TOPIC: CAPITAL EXPENDITURE AND REVENUE EXPENDITURE

 

Capital Expenditure

Capital expenditure can be defined as expenditure incurred on-

1. The purchase of fixed assets, For example, the purchase of a car to be use to deliver goods is capital expenditure.

2. Alteration or improvement of fixed assets.

 

Rules for Determining Capital Expenditure

Rule 1:- An expenditure incurred for the purpose of acquiring long term assets (useful life is at least more than one accounting period) for use in business to earn profits and not meant for resale, will be treated as a capital expenditure.

 

For example, if a second hand motor car dealer buys a piece of furniture with a view to use it in business, it will be a capital expenditure. But if he buys second hand motor cars, for re-sale, then it will be revenue expenditure because he deals in second hand motor cars.

 

Rule 2:- When expenditure is incurred to improve the present condition of a machine or putting an old asset into working condition, it is recognised as a capital expenditure. The expenditure is capitalized and added to the cost of the asset. Likewise, any expenditure incurred to put an asset into working condition is also a capital expenditure. • For example, if one buys a machine for Rs. 5,00,000 and pays Rs. 20,000 as transportation charges and Rs. 40,000 as installation charges, the total cost of the machine comes up to Rs. 5,60,000.

 

Similarly, if a building is purchased for Rs. 1,00,000 and Rs. 5,000 is spent on registration and stamp duty, the capital expenditure on the building stands at Rs. 1,05,000.

 

Rule 3:- If expenditure is incurred, to increase earning capacity of a business will be considered as of capital nature. For example, expenditure incurred for shifting the factory for easy supply of raw materials. Here, the cost of such shifting will be a capital expenditure.

 

Rule 4:- Preliminary expenses incurred before the commencement of business is considered capital expenditure.

 

For example, legal charges paid for drafting the memorandum and articles of association of a company or brokerage paid to brokers, or commission paid to underwriters for raising capital.

 

Treatments of Capital Expenditures

·       Capital expenditures are shown in the Balance Sheet Assets Side.

·       When we do journal entries for capital expenditures than we will add full cost in value of machine.

 

Ex: - if a building is purchased for Rs. 1,00,000 and Rs. 5,000 is spent on registration and stamp duty, the capital expenditure on the building stands at Rs. 1,05,000

 

Building A/c Dr.    105000

 

                To Cash a/c     105000

 

Some examples of capital expenditure:

(i) Purchase of land, building, machinery or furniture;

(ii) Cost of leasehold land and building:

(iii) Cost of purchased goodwill:

(iv) Preliminary expenditures;

(v) Cost of additions or extensions to existing assets:

(vi) Cost of overhauling second-hand machines:

(vii) Expenditure on putting an asset into working condition, and

(viii) Cost incurred for increasing the earning capacity of a business

 

Revenue Expenditures

Revenue expenditure is expenditure incurred in the running/management of the business.

 

For example, the cost of petrol or diesel for cars is revenue expenditure.

 

Rules for Determining Revenue Expenditure

 

Any expenditure which cannot be recognised as capital expenditure can be termed as revenue expenditure. Revenue expenditure temporarily influences only the profit earning capacity of the business

 

Rule 1:- Expenditure for day-to-day conduct of the business, the benefits of which last less than one year.

 

Examples are wages of workmen, interest on borrowed capital, rent, selling expenses, and so on.

 

Rule 2:- Expenditure-

ü on consumable items,

ü on goods and services for resale either in their original or improved form.

 

Examples are purchases of raw materials, office stationery, and the like.

 

Rule 3:- Expenditures incurred for maintaining fixed assets in working order.

 

For example, repairs, renewals and depreciation.

 

Some examples of revenue expenditure

 

(i) Salaries and wages paid to the employees;

(ii) Rent and rates for the factory or office premises;

(iii) Depreciation on plant and machinery;

(iv) Consumable stores;

(v) Inventory of raw materials, work-in-progress and finished goods;

(vi) Insurance premium:

(w) Taxes and legal expenses, and

(viii) Miscellaneous expenses.

 

Treatments of Revenue Expenditures

§  Revenue Expenditures are shown in the Trading and Profit And Loss Account debit side.

§  When we make journal entries of revenue expenditure transaction than it will Show as separate expenditure, not add in cost of assets.

 

-Repair expenditure on machinery Rs 1,000

 

Repair a/c Dr.          1000

 

To Cash a/c             1000

 

Treatment of Revenue Expenditure as Capital Expenditure:

The following are some of the instances where an item expenditure will be treated as capital expenditure

 

1. Repairs: Repairs expenditure is revenue in nature, but huge amount incurred on a second hand machinery in order to bring it to working condition can be treated as capital expenditure and should be added to the cost of Machinery

 

2. Wages: Normally, wages are revenue in nature. But wages paid to the workers for the construction or installation of fixed assets, will be treated as capital expenditure and added to the cost of that asset.

