Accounting, Lectures

1. Financial Accounting
1
Lecture – 21
Recap
• Up to now we have covered following areas in this course
 We started off with the basic concepts of accounting,
 Then we covered the basic book keeping and learnt how
to record transactions,
 After this basic overview we started detailed study of
different items reported in the financial statements an to
date we have covered following areas:
o Stocks
o Cost of Goods Sold, and
o Fixed Assets

2. Financial Accounting
2
Lecture – 21
Areas Covered in This Lecture
• In this lecture we will study in detail about
 Capital and Revenue Expenditure, and
 Capital and Revenue Receipts
• We will also establish rules to distinguish between Capital
and Revenue and see if there are any exceptions to these
rules.

3. Financial Accounting
3
Lecture – 21
• While preparing Profit and Loss we take into account only
Revenue Expenditure and Revenue Receipts.
• Whereas Capital Expenditure and Capital Receipts effect
the Balance Sheet
• Therefore to present a proper Profit and Loss Account it is
important to distinguish between Capital and Revenue
items.
• First we will deal with Capital and Revenue Expenditure.

4. Financial Accounting
4
Lecture – 21Capital Expenditure
• Capital Expenditure can be defined as the expenditure
incurred to benefit future periods.
• The term of capital expenditure is generally restricted to the
expenditure that adds fixed asset units or adds Life,
Capacity or Efficiency of existing fixed assets units.
Revenue Expenditure
• Revenue expenditure is the expenditure that benefits the
current period.
• Revenue Expenses are those expenses that are:
 Incurred on the day to day running of the business,
 Incurred to maintain fixed assets in their original / useable
condition.

5. Financial Accounting
5
Lecture – 21
• For Capital Expenditure the term “Capitalized” is used.
• For Revenue Expenditure the term “Charged” or “charged to
Profit and Loss” is used.
• For Capital Expenditure we have said that it is generally
incurred to Acquire an asset or Improve an asset and that it
benefits future period.
• This means that capital expenditure can be incurred at two
stages,
 When an asset is acquired, and
 When an improvement is made in an existing asset.

6. Financial Accounting
6
Lecture – 21
Acquiring an Asset
• Whenever a new asset is acquired, all the expenditure
incurred up to the point of bringing the asset to its intended
use is capitalized as the initial cost of asset.
• Following payments other than purchase price are included
in the initial cost of an asset:
 Cost of bringing the assets to business premises,
 Legal costs incurred to acquire them,
 Carriage and other charges paid to bring them to the
place of their intended use,
 Any other costs needed to get the asset ready for use

7. Financial Accounting
7
Lecture – 21
Subsequent Expenditure
• Classifying the expenditure incurred in acquiring an asset is
simple, as compared to subsequent expenditure.
• In case of subsequent expenditure we have to distinguish
between Capital and Revenue Expenditure.
• If the expenditure is incurred on the maintenance of the
asset then it is treated as Revenue Expense.
• This means that all the expenditure incurred to keep an
asset in good operating condition. For example fuel, routine
repairs and maintenance like oil, filter etc. in case of
vehicles or white wash, repairing of roof, windows and doors
in case of building.
• Whereas when an expenditure is incurred so that it
improves the performance of an asset from its originally

8. Financial Accounting
8
Lecture – 21
Subsequent Expenditure
assessed level of performance then it should be treated as
capital expenditure. For example if a room is added to a
building or a new part is added to a machinery that
increases its utility then the expenditure incurred should be
treated as capital expenditure.
Day to Day Business Expenses
• The day to day business expenses like salaries, utilities and
other administrative costs all benefit in the current period
and are therefore treated as revenue expenditure.

9. Financial Accounting
9
Lecture – 21
Examples
• Consider following examples:
• Purchase of a Car, Machine, Piece of Land or a Building
Capital – A simple example of purchase of an asset
• Fuel, Oil, Batteries for car, Lubricants, Nut, Bolts for
Machine, Gardening Expense on Land and whitewash,
repairs of building
Revenue – All these expenses are incurred to keep the
asset in its desired operational condition.
• Additional Room in the building or on land
Capital – This Expenditure will increase the utility of the
asset.

