Every business incurs expenses at each stage of its business operations. Right from establishment of a business to its day to day operations and even winding up of a business, expenses are incurred at each stage. Measuring, recording and analyzing expenditure is essential for every business as it impacts cash flows and profitability of the business. In fact the accounting treatment given to expenses is determined by the nature of the expense.
This article looks at meaning of and differences between two different types of expenses – revenue expenditure and capital expenditure.
Definitions and explanations
Revenue expenditures include those expenses whose benefits are received by the business within the same accounting period as they are incurred. These are mainly day to day expenses of the business which are essential to keep the operations of the business going.
Example – Purchase of raw materials, labor and staff salary, rent expenditure etc are few of the examples of revenue expenditure.
The accounting treatment for revenue expenditure is as follows:
Payment of salary to employees:
Salary a/c……………………….. Dr 10,000 (transferred to profit and loss account)
To Bank a/c……………….Cr 10,000
(Being salary paid to employees)
Revenue expenditure is debited to the profit and loss account and corresponding credit is given to cash/bank or the respective payable account.
Revenue expenditure impacts the gross and net profitability of a business. It may also impact cash flows of the business.
Capital expenditures generally include expenditure in acquisition of large assets that are utilized for future revenue generation for the business. Capital expenditure includes expenses whose benefit is received by the business across several accounting periods. These are essential for set up and long term sustenance of the business.
Example – Purchase of fixed assets such as plant and machinery. Plant and machinery are utilized for producing products of the business across several years. Accordingly as the benefit from the expense of fixed assets is received across several accounting periods, they qualify as capital expenditure.
Capital expenditure although paid for in one accounting period is not debited to profit and loss a/c in the year of incurrence. These expenses are capitalized in the balance sheet and are charged to the profit and loss account in the accounting periods in which the related benefit is received from the expense. In the above example, although the plant and machinery is capitalized in the books, a depreciation charge is debited to the profit and loss a/c which represents the periodic use of the asset in the business.
The accounting treatment for capital expenditure is as follows:
Purchase of fixed assets:
Plant and machinery a/c……………………………………………. Dr 2, 00,000 (capitalized in balance sheet)
To Bank/Creditor for fixed asset a/c…………………..Cr 2, 00,000
(Being plant and machinery purchased)
Difference between revenue expenditures and capital expenditures:
The differences between revenue and capital expenditure have been detailed below:
- Revenue expenditure is expenditure incurred on day to day operations of the business.
- Capital expenditure is expenditure incurred on acquisition of revenue generating fixed assets.
2. Benefit of expense
- The benefit of revenue expenditure generally accrues to the business within same accounting period. For e.g.: periodic salary paid to staff is for the work done by them in the specific period for which the payment is made itself.
- The benefit of capital expenditure accrues to the business over several accounting periods, in the case of fixed assets generally over its useful life. For e.g.: plant and machinery purchased is utilized by the business in its production process for several years.
- Revenue expenditure is essential for running the operations of the business – i.e.: its primary purpose is maintenance of earning capacity of the business.
- Capital expenditure is essentially for setting up or expansion of the business i.e.: its primary purpose is increasing the earning capacity of the business.
- Revenue expenditure is incurred more frequently than capital expenditure as it is essential to keep the operations of the business functioning. For e.g.: salary must be paid to staff each month, raw materials must be purchased for each production cycle etc.
- Capital expenditure is less frequent and can even be a onetime expenditure.
5. Quantum of expenditure
- Revenue expenditure is generally lower in amounts than capital expenditure as it is incurred more frequently. This however does not mean that revenue expenditure cannot be of high amounts. High value expenditures may still qualify as revenue expenditure if their benefit is received within the same accounting period.
- Capital expenditure is generally of considerably higher amounts than revenue expenditure.
6. Accounting treatment
- Revenue expenditure is debited to the profit and loss in the year in which it is incurred.
- Capital expenditure is capitalized to the balance sheet in the year in which it is incurred. It is charged periodically to the profit and loss in subsequent years to match the related revenue receipts.
7. Impact on profitability
- Revenue expenditure has immediate impact on reducing the profit of the business i.e.: in the same accounting period in which it is incurred.
- Capital expenditure does not have immediate impact on profit of the business but it impacts the profit over multiple subsequent accounting periods.
- Revenue expenditure includes purchase of raw materials, salary expenses, rent, repairs and maintenance etc.
- Capital expenditure includes acquisition of fixed assets and substantial overhaul of fixed assets.
Conclusion revenue expenditures vs capital expenditures:
Although the impact on profitability differs in the case of revenue and capital expenditure, they both have impact on cash flow of the business. Management aims to fund its revenue expenditure through its operational revenue itself. If this does not suffice then management can opt for working capital loans. Highly profitable businesses may able to fund additional capital expenditure through its operations but most business resort to external funding such as raising of equity and availing of loans to fund their capital expenditure.