 

3. Preliminary Expenses: All the expenses paid in the process of formation of a company should be treated as capital expenditure and recorded in the balance sheet on asset side.

 

4. Brokerage, Government Stamp Duty and Legal Expenses: All the expenses paid on the purchase of a property will be regarded as capital expenditure.

 

5. Raw Materials and Stores: These are generally revenue in nature, but if raw materials and stores consumed in the making of a fixed asset, the same should be treated as capital expenditure.

 

6. Development Expenditure: All the expenditure incurred for the development of mines and plantations should be treated as capital expenditure.

 

MCQ OF CAPITAL AND REVENUE EXPENDITURES

1.  An expenditure is capital in Nature when –

 

a)  The receiver of the amount is going to treat it for the purchase of fixed assets.

b)  It increase the quantity of fixed assets

c)  It is paid as interests on loans for the business

d)  It is maintains a fixed assets

 

2. Capital expenditures are recorded in the-

 

(a) Balance sheet

(b) Profit and loss A/c

(c) trading a/c

(d) manufacturing a/c

 

3. Which of the following transaction is of capital nature

 

(a) Purchases of a truck

(b) Replacement of old trucks

(c) Cast of repairing of truck

(d) all of the above

 

4. Rs. 10,000 incurred for up gradation of computer by installation of 8GB Ram is

 

(a) Capital expenditure

(b) Deferred revenue expenditure

(c) Revenue expenditure

(d) None of the above

 

5. Cost of goods purchased for resale is an example of

 

(a) Capital expenditure

(6) Revenue expenditure

(c) Deferred revenue expenditure

(d) None of these

 

6. Import duty of raw material purchased

 

(a) Revenue expenditure

(b) Capital expenditure

(c) Deferred revenue expenditure

(d) None of these

 

7. Received from soloman by co., an invoice for Rs. 1500 for repairs to factory walls

 

(a) Revenue expenditure

(b) Capital expenditure

(c) Deferred revenue expenditure

(d) None of these

 

 

8. Company received from government for compulsory acquisition of land

 

(a) Revenue expenditure

(b) Capital expenditure

(c) Deferred revenue expenditure

(d) None of these

 

9. All revenue receipts and expenditures are shown in: -

 

(a) Balance Sheet

(b) Trading and Profit and Loss A/c

(c) Cash Flow Statement

(d) Statement of Affairs

 

10. A bad debt recovered during the year will be

 

(a) Capital expenditure

(b) Revenue expenditure

(c) Capital Receipt

(d) Revenue Receipt

 

 

11. Insurance claim received on account of machinery damaged completely by fire is

 

(a) Capital Receipt

(b) Revenue receipt

(c) Capital expenditures

(d) Revenue Expenditure

 

12. Amount of Rs. 5,000 spent as lawyers' fees to defend a suit claiming that the firm's factory site belonged to the plaintiff's land is

 

(a) Capital expenditures

(b) Revenue Expenditure

(c) Deferred revenue expenditures

(d) None

 

13. Money spent Rs.10,000 as travelling expenses of the directors on trips abroad for purchase of capital assets is

 

(a) Capital expenditures

(b) Revenue Expenditures

(c) Deferred revenue expenditures

(d) None (CBSE UGC NET June 13 Paper 2)

 

14. Insurance expenses paid to bring an equipment from the place of purchase to the place of installation is a type of –

 

(A) Capital expenditure

(B) Revenue expenditure

(C) Deferred revenue expenditure

(D) Operating expense

 

(CBSE UGC NET June 13 Paper 2)

 

15. Which one of the following statements is true?

 

(A) Capital expenditure does not affect the profitability of a concern but revenue expenditure does.

(B) Capital expenditure affects the profitability of a concern directly but revenue expenditure does not

(C) Capital expenditure affects the profitability of a concern indirectly but revenue expenditure affects directly

(D) Both capital expenditure and revenue expenditure affect the profitability of a concern directly.

(KEARLA SET - June 13 Paper 2)

 

 

 

16. Wages paid to a worker for installing machinery is:

 

A) Debited to Wages a/c

B) Debited to Installation expenses a/c

C) Debited to Machinery a/c

D) Debited to Salary a/c

 

(KEARLA SET - June 13 Paper 2)

 

17. Subsequent expenditure that extends the useful life, improve quality of output or reduce operating cost of an existing asset beyond its originally estimated levels is:

 

A) Capital expenditure

B) Revenue expenditure

C) Deferred revenue expenditure

D) None of these

 

(KEARLA SET June 13 Paper 2)


18. In conventional accounting, the amount spent on human resources is taken as---

 

A) Capital expense

B) Revenue expense

C) Deferred revenue expense

D) Revenue and deferred revenue expense