Capital Expenditures are major expenditures incurred for acquisition of asset. Let's say something significant. These kind of expenditures generally improves the performance of an asset to an all new level. Capital expenditure generates lasting benefits and makes the entity generate revenue for more than one accounting period and these benefits of incurring Capital Expenditure usually extends beyond one accounting period.
When compared to the Capital Expenditure, a Revenue Expenditure is more of a day to day expenditure of the business. It is usually not as huge as the capital expenditure and is more concerned with the day to day operations of the business. The benefits of incurring Revenue Expenditure are not much of enduring in nature and are usually limited to one accounting period.
EXAMPLES OF CAPITAL EXPENDITURE
To make your understanding easy, let us take the example of any household expenditure. Now, list all the expenditures of a household on a paper and classify them into capital or revenue expenditure. Now compare your answers with the following list which I have created.
The following are the Capital Expenditures of a Household
Buying a new House
Buying a Refrigerator
Repainting and Renovating your existing house
Installation of Centralized Air Conditioning system to your house
Buying a Home Theatre
Buying Furnitures etc
EXAMPLES OF REVENUE EXPENDITURE
The following are the Revenue Expenditures of a Household
Electricity/ Power Charges
Annual Maintenance Expenses of a car.
Thus if you notice in the above example, you will agree that the following are the major differences between a Capital Expenditure and a Revenue Expenditure
DIFFERENCE BETWEEN CAPITAL AND REVENUE EXPENDITURE
Recurring in Nature: If you notice in the above example, Revenue Expenses are recurring in nature. It occurs periodically every month, every quarter, every year etc. Whereas capital expenses are one time in nature.
Purpose: In the above example, repainting and renovation expenditures are capital in nature, because it has enduring benefits and adds more value to the house. If you plan to rent them or sell them to a third party, the renovation and repainting expenses actually increases the value of the house by a considerable amount. On the other hand, Annual Maintenance Expense of a car is revenue in nature, as it is incurred to ensure that the car runs smoothly as it does currently, and is not incurred to enhance the performance of the car manifold.
Nature of Business: Let us now take the example of a Business. When it comes to business of buying and selling Sewing Machines, purchase of 5 sewing machine sets is a Revenue Expense, whereas when it comes to the tailoring business, where the main activity is stitching clothes using the sewing machines, buying 5 sets of sewing machine is a Capital Expenditure. So, before classifying it as Revenue and Capital Expenditure, look at the nature of the business too.
Materiality: Next comes the materiality of the amount involved. Quite often, we will be able to guess the nature of expense, just by looking at the amount spent. If the amount spent is huge, then there is a good chance of classifying it as a capital expenditure, although one should take other factors mentioned above into consideration before arriving at a conclusion.
Incidental to Capital Expenditure: Some expenses, although small, will be classified as Capital Expenditure. These are the expenses which form part of the Capital Expenditure and is incidental to it or accompanies it.
CAPITAL EXPENDITURE AND REVENUE EXPENDITURE OF BUSINESS ORGANIZATIONS
In the businesses, Revenue Expenses are always shown in profit and loss account of the entity and goes to reduce the Net Profit of the entity.
On the other hand, Capital Expenses are carried as an Asset in the Balance Sheet as they generate future, enduring benefits. Part of the capital expense will be transferred to Profit and Loss account on periodical basis in the form of Depreciation year on year. This is to match it with the revenue it is generating.
EXAMPLES OF CAPITAL EXPENDITURE - BUSINESS
1) Purchase of a Machinery
2) Installation charges paid to install a new machinery
3) Renovation and Repainting of Factory Premises
4) Replacing major part of a machinery
EXAMPLES OF REVENUE EXPENDITURE - BUSINESS
1) Yearly maintenance cost of a machinery
2) Plumbing and Electrical repairs of a factory
3) Monthly rental expenses of the administrative office of a company
4) Travel Expenditure of Managers to USA for periodical review meetings
Finding the difference between Capital and Revenue Expenditure involves careful judgement regarding the nature of transaction, nature of business, the amount involved among others.
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