LECTURE NOTE FIVE

Capital and Revenue Expenditures

Introduction
When a manufacturing company decides to purchase a new machine for the production of customer goods, two
things are involved. First is the initial cost and the second is the installation cost.
The initial cost of the fixed asset, that is, the machine is classified as capital expenditure, while subsequent
repair and maintenance charges incurred in the future will be classified as revenue expenditure.
In this study session, you will learn about the differences between capital and revenue expenditure in terms of
their features and examples; differences between capital and revenue receipts; and discuss the relationship that
exists between capital and revenue items and the final accounts.

Learning Outcomes for Study Session 5

On completion of this study session, you should be able to:
1.1 Define Expenditure and explain the types of Expenditure
1.2 Differentiate between Capital and Revenue Expenditure
1.3 Explain the differences between Capital and Revenue Receipts
1.4 Discuss Capital and Revenue items in relation to final accounts

5.1 Expenditure
Businesses usually incur expenditure and the type of expenditure they incur determines the kind of benefits they
will derive. Some of the expenditure brings economic benefits to the businesses for a short period of time
within the financial year or accounting period while others benefit the business over a long period of time.
As such, expenditures are classified under different categories and are accounted for differently. Expenditure on
fixed assets is classified into Capital Expenditure and Revenue Expenditure. Figure 5.1 presents this.
For instance, a company buys a machine for the production of biscuits. Whereas the initial purchase and
installation costs would be classified as capital expenditure, any subsequent repair and maintenance charges
incurred in the future will be classified as revenue expenditure. This is so because repair and maintenance costs
do not increase the earning capacity of the machine but only maintains it.

Expenditure

Revenue Capital

Operating Maintenance Renewal Upgrade Expansion New

Figure 6.1: Classification of Expenditure

Figure 5.1 Classification of Expenditure

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5.1.1 Capital Expenditure
Capital Expenditures are payments for the purchase of assets that can be used over and over again in the
business. Normally, such assets can last for more than one accounting period.
The capital expenditure also adds to the value of an existing fixed asset. The benefits of such expenditure to be
derived by the business are spread over a number of years according to the lifespan of the fixed asset.
Capital expenditure includes costs incurred on the acquisition of a fixed asset and any subsequent expenditure
that increases the earning capacity of an existing fixed asset.
The cost of acquisition not only includes the cost of purchases but also any additional costs incurred in bringing
the fixed asset into its present location and condition such as delivery costs.

Features of Capital Expenditure

i. The benefits are not usually fully consumed in a year but spread over several years.
ii. It is the expenditure which results in the purchase or acquisition of asset
iii. It is the expenditure incurred in connection with the purchase of asset.
iv. It is the expenditure incurred to bring an old asset into working condition.
v. It is the expenditure incurred for extending or improving an existing asset to increase its productivity
vi. Capital expenditures are shown in balance sheet.

Examples of Capital Expenditure

 Purchase of fixed assets e. g. land, office equipment
 Extension of premises
 Renovation of premises
 Legal fees involved in the purchases of fixed assets

Purchase costs
Delivery costs
Legal charges
Installation costs Capital
Expenditure
Up gradation costs
Replacement costs

Figure 5.2: Costs associated with capital expenditure

As capital expenditure results in increase in the fixed asset of the entity, the accounting entry is as follows:
Debit Fixed Assets account
Credi
Cash/Payable account
t

5.1.2 Revenue Expenditure

Revenue expenditures are costs incurred for the day-to-day running expenses of the business.
Revenue expenditure incurred on fixed assets includes costs that are aimed at maintaining rather than enhancing
the earning capacity of the assets. These are costs that are incurred on a regular basis and the benefit from these
costs is obtained over a relatively short period of time.
Revenue expenditure is the expenditure which benefits in the current accounting year. It is not
carried forward to the next year or years.

Features of Revenue Expenditure

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1. Its benefits are usually consumed in the normal course of business to run the business and to maintain the
fixed assets of business.
2. It is the expenditure which is incurred on purchase of goods meant for resale
3. It is the expenditure incurred to purchase materials which will be used to convert them into final product.
4. It is a recurring expenditure made to maintain the business.
5. The amount spent is generally small and the benefit is for a short period which is not more than a year.
6. All revenue expenditure are charged to trading and profit and loss account

Examples of Revenue Expenditure

i. Goods bought for resale
ii. All running expenses e.g. rents
iii.Decoration of premises
iv.Depreciation

Revenue Expenditure
Repair costs

Maintenance
charges

Repainting costs

Renewal expenses

Figure 5.3: Cost associated with revenue expenditure

As revenue costs do not form part of the fixed asset cost, they are expensed in the income statement in the
period in which they are incurred.

