There are two main types of expenditures in business:
- Capital expenditures
- Revenue expenditures
This article provides a brief overview of capital and revenue expenditures and offers definitions.
Definition and Explanation of Capital Expenditures
An expenditure is a capital expenditure if the benefit of the expenditure extends to several trading years. Capital expenditure may include different types of expenditures, each of which is shown as an asset in the balance sheet.
First, expenditures incurred on the acquisition of fixed assets (tangible or intangible), which the business uses to earn profit and not for resale (e.g., land and buildings, plant and machinery, furniture and fixtures, goodwill, patent rights, and copyrights).
Second, the cost of fixed assets would include all expenditures necessary up to the time the asset is ready for use. For instance, the cost of all buildings purchased would include the price paid to the seller, legal charges, and the broker’s commission.
Similarly, the cost of machinery would include the purchase price, freight, import duty, cartage, octroi duty, and erection and installation charges.
Third, expenditures that result in an increase in the earning capacity of a business.
Examples include expenditures incurred in relocating the business and money paid for goodwill (e.g., the right to use the established name of an outgoing firm). These is because it will attract the old firm’s customers and, in this way, lead to higher sales and profits.
Fourth, money spent on improving existing assets so as to increase their life or reduce the cost of production (e.g., converting hand-driven machines into power-driven machines).
Fifth, expenditures incurred on the extension and addition of existing fixed assets. Examples include the cost of making additions to the building, furniture, machinery, or motor vehicles.
Finally, any expenditure that is incurred to raise capital for the business (e.g., commission and brokerage paid to an agent to arrange long-term loans, or discounts on the issue of shares and debentures).
Examples of Capital Expenditures
The following are the most important items of capital expenditure:
- Purchase of factories and buildings
- Purchase of machines, furniture, motor vehicles, or office equipment
- Cost of goodwill, trademarks, patents, copyrights, patents, and designs
- Expenditure on installation of plant and machinery and other office equipment
- Additions or extension of existing fixed assets
- Structural improvement or alterations to fixed assets that increase their lifetime or earning capacity
- Preliminary expenses of a limited company
- Cost of issue of shares and debentures
- Legal expenses on loans and mortgages
- Interest on capital during construction periods
- Development expenses (e.g., for mines and plantations)
Definition and Explanation of Revenue Expenditures
An item of expenditure for which the benefit expires within the year is classed as revenue expenditure. Revenue expenditure does not increase the efficiency of the firm.
Expenditures incurred for the following purposes are treated as revenue expenditures:
- Expenditures incurred for the purpose of floating assets (i.e., asset for resale purposes such as cost of merchandise, raw materials, and stores required for manufacturing process).
- All establishment and other day-to-day expenses incurred in the operation and administration of the business (e.g., salaries, rent, taxes, postage, stationery, bank charges, insurance, and advertisement charges).
- Expenditures incurred to maintain fixed assets in proper working condition (e.g., repairs, replacement, and renewals for buildings, furniture, and machinery)
Examples of Revenue Expenditures
Examples of important items of revenue expenditure are shown as follows:
- All expenses incurred in the ordinary conduct of business (e.g., rent, salaries, wages, free samples, advertising costs, and so on)
- Expenses incurred by way of repairs, renewals, and replacement for the purpose of maintaining existing fixed assets
- Cost of merchandise bought for resale
- Cost of raw materials and stores purchased for manufacturing
- Wages paid to manufacture products for sale
- Depreciation of assets used in business
- Interest on business loans
- Freight and cartage paid on merchandise purchased
- Cost of oil to lubricate machinery
- Vehicle servicing
- Any expenditures incurred in defending lawsuits relating to the sale or purchase of merchandise
Do you want to test your knowledge about capital and revenue expenditure? We have prepared quizzes for you.
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True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.