Treatment of Capital and Revenue Expenditure

In accounting, every expenditure incurred by a business must be correctly categorized and treated to present a true and fair view of the financial position. Broadly, expenditures fall into two categories:

  • Capital Expenditure

  • Revenue Expenditure

Correct classification and accounting treatment are crucial because it impacts both the profit and loss account and the balance sheet. Misclassification may mislead stakeholders and lead to incorrect tax computations and profit reporting.

Capital Expenditure

Capital expenditure (CapEx) refers to money spent by a business to acquire, upgrade, or extend the life of long-term assets. These expenditures offer economic benefits beyond the current accounting period and are not incurred regularly.

Examples

  • Purchase of land, building, plant, and machinery

  • Cost of installation or delivery of fixed assets

  • Legal fees on the purchase of property

  • Major improvements or extension of assets

Characteristics

  • Non-recurring and long-term in nature

  • Provides benefit over several accounting periods

  • Increases the earning capacity of the business

  • Capitalized and shown on the assets side of the balance sheet

Revenue Expenditure

Revenue expenditure (RevEx) is the money spent on the daily operational needs of the business. It is incurred to maintain the existing earning capacity of the business and is consumed within the same accounting period.

Examples

  • Salaries and wages

  • Rent, electricity, and water charges

  • Repairs and maintenance

  • Office stationery and administrative expenses

  • Insurance premiums

Characteristics

  • Recurring and short-term in nature

  • Maintains the existing assets, does not increase efficiency

  • Fully charged to the profit and loss account in the year incurred

  • Necessary for the regular functioning of the business

Key Differences between Capital Expenditure and Revenue Expenditure

Particulars Capital Expenditure Revenue Expenditure
Nature Non-recurring, long-term Recurring, short-term
Benefit Duration More than one accounting period Only current accounting period
Impact on Assets Increases asset base Does not affect asset base
Financial Statement Effect Appears in Balance Sheet (as asset) Charged to Profit & Loss Account
Examples Purchase of equipment, land, building Rent, salaries, utilities

The treatment in the accounting books varies significantly based on the nature of the expense. Here’s a table showing the accounting treatment:

Expenditure Type Accounting Entry Impact on Financial Statements
Capital Expenditure Asset A/c Dr.
 To Bank A/c
Asset added in Balance Sheet
Revenue Expenditure Expense A/c Dr.
 To Bank A/c
Charged as expense in Profit & Loss Account
Depreciation (CapEx) Depreciation A/c Dr.
 To Asset A/c
Depreciation charged in P&L A/c, asset value reduced
Deferred Revenue Exp. Deferred Exp. A/c Dr.
 To Bank A/c
Shown as Asset initially, amortized in future P&L A/c

Deferred revenue expenditure is a revenue expenditure in nature but the benefit lasts more than one accounting period. Hence, instead of charging it off in one year, it is spread over several years.

Examples

  • Heavy advertisement for new product launch

  • Preliminary expenses

  • Development costs for new technology

Treatment

Initially shown on the asset side of the balance sheet and gradually written off in the profit and loss account.

At the time of incurring:
Deferred Revenue Exp. A/c Dr.
 To Bank A/c

At the time of amortization:
Profit & Loss A/c Dr.
 To Deferred Revenue Exp. A/c

Capitalized Revenue Expenditure

Certain revenue expenses, when directly related to bringing a capital asset into use, are capitalized.

Examples

  • Wages paid to workers installing machinery

  • Transportation cost for delivering machinery

Though they are revenue in nature, such costs are added to the value of the asset.

Accounting Treatment

Machinery A/c Dr.
 To Bank/Wages/Carriage A/c

Importance of Correct Treatment

Why It Matters

  • Ensures correct computation of profit

  • Proper representation of assets and expenses

  • Compliance with accounting standards (AS-10, AS-26)

  • Affects decision-making by management, investors, and regulators

  • Prevents overstatement or understatement of income

Errors in Classification: Consequences:

Misclassifying Capital as Revenue

  • Understatement of assets

  • Overstatement of current year’s expenses

  • Lower profit shown

Misclassifying Revenue as Capital

  • Overstatement of assets

  • Understatement of expenses

  • Artificially inflated profits

Both types of misclassification violate the principle of prudence and may lead to legal and audit complications.

Accounting Standards Related:

AS-10 (Revised): Property, Plant and Equipment

  • Governs the treatment and recognition of capital assets.

  • Requires capitalization of all costs necessary to bring an asset to working condition.

AS-26: Intangible Assets

  • Applicable to intangible assets like trademarks, patents, and development costs.

  • Clarifies what can and cannot be capitalized.

Special Cases in Treatment

Expense Treatment

Repairs (extensive, long-term)

Capital Expenditure

Ordinary repairs

Revenue Expenditure

Legal charges for buying land

Capital Expenditure

Rent for office

Revenue Expenditure

Renovation increasing asset life

Capital Expenditure

Advertisement (ordinary)

Revenue Expenditure

Advertisement (for long-term impact, e.g., brand building)

Deferred Revenue Expenditure

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