PRINCIPLE OF ACCOUNTING II
CAPITAL AND REVENUE EXPENDITURES
Prepared by
Mbwambo Edwin C.
Bachelor of accounting
CAPITAL AND REVENUE EXPENDITURES
Objectives of this topic
How to distinguish between capital expenditure and revenue expenditure.
That some items are part capital expenditure and part revenue expenditure,and need to
be apportioned accordingly.
That if capital expenditure or revenue expenditure is mistaken one for the other then gross or net profit figures (or both) will be incorrectly stated, as will the capital account and fixed assets in the balance sheet.
CAPITAL EXPENDITURES
Capital expenditures are incurred when a business spends money either to buy non-current assets, or add to the value of an existing non-current asset. This includes tangible and intangible assets Example acquisition of building, land, deliver van. According to IAS 16Property, Plant and Equipment Included in such expenditure should be spending on;
acquiring fixed assets,
bringing them into the business,
legal costs of buying buildings i.e. properties tax,
carriage inwards on machinery bought,
any other cost needed to get a fixed asset ready for use include installation cost,
Cost of arising loan,
Preliminary expenses i.e. expenses for formation of a new company,
Inspection and testing the fixed asset before use;
Architects’ fees for building plans and for supervising construction ofbuildings;
Demolition costs to remove something before new building can begin
costs of site preparation;
Hint
As mentioned earlier, capital expenditure not only consists of the cost of purchasing a fixed asset, but also includes other costs necessary to get the fixed asset operational
CAPITAL RECEIPTS.
Capital receipts are the money received from disposal of fixed asset. For example sale of building, land, and deliver van. These receipts are capitalized but difference between net book value and cash received is taken to profit and loss.The following are to be treated as capital receipt;
• Cash from sales of investments,
• Cash from issue of shares,
• Specific donation ,
• Loan received,
• Cash received for insurance claim of damaged fixed assets.
REVENUE EXPENDITURE.
Revenue expenditure is money which is spent on running the business on a day-to-day basis. These include purchase of merchandize goods and expenses paid by business such as wages, rent, salaryetc. These expenses paid for each financial year so they stay for short time according to IAS 18 Revenue the following should be treated as revenue expenditure;
• Purchase of merchandize goods,
• Expenses incurred by business in daily business operation,
• Loss on investment,
• Loss on disposal,
• Depreciation of fixed asset,
• Repair and maintenance of fixed assets,
• Cost of running fixed assets like fuel. Hint;
These Revenue expenditures are shown on profit and loss account.
Effect of interchange capital and revenue expenditure in presentation of financial
statements.
Capital expenditure appears in the balance sheet whereas revenue expenditure appears in the
Trading and profit and loss account. If expenditure is treated as revenue, it reduces profit immediately by the amount spent. If it is treated as capital, there is no immediate impact upon profit. Profit is only affected when a part of the expenditure is charged against income during the time the item purchased is in use, and those charges (called ‘depreciation’) spread the cost of the item over a number of years. As a result, profits are lower if an item of expenditure is treated as revenue. Businesses like to show that they are being as profitable as possible, so they tend to want to treat everything possible as a capital expense. Doing this also makes the business look wealthier as the fixed assets are at a higher value than they would have been had the expenditure been treated as revenue.
Difference between capital and revenue expenditures
Capital expenditure Revenue expenditure•
Spend on acquisition or improve fixed
asset
•
Stay in business for long time.
•
Shown on balance sheet.
•
Include expenses for acquisition of
non-current asset example machine
installation costs.
•
Shown on statement of comprehensive
income,
•
Stay for short period in the business,
Include expenses of running fixed asset example fuel expensesCapitalization is the process of converting revenue expenditure to capital expenditure.
JOINT EXPENDITURES
Joint expenditures are those expenditures which consist of capital and revenue expenditures at the same. Example a builder was engaged to tackle some work on your premises, the total bill being for sh3,000. If one-third of this was for repair work and two-thirds forimprovements, where should the two parts be entered in the accounting booksand where would they appear in the financial statements?
Solution
Cost of repair was 1/3×3000=1000
Cost of improving was 2/3×3000=2000
So 3000 is joint expenditure because it involves both capital expenditure of 2000 and shown on balance sheet because it adds the value of building and revenue expenditure of 1000 will be shown on profit and loss account.
Example 1
Some of the following items should be treated as capital and some as revenue. For each ofthey state which classification applies:
(i) The purchase of machinery for use in the business.
(ii) Carriage paid to bring the machinery in (i) above to the works.
