on a new (or newly acquired) asset to bring it to workable condition. Examples are : Installation, Electrical Wiring, Erection of guard frames, etc. after first purchase of a machine. (By "newly acquired", we include also second-hand purchases.) In other words, all expenses (though called as expenses - i.e. incurred within the accounting period for specific purposes and unlikely to be incurred again for the same purpose) incurred in making the asset ready for operation for the first time will be added to the cost of the asset and thus capitalised. 

• When buying a building, the deed-writer's fee, the lawyer's fee to verify the title deed if fully in favour of the seller and to verify no-encumbrances, broker's commission, etc. will be added to the first, or acquiring, cost of the building. 
• If a machine is bought second-hand, the cost of overhauling it initially, renewing the upholstery of the car purchased second-hand, making the platform for erecting the mono block pump-motor together with wiring, switch board panel, guard frames, etc. -will all be capitalised. 
• Interest paid on loan taken to acquire an asset, till it is made operational, would be added to the cost of the asset to set its capitalised value. 

Expenses incurred in merely maintaining the assets in proper working condition are revenue expenses. 

Following are some of the examples of revenue expenses : 

• Any annual repairs for the building, including painting, white or colour washing, changing of fittings when damaged (of minor costs) are revenue expenses. 
• Operation, maintenance and repair costs (OMR) like diesel, lubricants, etc. included, constitute revenue expenses. 
• Interest after the date the asset is ready to operate (no matter if operated or not) is revenue expense. 

Capital expenditure is also called Capital outlay. The portion which is earmarked for a particular accounting period (because of wear and tear) is called Depreciation. Depreciation goes to the P & L Arc and is reduced from the capital outlay. The rest is called cost-residue or written-down value (WDV) and is transferred to BS. Since capital expenditure (or residual part thereof) is transferred to BS, it is called also as Balance Sheet expenditure. Like the term "expanse" associated with Revenue expenditure, so are the terms "outlay" and. "residue" and capital expenditure. 

To recall, revenue expenditure is incurred to maintain the earning capacity of the business, and capital expenditure is incurred to improve the earning capacity of the business. Acquiring  and initiating are also part of improving. Moreover, there is no discernible intention of reselling in the case of capital expenditure.