Capital Expenditure Versus Revenue Expenditure

In the realm of financial accounting, various classifications exist to determine how to treat values. With reference to expenditure, financial accountants need to know whether to treat it an as asset or expense. Capital expenditure and revenue expenditure are the two fundamental classes of expenditure.

Capital expenditure refers to expenditure on the procurement or enhancement of non-current assets (assets that the business intends to keep for 12 months or longer). Revenue expenditure refers to expenditure that the business incurs either for the purpose of trade or for maintenance of the earning capacity of non-current assets.

The key issue between capital and revenue expenditure is whether it can appear in the Statement of Financial Position (balance sheet) or not. Any expenditure that does not increase the net book value of non-current assets or result in the appearance of a new one on the Statement of Financial Position is an expense. Recall that expenses are deducted from gross profit in the Statement of Comprehensive Income.

Naturally, classifying expenditure as revenue or capital expenditure is important, since it would determine the impact on the assets of the business or its profitability. It is also critical to note that actions on a non-current asset can result in either class of expenditure. For instance, suppose a business purchases a motor vehicle and has it modified to improve its fuel efficiency. In addition to this, during the course of the year, other expenses like insurance and maintenance crop up.

The amount that the business used to purchase the vehicle is capital expenditure because the motor vehicle would now appear on the Statement of Financial Position and the business intends to keep the car for more than a year. The cost of the modification to improve fuel efficiency is expenditure that improves the earning capacity of the motor vehicle and increases its net book value. Therefore, the modification is also capital expenditure and should not be written off as an expense. The insurance and maintenance costs associated with the motor vehicle represent revenue expenditure on a non-current asset.

Although capital expenditure is not charged to the income statement, depreciation on non-current assets eventually account for the capital expenditure over time. Recall that accumulated depreciation decreases the net book value of a non-current asset and the current depreciation expense is charged to the income statement. This helps to reinforce the fair presentation assumption.

The distinction between capital and revenue expenditure is critical in financial accounting as it determines the treatment of the expenditure and how the business' operations are presented.