Introduction – Capital and Revenue Items:
In order to know the fair performance and financial standing of a business; the nature of business transactions taking place during the year has to be analyzed. The accounting transactions may be divided into two categories:
(1) Capital transactions (relating to capital items)
(2) Revenue transactions (relating to revenue items)
Definition of Capital Items:
Capital items are those items which have long term effects on business, (normally more than one year). There are two main types of of capital items; (i) capital expenditure and (ii) capital receipt. For example, fixed assets; tangible or intangible assets; (land, building, machinery, legal rights, etc) are capital items.
Definition Revenue Items:
Revenue items are those items having short term effects on business, (normally less than one year). There are two main types of revenue items; (i) revenue expenditure and (ii) revenue receipts. For example, repairs, wages, salaries, fuel, etc., are revenue items.
Treatment of Capital and Revenue Items in Financial Statements:
Capital expenditure = Shown as a non-current asset in the balance sheet.
Revenue expenditure = Shown as an expense in the income statement.
Capital receipt = Shown as a liability or reduce the value of a capital expenditure.
Revenue receipt = Shown as income in income statement
Solved Example and Problem 1:
Which of the following expenditures are capital or revenue, give your reasons?
(a) Cost of overhauling and painting a recently bought old van.
(b) Cost of pulling down an old building in order to replace it by a new one.
(c) The cost of removing plant and machinery to new site.
(d) Payment made to purchase an existing business.
(e) Carriage paid on purchase of goods.
State with reasons whether the above items of expenditures are capital or revenue in nature:
(a) Capital Expenditure = When a second hand asset is purchased then any expenditure incurred to put it into working order will be treated as capital expenditure.
(b) Capital Expenditure = This is a capital expenditure as it is a part of the total cost of the building.
(c) Capital Expenditure = The removal of the business to the new site will enhance the income earning capacity of the business; this expense will be treated as capital expenditure.
(d) Capital Expenditure = Purchase of business means purchase of its assets and liabilities; therefore, it is a capital expenditure.
(e) Revenue Expenditure = The expenditure is related to purchase of goods for resale, which itself is a revenue expense, therefore, carriage is also a revenue expense.
Solved Example and Problem 2:
The following transactions are taken from the books of H. Hanson for the first week of January 2019:
(a) Cost of the air-conditioning the office of director.
(b) Wages paid to business’ workers for extension of its building.
(c) Expenditure incurred on renewal of patent’s right.
(d) The freight, carriage and the installation charges cost on new machine amounting to $400.
(e) Wages paid for manufacture of goods.
(f) Legal expenses incurred for debt collection.
(g) Legal expenses incurred in purchasing a landed property.
Classify with reasons that which of the above items are capital expenditure and which are revenue expenditure?
(a) Capital Expenditure = The benefit of this expenditure will be available for a number of years; therefore, it is capital expenditure.
(b) Capital Expenditure = The wages paid to workmen employed for extension of building is a capital expenditure, because wages have been incurred in extension of a non-current asset.
(c) Revenue Expenditure = Expenditure incurred on renewal of patent is revenue expenditure as it is of recurring nature and it has been incurred in the ordinary course of business.
(d) Capital Expenditure = Amount expended on freight and carriage and installation charges of the new machine into working condition.
(e) Revenue Expenditure = Wages paid for manufacture of goods is revenue expenditure as it has been incurred connection with the manufacture of goods for resale.
(f) Revenue Expenditure = Legal costs incurred on debt collection is a revenue expenditure; being incurred to avoid a revenue expense of bad debts.
(g) Capital Expenditure = Legal expenses incurred in purchasing landed property are capital expenditures, as part of the cost of a non-current asset purchased.