Expenditure and Classification

An expenditure represents a payment with either cash or credit to purchase goods or services. An expenditure is recorded at a single point in time (the time of purchase), compared to an expense which is allocated or accrued over a period of time. This guide will review the different types of expenditures used in accounting and finance.

Expenditure vs Expense

It’s important to understand the difference between an expenditure an expense. Though they seem similar, they’re actually different and have some important nuances you must know about.

Expenditure: This is the total purchase price of a good or service. For example, a company buys a $10 million piece of equipment that it estimates to have a useful life of 5 years. This would be classified as a $10 million capital expenditure.

Expense: This is the amount that is recorded as an offset to revenues or income on a company’s income statement. For example, the same $10 million piece of equipment with a 5-year life has a depreciation expense of $2 million each year.

Types of Expenditures in Accounting

Expenditures in accounting comprise two broad categories: capital expenditures and revenue expenditures

1. Capital Expenditure

A company incurs a capital expenditure (CapEx) when it purchases an asset with a useful life of more than 1 year (a non-current asset).

In many cases, it may be a significant business expansion or an acquisition of a new asset with the hope of generating more revenues in the long run. Such an asset, therefore, requires a substantial amount of initial investment and continuous maintenance after that to keep it fully functional.  As a result, many companies often finance the project using either debt financing or equity financing.

Because the investment is a capital expenditure, the benefits to the business will come over several years. As a consequence, it cannot deduct the full cost of the asset in the same financial year.  Therefore, it spreads these deductions over the useful life of the asset. The value of this asset will be shown on the balance sheet, under non-current assets, as part of plant, property, and equipment (PP&E).

Example 1

Let’s say Company Y deals with iron sheet manufacturing. Due to the increase in demand for its high profiled iron sheets, the company executives decide to buy a new minting machine to revamp production. They estimate the new machine will be able to improve production by 35%, thus closing the gap in the demanding market. Company Y decides to acquire the equipment at the cost of $100 million. The useful life of the machine is expected to be 10 years.

In this case, it is evident that the benefit of acquiring the machine will be greater than 1 year, so a capital expenditure is incurred. Over time, the company will depreciate the machine as an expense (depreciation).

2. Revenue Expenditure

A revenue expenditure occurs when a company spends money on a short-term benefit (i.e., less than 1 year). Typically, these expenditures are used to fund ongoing operations which, when they are expensed, are known as operating expenses. It is not until the expenditure is recorded as an expense that income is impacted.

Deferred Revenue

Deferred Revenue Expenditure is an expense which is incurred while accounting period. And the result and benefits of this expenditure are obtained over the multiple years in the future. For example, revenue used for advertisement is deferred revenue expenditure because it will keep showing its benefits over the period of two to three years. Thus, the profit and loss account statement is prepared as a periodic statement.

Capital expenditure leads to the purchase of an asset or which increases the earning capacity of the business. The organization derives benefit from such expenditure for a long-term.

For example, the purchase of building, plant and machinery, furniture, copyrights, etc.

On the other hand, revenue expenditure is that from which the organization derives benefit only for a period of one year and it only helps in maintaining the earning capacity of the business.

For example, the cost of raw materials, labour expenses, depreciation on assets, etc. However, there is also one more category of expenses, often referred to as Deferred Revenue Expenditure.

These expenses are revenue in nature but the business derives benefits from these expenses for a period of more than one year.

Though the benefit of these expenses lasts for a number of years, these do not fall under the Capital expenditure. Because these are heavy expenses but do not result in the acquisition of an asset.

The charge of these expenses is proportionately deferred over the period for which its benefits are derived. This is as per the Matching Principle.

Characteristics of Deferred Revenue Expenditure

1. It is revenue in nature.
2. The benefit of this expenditure lasts for a period of more than one accounting year.
3. It pertains wholly or partly for the future years.
4. It is a huge amount of expense and thus, is deferred over a period of time.

Classification of Deferred Revenue Expenditure

1. Expenses partly paid in advance: It is when the firm derives a portion of the benefit in the current accounting year and will reap the balance in the future years. Thus, it shows the balance of the benefit that it will reap in future on the Assetsof the Balance Sheet. For eg. advertising expenditure.
2. Expenditure in respect of services rendered: Such expenditure is considered as an asset as it cannot be allocated to one accounting year. For example, discount on issue of debentures, the cost of research and experiments, etc.
3. Amount relating to exceptional loss: We treat the exceptional losses also as deferred revenue expenditure. For eg. Loss by earthquake or floods, loss by confiscation of property, etc.