How to Treat capital and revenue expenditures, how to distinguish between them

 Treatment of capital and revenue expenditure 

Expenditure means spending on something.

 This can be a payment is cash or can also be the exchange of some valuable item in exchange for goods or services. It is the process of causing a liability by a commodity. 

An expense is a word very similar to expenditure but expense shows the deduction in the value of the asset while expenditure simply denotes the obtaining of assets.

 Two types of expenditures are present on the basis of time durations, That is 

 Capital expenditures 

 Revenue expenditures 

There different types of capital expenditure, for example 

 Cash money spent on business purposes. 

 Purchasing of Plants and machinery items 

 IT items 

 Electric power equipment 

 Permanent additions to existing fixed assets 

There are two sub-categories of revenue expenditures: 

 Direct Expenses: (PRODUCT KO BNANE ME KHARCHA KARNA)

These include the cost of manufacturing of raw material to turn it into a finished product. For instance, Productive wages and salaries to workers, shipping costs, legal expenses, electricity, and water bills, fuels costs, rent, commissions, packaging charges. 

 Indirect Expenses: ( BECHNE ME KHARCHA KARNA)

These connect with only selling and distributing goods other than manufacturing. For example, salaries, depreciation, machinery, items of furniture and fixing, etc.

Capital Expenditure 

Consider the following points to decide the nature of capital expenditure:

  The expenditure, the benefit of which cannot be consumed or utilized in the same accounting period should be treated as capital expenditure. 

 Expenditure incurred to acquire fixed assets for the company. 

 Expenditure incurred to acquire fixed assets, erection and installation charges, transportation of assets charges, travelling expenses directly relates to purchase fixed assets are covered in capital expenditure. 

 Capital addition to any fixed assets which increases the life or efficiency of those assets; for example, additional expenses made on a building. 

Revenue Expenditure 

The benefit of which is consumed in the same accounting year in which those are incurred comes under the category of revenue expenditure. 

Following are a few examples of revenue expenditure −

 Purchases 

 Wages 

 Freight inward & outward

 Salary and wages

 Selling and distribution expenditure 

 Depreciation 

 Assets purchased for resale purpose

  Repairs and renewal expenditure which are necessary to keep fixed assets in running and efficient conditions

Rules for Determining Capital Expenditure 

An expenditure can be recognized as capital if it is incurred for the following purposes: 

� 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 a revenue expenditure because he deals in second hand motor cars. 

� When an expenditure is incurred to improve the present condition of a machine or putting an old asset into working condition, it is recognized 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 ` 5,00,000 and pays `20,000 as transportation charges and `40,000 as installation charges, the total cost of the machine comes up to `5,60,000. Similarly, if a building is purchased for `1,00,000 and `5,000 is spent on registration and stamp duty, the capital expenditure on the building stands at `1,05,000. 

� If an expenditure is incurred to increase earning capacity of a business, it will be considered as capital expenditure. 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. 

� 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.

 Note: One useful way of recognizing expenditure as capital is to see that because of the expenditure, the business will own something which qualifies as an asset at the end of the accounting period.

Rules for Determining Revenue Expenditure 

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

 An expenditure is recognized as revenue when it is incurred for the following purposes: 

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.

 Expenditure on consumable items, on goods and services for resale either in their original or improved form. Examples are purchases of raw materials, office stationery, and the like. At the end of the year, there may be some revenue items (stock, stationery, etc.) still in hand. These are generally passed over to the next year though they were acquired in the previous year.