What is Capital Expenditure and Revenue Expenditure? Expenditure is an inevitable part of any business. If we want to establish any business we have to incur different types of costs like – purchasing the building, machinery, raw material cost, labor cost, electricity cost, etc. There are mainly 2 types of expenditure incurred in a business which are as follows:
- The Capital expenditure
- The Revenue expenditure
The cost of buying a new asset is Capital Expenditure while the cost incurred to maintain it is Revenue Expenditure. The capital expenditure is a purchase of an asset from which we can avail of the benefits over a long period and the Revenue expenditure is an expense to meet the working capital of a business.
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Contents
Capital Expenditure
Capital Expenditure is the investment made on a large scale to purchase any long-term asset type of land, building, office, etc. These are the expenditures made to maintain or, expand the business and generate additional profits for a longer period. These assets last for more than one year.
The capital expenditure includes the purchase that upgrades or expansion of the company. Moreover, it can be an investment in vehicles, manufacturing equipment, computers, furniture, etc which raises the productivity of the company.
These expenses are generally known as Capex in finance terms. The investment in assets can be both a tangible asset and an intangible asset. The Capital expenditure showed under the asset side of the Balanced Sheet. However, the depreciation or amortization is charged over some time in the Profit and Loss statement. On assets like Land, deprecation is not charged.
Types of Capital Expenditure:
1. Maintenance of the current operation of the business
Suppose a company has purchased a Machine A of Rs. 10Lakhs which produces 1,00,000 units of product. But the machine will eradicate over 10 years due to wear and tear. After 10 years, the company has to replace Machine A with Machine B which works with the same capacity of Rs. 15 Lakhs. The expenditure incurred to purchase Machine B is Capital Expenditure as the benefits of expense incurred to maintain the existing business of the company.
2. Expansion of business
Suppose a company has purchased a Machine A of Rs. 10Lakhs which produces 1,00,000 units of product in a year. After 2 years the company received a big order of 10,00,000 units of product. But they cannot fulfill the order with the same Machine. So, they decided to replace Machine A with Machine B which works with can produce 10,00,000 units in 1 year of Rs. 50 Lakhs. The expenditure incurred to purchase Machine B is Capital Expenditure as the benefits of expense incurred to increase the productivity and expansion of the company.
Journal Entry:
1. At time of Purchase of Machine
Machinery A/c Dr. 10,00,000
To Bank A/c 10,00,000
(Being machinery purchased)
2. On year-end
Depreciation A/c Dr. 2,00,000
To Machinery A/c 2,00,000
(Being depreciation charged assuming 5 years of the life of machinery)
Profit and Loss A/c Dr. 2,00,000
To Depreciation A/c 2,00,000
(being depreciation charged to the Income statement)
Revenue Expenditure
Revenue expenditure is the expenditure incurred to meet day-to-day functions of a business like rent, electricity, insurance, stationery, maintenance, taxes, etc. Revenue expenditures are recurring expenditures and do not involve a huge chunk of money.
Revenue expenditures include salaries and employee wages, administrative expenses, business travel, property taxes, etc. They are short-term expenditures and they do not enhance existing assets’ value.
It is popularly known as Opex (Operational Expense)
Revenue expenditure is of two types:
1.Direct Revenue Expenditure
All the expenses that have been incurred in the process of conversion of input into output are known as direct expenses. For eg. The Purchase of raw materials, wages, etc.
Example
Suppose Machine A of Rs.10 Lakh has been purchased by the company then the cost of the operator of Machine is 30,000Rs. Per month and the repair of the asset is Rs. 2000 per month, the electricity expense of Rs. 1000 is incurred every month to run the machine. Then the Revenue expenditure will be 33,000Rs. Per month (30k + 2k + 1k). All the revenue expenditure will be charged to profit in the Income Statement.
2. Indirect Revenue Expenditure
All the expenses that have been incurred after the production of goods or services for marketing and distribution purposes will be covered under the ambit of indirect expenses.
Example
Suppose 1,00,000 units have been produced by utilizing Machinery A then 1 Lakhs Rs. Has been incurred for advertising the product, 20k Rs. Per month has been paid for the salary of staff for administration purposes. Then the Revenue expenditure will be 3,40,000Rs. Per month (1,00,000 + (20,000*12)). All the revenue expenditure will be charged to profit in the Income Statement.
Conclusions
Capital benefits are the investments made right now but generate benefits for the company for a longer period while the revenue expenditure gives us short-term benefits for business.
For maintaining the accounts of the company, the Capital expenditure always appears as assets on the balance sheet and some portion in the income while the revenue expenditure always appears in the income statement.
Capital expenditure and recurring expenditure are necessary and contribute to the company’s profit in different ways.
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