10. Financial Accounting
10
Lecture – 21
Examples
• Overhaul of Car, Machine
This is a tricky area. Now we have to decide that whether
this Expenditure has increased the performance of the asset
from it’s originally assessed performance or not.
If the life of machine or car was say five years and due to
this overhaul the life is increased beyond this life then this
expenditure should be capitalized.

11. Financial Accounting
11
Lecture – 21
Difference Between Capital and Revenue Expenditure
Capital Expenditure Revenue Expenditure
The effect / utility of these lasts
for a long time.
The utility is drawn immediately.
Usually spent to acquire an
asset
Incurred to maintain an asset in
a usable condition
These are in most of the cases
non-recurring.
These are mostly of recurring
nature.
This expenditure increases the
future earning capability of the
organization.
These are incurred to for the
current earning of the
organization.
These appear in the balance
sheet until benefit is drawn from
them
These are charged to profit and
loss account.

12. Financial Accounting
12
Lecture – 21
Capitalized or Deferred Revenue Expense
• The nature of some expenses is such that though they do
not create an asset but their benefit is spread over more
than one accounting period.
• These are mostly non-recurring and large in amount.
• In such circumstances instead of debiting the entire amount
of these expenses to Profit and Loss of the year, it may be
spread over a number of years with a proportionate amount
being charged each year to P&L Account.
• The portion that is still not charged to Profit and Loss is
shown in the balance sheet on the asset side after Capital
Work in Progress and is called Deferred Expenditure.
• Examples are Expenses incurred to start a business, Initial
marketing cost to launch a product etc.

13. Financial Accounting
13
Lecture – 21
Importance of Distinguishing Between Capital & Revenue Expense
• The whole purpose of accounting is that at the end of the
day one can produce such results that reflect a true picture
of the state of the business and its performance.
• This means that if the revenue is of one month than
expense that is being deducted from it should also be of one
month. This concept is called the Matching Concept in
accounting.
• So if a payment is made that will provide benefit to the
business for period longer than one accounting period then
it should be matched or deducted from the income of the
same number of years for which it benefits the business.
• therefore it is extremely important to distinguish between
capital and revenue expense.

14. Financial Accounting
14
Lecture – 21
The General Rule
• So the general rule can be devised as:
 The expense whose benefit lasts for a period longer than
an accounting period is called capital expenditure, and
 The expenses whose benefit is obtained within an
accounting period is termed as a revenue expense.

15. Financial Accounting
15
Lecture – 21
Exceptions to the General Rule
• A business may acquire several small items whose benefit
is drawn for a longer period, such as batteries, wastepaper
baskets, pencil sharpeners etc.
• But capitalizing these will mean that a proper record will
have to be kept and depreciation will be charged.
• Here the question rises that, is it really worth going through
all the trouble for such small amounts? (Cost Benefit
Analysis).
• Therefore we draw an exception to the rule i.e. depending
upon the size of expenditure and organization such
expenses can be “Charged” instead of “Capitalizing”

16. Financial Accounting
16
Lecture – 21
Exceptions to the General Rule
• Legal Charges – are as rule charged to P & L but when
these are incurred to acquire an asset these should be
capitalized with the asset.
• Repairs – are also charged to P&L but when it is of such a
nature that it enhances the performance of an asset from its
original performance than it should be capitalized.
• Wages – are normally revenue expense but when these are
paid to men employed to create an asset these should be
capitalized as the cost of asset.
• Freight and Carriage – normally a revenue expense, but
when paid to bring an asset to its intended use then it is
treated as capital.
• Interest on Loan – is normally a revenue expenditure but
when the loan is taken to purchase an asset its interest is
treated as Capital and added to cost of the asset.

17. Financial Accounting
17
Lecture – 21
Capital and Revenue Receipts
• It is as important to distinguish between capital and revenue
receipts as it is for capital and revenue expenditure.
• A simple rule for receipts is that, a receipt against an item of
capital nature is termed as Capital Receipts. Examples are
sale of a Fixed Asset, Sale of an Investment etc.
• Whereas receipts from day to day business activities are
termed as revenue receipts. Examples are sale of goods
that purchased for resale (stock), rendering of services.