• You incur expenditure on various items every day.
• You buy food items, stationery, cosmetics; utensils, furniture, etc. Some of them are consumables and some are durables.
• The benefit of expenditure consumables like stationery, cosmetics, etc. is derived over a short period.
• But in case of durables like furniture, utensils, etc., the benefit spreads over a number of years.
• Same is true of business also. In business you incur expenditure on two types of items: (i) routine items like stationery, and (ii) fixed assets like machinery, building, furniture, etc., whose benefit is available over a number of years.
• In accounting terminology the first category of expenditure is called revenue expenditure and the second one is called capital expenditure.

Capital Expenditure:

As stated above, when the benefit of an expenditure is not exhausted in the year in which it is incurred but is available over a number of years it is considered as capital expenditure.

1. Any expenditure which results in the acquisition of fixed assets such as land, buildings, plant and machinery, furniture and fixtures, office equipment, copyright, etc. You should note that such capital expenditure includes not only the purchase price of the fixed asset but also the expenses incurred in connection with their acquisition. Thus, the brokerage or commission paid in connection with the acquisition of an asset, the freight and cartage paid for transportation of machinery, the expenses incurred on its installation, the legal fees and registration charges incurred in connection with purchase of land and buildings are also treated as capital expenditure.
2. Any expenditure incurred on a fixed asset which results in (a) its expansion (b) substantial increase in its life (c) improvement in its revenue earning capacity. Improvement in the revenue earning capacity can be in the form of (i) increased production capacity, (ii) reduced cost of production and (iii) increased sales of the firm. Thus, cost of making additions to buildings and the amount spent on renovation of the old machinery are also regarded as capital expenditures. If you buy a second hand machinery and incur heavy expenditure on reconditioning it, such expenditure is also to be treated as capital expenditure. Similarly, expenditure on structural improvements or alteration to existing fixed assets whereby their revenue earning capacity is increased, is also treated as capital expenditure.
3. Expenditure incurred, during the early years, on development of mines and land for plantations till they become operational.
4. Cost of experiments which ultimately result in the acquisition of a patent. The cost of experiments which are not successful is not to be treated as capital expenditure. It is treated as a deferred revenue expenditure which is written off within two to three years.
5. Legal charges incurred in connection with acquiring or defending suits for protecting fixed assets, rights, etc.

Revenue Expenditure:

When the benefit of an expenditure is not likely to be available for more than one year, it is treated as revenue expenditure. So all expenses which are incurred during the regular course of business are regarded as revenue expenditures. The examples of such expenses are: Concepts relating to Final Accounts

1. Expenses incurred in day-to-day conduct of the business such as wages, salaries, rent, postage, stationery, insurance, electricity, etc.
2. Expenditure incurred for buying goods for resale or raw materials for manufacturing.
3. Expenditure incurred for maintaining the fixed assets such as repairs and renewals of building, machinery, etc.
4. Depreciation on fixed assets. This can also be termed as revenue loss.
5. Interest on loans borrowed for running the business. You should note that any interest on loan paid during the initial period before production commences, is not treated as revenue expenditure. It is treated as capital expenditure.
6. Legal charges incurred during the regular course of business such as legal expenses incurred on collection from debtors, legal charges incurred on defending a suit for damages, etc.

If Expenditure is incorrectly classified then:

• Profit and Non-current asset will be incorrectly reported.
• Non-current asset values will be either overstated / understated, Balance Sheet will be incorrect.
• Expenses will be overstated (too high) or understated (too low), Income Statement will be incorrect.
• Incorrect decisions will be made.

For example if and expenditure on a vehicle is incorrectly categorised as revenue rather than expense, the expenses would be overstated and the profit understated while the assets will also be understated.