The accounting entry to record revenue is as follows:

Debit Revenue Expense (Income Statement)
Credi
t Cash/Payable
5.2 Differences between Capital and Revenue Expenditure
The distinction between the nature of capital and revenue expenditure is important so as to enhance easy
identification of each of the expenditures. Only capital expenditure is included in the cost of fixed asset while
revenue expenditures are expensed in the income statement of the business. Further distinctions are summarized
in the table below.
Table 5.1: Differences between Revenue Expenditure and Capital Expenditure
Revenue Expenditure Capital Expenditure

They involve the expenditure for items used for They involve expenditure on assets which last for
the day-to-day running expenses of the business a long time usually

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 They are normally used up within an accounting Their benefits last for over a year
year, that is, one year

They temporarily increases the profit-making They permanently increases the profit-making
capacity of the business capacity of the business

They appear in the Trading and profit and loss They appear in the balance sheet as an increase in
accounts as a reduction to profits the value of assets

Key Differences vs. Capital Expenditure and Operating/Revenue Expenditure

Funds that fall under capital expenditures are for major purchases that will be used in the future. The life of
these purchases extends beyond the current accounting period in which they were purchased. Because
these costs can be recovered only over time through depreciation, companies usually prepare a capital budget
for such expenditure.
Operating expenses represent the day-to-day expenses necessary to run a business. Because these are short-
term costs that are used up in the same accounting period in which they were purchased, it makes sense for
them to have an operating budget.
Capital expenditures are fixed assets like property plant and equipment. Revenue expenditures are short-term
expenses used in the current period or typically within one year.
Capital expenditures are typically a larger amount than revenue expenditures. However, there are
exceptions when large asset purchases are consumed in the short term or in the current period.
Capital expenditures are typically expensed over many periods or years through depreciation whereas
revenue expenditures are expensed in the current year or period.
Capital expenditures are funds used by a company to acquire, upgrade, and maintain physical assets such as
property, industrial buildings, or equipment. Capital expenditures are often used to undertake new projects or
investments by a company. Typically, the purpose of capital expenditures is to expand a company's ability to
generate earnings, whereas revenue expenditures include the operational costs of running a business and the
maintenance costs that are necessary to keep the asset in working order
5.3 Differences between Capital and Revenue Receipts/Income
The differences between capital and revenue income are summarized in the table below:
Many kinds of economic events may lead to a reduced cost of goods and services used in operating programs.
Three of these are listed below along with the different accounting treatments that each should receive.
 Expenditure transactions which include taking a purchase discount or a quantity discount should be
booked and reported net of these kinds of applicable credits.
 When a vendor returns an amount that was overpaid, or offers an after-the-fact rebate or refund which is
conditional upon first sending in a payment, such amounts should be treated as refunds of expenditures,
which reduce previously recorded expenditures. Refunds of expenditures pertaining to current-year
transactions should be credited to expenditure accounts. Refunds of expenditures to be received in a
subsequent year should be accrued as a receivable. Separate accounts should be used for significant
refunds related to a prior year.
 Typically, any fees paid by program clients are revenues and should be credited to current-year revenue
accounts.

Table 6.2: Differences between Revenue and Capital Receipts

Revenue Receipts Capital Receipts
They are related to normal activities of the They are related to activities that are not part of
business the normal activities of the business
Usually credited to Trading and profit and They are credited to the relevant ledger
loss accounts accounts

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5.3.1 Revenue Receipts/Income
Revenue receipts refer to receipts from the normal activities of the business. For example, revenue receipts of a
trading organization are receipts from sale of goods, discounts received, commission received and interest on
bank deposits.
All revenue receipts earned for a particular period, whether payments for them have actually been received or
not, have to be credited to the Trading and Profit and Loss Accounts. This will however, increase the profits of
the business.
Revenue income means income which arises out of and in the course of regular business transactions of a
concern
Sources of Revenue Receipts
i. Revenue from sale of goods
ii. Interest from bank deposits
iii. Cash discounts received from prompt payment
5.3.2 Capital Receipts/Income
Capital income is money that has been invested by the owners or other investors. It is used to set up the
business or to buy equipment. The money is usually used to buy equipment that is going to stay in the business
for a long period of time
Capital income can also refer to receipts that are derived from sources other than the normal trading activities of
the business. It may comprise capital paid by partners, or in the case of a limited company, sums received from
its shareholders or debenture holders, loans and proceeds from the sale of its assets.

5.4 Final Accounts in Relation to Capital and Revenue Items

A final account is a general term used in bookkeeping for the account where the profit or loss of the business is
determined at the end of the accounting period.
Examples of final accounts for the trader are his Trading Account and Profit and Loss Account; for the
manufacturer, they are his Manufacturing Account, Trading and Profit and Loss Account; and for a non-profit
making organization, it is its Income and Expenditure Account. However, it is important to note that the
balance sheet is not an account but a statement of affair.
Revenue expenditure is considered as an expense and must be debited to the final account, whereas revenue
receipts are revenue of the business and must be credited to the final account.
On the other hand, capital expenditure and capital receipt are not brought to the final account but are stated on
the balance sheet of the business.

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