Considerations in determining capital and revenue expenditures

Considerations in determining capital and revenue expenditures

The basic considerations to differentiate between capital and revenue expenditures are:

(i)     Nature of business

Expenditure on purchase of goods is revenue expenditure. Expenditure on purchase of asset is capital expenditure. Whether an item of expenditure is goods or asset depends on the nature of business. Goods include articles or commodities in which the business is dealing with. For example, for a trader dealing in furniture, purchase of furniture is revenue expenditure but for any other trade, the purchase of furniture should be treated as capital expenditure and shown in the balance sheet as asset. Therefore, the nature of business is very important criteria in classifying expenditure between capital and revenue.

(ii) Effect on revenue generating capacity of business

If expenditure helps to generate income or revenue in the current accounting period, it is revenue expenditure. On the other hand, if expenditure helps to generate revenue for more than one accounting period, it is capital expenditure.

(iii) Purpose of expenditure

If expenditure is incurred in the normal course of maintenance of an asset, it is revenue expenditure. On the other hand, if expenditure is incurred for major repair of an asset which increases its productive capacity, it is capital expenditure.

(iv) Materiality of the amount involved

Relative proportion of the amount involved is considered in distinguishing between revenue expenditure and capital expenditure. If the amount of expenditure is material, it is treated as capital expenditure even if the expenditure does not increase the productive capacity of the asset. On the other hand, when the amount of expenditure is immaterial, it is treated as revenue even if the benefit of the expenditure extends beyond one accounting period. For example cost of waste basket is treated as revenue expenditure.