Difference Between Capital And Revenue Expenditure

June 10th, 2006 Comments off
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It’s important to understand the basic difference between Capital and Revenue expenditure.

 

Append below, in tabulated form, the characteristic and some salient points to understand the difference:

 

CAPITAL EXPENDITURE

Outlay resulting in the increase or acquisition of an asset or INCREASE in the earning capacity of a business

REVENUE EXPENDITURE

Outlay as is necessary for the MAINTENANCE of earning capacity including the upkeep of the fixed assets in a fully efficient state.

SALIENT POINTS TO NOTE

1.   Accounting fraud occur because management choose to classify should be revenue expenditure as capital expenditure. The should be revenue expenditure should be taken up into the Income Statement but instead now being “suspended” or deferred into the Balance Sheet. In the process, lesser expenses are being charge into the Income Statement, hence profit are  overstated to impress the investors or outsiders

2.   Strong GAAP and Accounting standards have classified what should be assets, what should be deferred in the balance sheet  so that there should be a clearer demarcation between Capital and Revenue expenditure

3.   We need to note that certain expenses are recognized as being of a capital nature, although no tangible property may have been acquired as a result. Examples are research and development expenditure, pre-incorporation and preliminary expenses, interest on borrowings for building, legal expenses to acquire property, additional renovations to properties and others

4.   The classification of what is capital expenditure of a company might not applies to another company that is not in the same industry. Say in a property based company, most land and buildings are revenue expenditure as they are purchase with the intent for re-sale.

5.   As we learned from the above, when the purpose of expenditure is to Maintain the business it is revenue and if it is to Improve the business it is capital. However, at times in a company, the  classification of pure capital or revenue expenditure in a company is not so straightforward especially when there is a mixture of both capital and revenue expenditure in nature.

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Financial Accounting

 
 

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