Capital and Revenue Expenditure: Understand Here

Are you a business owner or a finance enthusiast? If yes, then you must have heard about capital and revenue expenditures. These are the two main categories of business expenditures that play a crucial role in financial reporting and analysis. Whether you’re planning to invest in your business or just curious to know more about it, this article will give you a comprehensive overview of capital and revenue expenditures. 

What are capital expenditures?

Capital expenditures (CapEx) refer to funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, technology, or equipment. To be classified as capital expenditures, these assets must be capitalised on the balance sheet. CapEx results in costs that provide benefits over multiple years. These long-term investments are vital for a company’s growth and success.

Characteristics of capital expenditures 

1. Investments in tangible assets, such as land, equipment, machinery, facilities, etc. that provide benefits for multiple years
2. Investments in intangible assets like trademarks, patents, copyrights, etc. 
3. Expenses capitalised on the balance sheet and depreciated over the useful life of the asset
4. Outcomes benefits for more than one accounting period / fiscal year  
5. Requires huge initial outlays of money
6. Difficult to reverse and requires thorough decision-making

Examples of capital expenditures

Some common examples of CapEx include:

• Tangible Assets:

1. Purchase of property, land, office buildings, factories, or equipment
2. Construction costs of new plants, properties, or factories  
3. Significant upgrades/additions to machinery and equipment
4. Major renovations to increase the useful life of buildings
5. Infrastructure development costs
   

• Intangible Assets:  

1. Development and purchase of patents, trademarks, licenses 
2. Computer software purchases  
3. Costs associated with starting up a new business
4. Goodwill paid when acquiring another company

Accounting treatment and journal entries

When a company buys a big item like a building or a machine, they have to record it as an asset on their financial reports. They can’t just count the whole cost as an expense right away. Instead, they spread the cost out over time by counting a little bit of the cost as an expense each year. This is called “depreciation,” and it helps the company show a more accurate picture of its finances over time.

Examples of journal entries for recording CapEx transactions:

1. Purchased new machinery worth ₹100,000  through cash/credit:  

Dr. Property, Plant & Equipment – ₹100,000  

Cr.  Cash / Accounts Payable     – ₹100,000  

2. Purchased ₹50,000  worth of intangible assets with Cash:   

Dr.  Intangible Assets – ₹50,000   

Cr.  Cash   – ₹50,000 

When a company buys equipment or property, it shows up as an investment while their Cash goes down. The investment loses value over time, which is called depreciation. This is calculated each year and reduces the investment’s value, but doesn’t affect the company’s income statement right away.

Importance of capital expenditures

CapEx plays an invaluable role for businesses in terms of:

1. Enabling innovation via investments in equipment and technology 
2. Increasing production efficiencies and cost reductions ultimately 
3. Supporting expansion plans and growth strategies  
4. Developing new products or entering new markets
5. Gaining long-term competitive advantage  
6. Ensuring operations continuity and future profitability  
7. Adhering to regulations, improving work conditions for employees
8. Enhancing reputation, goodwill, and overall brand image  

What are revenue expenditures? 

Day-to-day expenses that are necessary to keep a business running are called revenue expenditures. These costs happen often and are vital for the company’s operations. Examples of revenue expenditures are things like paying for employee salaries, buying office supplies, or renting a space for the business.

Characteristics of revenue expenditures

1. Expenses linked to daily business operations and management 
2. Recurring expenses consumed during the current accounting period  
3. Results benefits only for the current period, not future periods
4. Includes repairs/maintenance expenses not improving the asset
5. Directly deducted from total revenue when calculating profit   
6. Expensed immediately on the income statement 

Examples of revenue expenditures 

Common examples of revenue expenditures include:

1. Employee salaries, wages, and other employee benefits
2. Utility expenses like electricity, water, telephone, etc  
3. Inventory costs related to producing or purchasing goods   
4. Insurance premium costs 
5. Rent, lease & interest payments on loans taken  
6. Marketing, advertising, and other selling expenses
7. Transportation, distribution, delivery & shipping costs
8. Repairs and servicing expenses not improving assets
9. Travel, legal, commission, and printing expenses  

Accounting treatment of revenue expenses

Unlike capital expenditures, revenue expenditures are directly recorded on a company’s income statement in the period they are incurred under expense accounts related to operations. 

These expenses of doing business are matched against total revenues earned and deducted in the same accounting period to calculate operational profit. No assets are recorded on the balance sheet.

Some examples of journal entries for recording revenue expenditure transactions:

1. Paid employees a monthly salary of ₹8,000 through Cash:

Dr Salaries Expense – ₹8,000

Cr. Cash – ₹8,000

2. Quarterly utilities invoice received and recorded:

Dr. Utilities Expense     – ₹2,500

Cr. Accounts Payable   – ₹2,500

The key thing to note is revenue expenses directly reduce net income while assets/liabilities stay unchanged on the balance sheet.

Analysing trends in revenue vs. capital expenditures 

Analysing a company’s capital expenditure and operating costs can reveal its financial health, focus, and direction. Regular costs vary seasonally, so proper planning is important. 

Capital spending changes reflect strategic decisions made by management, indicating the asset lifecycle stages. Over/under-investment in any area can signal operational challenges, so striking the right balance is key for profitability.

Difference between revenue and capital expenditure

There are two types of expenses that businesses incur: revenue expenditure and capital expenditure. 

1. The main difference lies in their purpose. Revenue expenditure is incurred for day-to-day operations to keep the business running smoothly. On the other hand, capital expenditure is made to acquire assets that will benefit the business multiple times. 

2. Another difference is the impact on cash flow. Revenue expenditures are recurring expenses that impact the cash flow in the current period. Whereas, capital expenditures are substantial investments that may require significant cash outflows in the short term, but they have long-term benefits. 

3. Another difference is how they are accounted for. Revenue expenditures are directly expensed on the income statement, while capital expenditures are capitalised on the balance sheet and depreciated over time. 

Some examples of revenue expenditures include wages and utilities, while capital expenditures include machinery and buildings.

4. Lastly, another difference is related to tax treatment. Revenue expenditures are usually tax-deductible, while capital expenditures are subject to depreciation.

Companies spend money on revenue and CapEx, which serve different purposes and have different effects on their finances. Properly tracking and reporting these expenses is essential for an accurate financial situation.

Conclusion

Capital expenditures are long-term investments in company assets. These are not immediately reflected in profit/loss but instead spread out over the asset’s useful life. Revenue expenditures are everyday expenses that reduce net income in the accounting year. Careful management of both is crucial for financial stability and business health. Understanding the difference between them helps companies allocate resources and manage costs over time.

FAQs