(iii) Complete redecoration of the premises at a cost of £1,500.
(iv) A quarterly account for heating.
(v) The purchase of a soft drinks vending machine for the canteen with a stock of soft drinks.
Transaction Type
(i) The purchase of machinery for use in the business. Capital expenditure
(ii) Carriage paid to bring the machinery in (i) above to the works. Capital expenditure
(iii) Complete redecoration of the premises at a cost of sh1,500. Revenue expenditures
(iv) A quarterly account for heating. Revenue expenditures
(v) The purchase of a soft drinks vending machine for the canteen with a stock of soft drinks. Jointly expenditures
(vi) Wages paid by a building contractor to his own workmen for the erection of an office in
the builder’s stockyard. Capital expenditure
Example 2
Indicate which of the following would be revenue items and which would be capital
Items in a wholesale bakery:
(a) Purchase of a new van.
(b) Purchase of replacement engine for existing van.
(c) Cost of altering interior of new van to increase carrying capacity.
(d) Cost of motor tax for new van.
(e) Cost of motor tax for existing van.
(f) Cost of painting business’s name on new van.
(g) Repair and maintenance of existing van.
Transaction Type
(a) Purchase of a new van. Capital expenditure
(c) Cost of altering interior of new van to increase carrying capacity. Capital expenditure
(d) Cost of motor tax for new van. Capital expenditure
(e) Cost of motor tax for existing van. Revenue expenditures
(f) Cost of painting business’s name on new van. Capital expenditure
(g) Repair and maintenance of existing van. Revenue expenditures
NOTE FORM WORKED EXAMPLES
i. It should be known that repairing asset does not add value of asset but turn it to the original position.
ii. Expenses which are capitalized are those which associate with bringing asset into use for the first time.
iii. Extension cost of fixed asset which increase the capability of asset are capital expenditures.
iv. Expenses of existing asset are revenue expenditures
v. Expenditures which are partly capital and partly revenue are jointly expenditure
EXERCISE
1. Distinguish between capital and revenue expenditure
2. The following costs were also incurred by Napa Ltd during the financial year ended 30June 20X7: a. Interest on loan to purchase microcomputer.
b. Cost of software for use with the microcomputer.
c. Cost of customizing the software for use in Napa Ltd.'s business. d. Cost of paper used by the computer printer.
e. Wages of computer operators.
f. Cost of ribbons used by the computer printer. g. Cost of adding extra memory to the microcomputer. h. Cost of floppy disks used during the year.
i. Costs of adding a manufacturer’s upgrade to the microcomputer equipment. j. Cost of adding air conditioning to the computer room.
Classify each of the above as capital expenditure or revenue expenditure.
3. Washamoto Ltd took delivery of a microcomputer and printer on 1 July 20X6, the beginning of its financial year. The list price of the equipment was sh4,999 but Washamoto Ltd was able to negotiate a price of sh4,000 with the supplier. However, the supplier charged an additional sh340 to install and test the equipment. The supplier offered a 5% discount if Washamoto Ltd paid for the equipment and the additional installation costs within seven days. Washamoto Ltd was able to take advantage of this additional discount. The installation of special electrical wiring for the computer cost sh110. After initial testing certain modifications costing sh199 proved necessary. Staff were sent on special training courses to operate the microcomputer and this cost sh 990. Washamoto Ltd insured the machine against fire and theft at a cost of sh 49 per annum. A maintenance agreement was entered into with Sonoma plc. Under this agreement Sonoma plc. Promised to provide 24 hour breakdown cover for one year. The cost of the maintenance agreement was sh350.
Required:
Calculate the acquisition cost of the microcomputer to Washamoto Ltd.
4. Classify the following items as either revenue or capital expenditure: a) An extension to an office building costing £24,000.
b) The cost of replacement valves on all the labeling machines in a canning factory. c) Repairs to the warehouse roof.
d) Annual service costs for a courier firm’s fleet of vans.
(e) Replacement of rubber tread on a printing press with a plastic one that has resulted in the useful economic life of the printing press being extended by three years.
(f) A new bicycle purchased by a newsagent for use by the newspaper delivery boy.
(g) Repairs to a refrigeration system of a meat wholesaler.
(h) Repainting of the interior of a bar/restaurant which has greatly improved the potential for finding a buyer for the bar/restaurant as a going concern.
(i) Wages paid to employees who worked on the construction of their company’s new office building
REFERENCES
Frank Wood & Alan Sangster Business Accounting 1Tenth edition (2007) Pearsoned education Limited publishers United kingdom
