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Capital and Revenue Expenditure

"Misclassify this, and your profit, tax, and Balance Sheet are all wrong!"

One of the most important concepts in accounting is distinguishing between Capital Expenditure and Revenue Expenditure.

What is Expenditure?

Expenditure = Money spent by the business to acquire goods/services.

But WHERE it's recorded depends on its nature and purpose.

Capital Expenditure

Definition: Expenditure incurred to acquire or improve fixed assets or to increase their earning capacity.

Characteristics:

  • Long-term benefit (more than 1 year)
  • Capitalized (added to asset value, shown in Balance Sheet)
  • NOT immediately expensed in P&L
  • Depreciated over useful life

Examples

✅ Purchase of machinery
✅ Purchase of building/land
✅ Cost of furniture, vehicles, computers
✅ Installation/transportation of machinery
✅ Major repairs/renovations that increase asset life
✅ Legal fees for purchasing property

Revenue Expenditure

Definition: Expenditure incurred for day-to-day operations or to maintain existing assets in working condition.

Characteristics:

  • Short-term benefit (within 1 year)
  • Expensed immediately in P&L Account
  • NOT shown in Balance Sheet (except prepaid portion)
  • Reduces profit

Examples

✅ Salaries and wages
✅ Rent, electricity, telephone bills
✅ Routine repairs and maintenance
✅ Advertising and marketing
✅ Purchase of raw materials/trading goods
✅ Insurance premium
✅ Depreciation on assets

Detailed Comparison

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Borderline Cases: When It's Tricky

1. Repairs

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Example:

  • Changing engine oil in truck: Revenue (₹2,000)
  • Replacing whole engine: Capital (₹5,00,000)

2. Interest on Loan

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Example:

  • Loan taken to build factory
  • Interest during construction (2 years): Capital → added to Building cost
  • Interest after factory starts production: Revenue → expense in P&L

3. Insurance

  • Insurance of fixed asset (building, machinery): Revenue
  • Insurance premium for constructing building: Capital

Deferred Revenue Expenditure

Definition: Heavy revenue expenditure that gives benefit for 2-3 years.

Though revenue in nature, it's partially capitalized and written off over a few years.

Examples:

  • Heavy advertising for launching new product (₹50 Lakhs)
  • Pre-operative expenses
  • Preliminary expenses of a company

Treatment:

  • Write off 1/3rd or 1/2 each year over 2-3 years
  • Balance shown as "Miscellaneous Expenditure" in Balance Sheet

Real-World Impact

Case Study: Tata Motors

Scenario 1: Buys robotic assembly line for ₹100 Crores

  • Treatment: Capital Expenditure
  • Accounting: Asset in Balance Sheet, depreciation ₹10 Cr/year for 10 years
  • Tax: Cannot deduct full ₹100 Cr immediately, only depreciation each year

Scenario 2: Spends ₹5 Crores on monthly electricity

  • Treatment: Revenue Expenditure
  • Accounting: Expense in P&L
  • Tax: Full ₹5 Cr deductible immediately

Wrong Classification Impact:

  • If Capital treated as Revenue → Profit understated, tax saved (illegal!)
  • If Revenue treated as Capital → Profit overstated, higher tax, Balance Sheet wrong

Tax Implications

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Journal Entries

Capital Expenditure:

Machinery A/c               Dr.    ₹10,00,000
    To Cash/Bank A/c                   ₹10,00,000
(Being machinery purchased)

Revenue Expenditure:

Salary Expense A/c          Dr.    ₹50,000
    To Cash/Bank A/c                   ₹50,000
(Being salary paid)

Quick Decision Tree

Ask yourself:

  1. Does it acquire/improve an asset? → Capital
  2. Does it help in daily operations? → Revenue
  3. Benefit more than 1 year? → Capital
  4. Benefit within 1 year? → Revenue

Quiz: Capital and Revenue Expenditure

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