Accounting (9215) | Accounting for capital and revenue expenditure and income

👋 Welcome to the World of Capital and Revenue!

Hello future accountants! This chapter is absolutely critical because it teaches you how to sort things out correctly in the business world. Think of it as teaching your accounts to put expenses and income into the right 'buckets'.

Why does sorting matter? If you put a long-term expense into the short-term bucket, your profit calculation will be completely wrong! Mastering this distinction ensures that the financial statements you produce show a true and fair view of the business's performance and position.

Section 1: The Difference Between Capital and Revenue EXPENDITURE

Every time a business spends money, that spending is called expenditure. We need to decide if that expenditure is 'Capital' or 'Revenue'. This is based on when the business will benefit from that spending.

1.1 What is Capital Expenditure (CapEx)?

Capital Expenditure (CapEx) is money spent on acquiring or improving Non-Current Assets (NCAs). These are assets the business expects to use for more than one year.

The key characteristics of CapEx are:

• Long-Term Benefit: The spending benefits the business for many accounting periods (e.g., 5, 10, or 20 years).
• Asset Creation/Improvement: It results in the purchase of a new asset (like machinery) or significantly increases the earning capacity, efficiency, or useful life of an existing asset (like adding an extension to a building).

CapEx Examples:

• Buying a new factory building or vehicle.
• Adding a new wing to an existing office building (improving/extending the asset).
• The cost of installing a new machine (like delivery and setup fees) - these costs are necessary to get the asset ready for use, so they are added to the asset's cost.

Accounting Treatment: CapEx is recorded on the Statement of Financial Position (SFP) as an Asset. It is not recorded as an expense immediately, but its cost is spread over its useful life through depreciation (a topic we cover later).

1.2 What is Revenue Expenditure (RevEx)?

Revenue Expenditure (RevEx) is money spent on the day-to-day running of the business. It maintains the current earning capacity of the assets, but does not increase their value or life significantly.

The key characteristics of RevEx are:

• Short-Term Benefit: The benefit is usually used up within the current accounting period (i.e., less than one year).
• Maintenance Costs: It keeps existing assets in their normal working condition.

RevEx Examples:

• Paying monthly rent, salaries, or electricity bills.
• Routine maintenance or small repairs (e.g., changing the oil in a company vehicle or replacing a lightbulb).
• Buying stationery, or fuel for company cars.

Accounting Treatment: RevEx is treated as an expense and is recorded on the Statement of Profit or Loss (SPL). It reduces the profit for the current year.

🧠 Memory Aid and Analogy: The House Analogy

Think about your family home:

• Capital Expenditure (CapEx): Buying the house itself, or building a new conservatory. This lasts for decades and increases the house's market value. (Long-term Asset)
• Revenue Expenditure (RevEx): Paying the monthly electricity bill, cleaning supplies, or fixing a broken door handle. This keeps the house running but doesn't increase its value significantly or last for years. (Current Expense)

Section 2: The Difference Between Capital and Revenue INCOME

Just as we classify expenditure, we must also classify the money the business receives (income).

2.1 What is Revenue Income (RevIn)?

Revenue Income (RevIn) is the money received from the business's core, normal, day-to-day activities. This income is regular and expected.

RevIn Examples:

• Sales of goods or services (the main source of income).
• Rent received (if the business owns property and rents it out).
• Interest or commissions received.

Accounting Treatment: Revenue Income is recorded on the Statement of Profit or Loss (SPL) and increases the profit for the year.

2.2 What is Capital Income (CapIn)?

Capital Income (CapIn) is the money received that is not related to the normal operations of the business. It usually involves selling a Non-Current Asset (NCA).

CapIn Examples:

• Money received from the sale of an old, unused delivery van.
• Money received from selling surplus machinery.

Accounting Treatment: Capital Income does not go into the main 'Sales' figure on the SPL. Instead, any gain or loss from selling the NCA is calculated and included in the SPL, and the cash received increases the Assets on the SFP.

Did you know? The focus in this chapter is classifying the *transaction*. Selling a machine is Capital Income, but the profit or loss on that sale is factored into the final profit calculation, showing the business isn't making profit from its daily sales.

Section 3: The Critical Importance of Correct Classification

This is perhaps the most important section. What happens if you get it wrong? Misclassification leads to incorrect financial statements, which can mislead owners, investors, and banks.

3.1 The Impact on the Statement of Profit or Loss (SPL)

The SPL calculates the business's profit for the period.

Rule: Only Revenue Expenditure (Expenses) and Revenue Income (Revenue) should affect the core profit calculation.

3.2 The Impact on the Statement of Financial Position (SFP)

The SFP shows the business’s assets, liabilities, and capital at a specific date.

Rule: Capital Expenditure (Assets) and Capital Income (affecting cash/assets) must be shown here.

3.3 Common Mistake: Treating CapEx as RevEx (Expense)

This is the most frequent and serious error. Let's say a business spends $50,000 on a new machine (which is CapEx). They mistakenly record it as "Repairs and Maintenance" (RevEx).

Step-by-Step Consequences of the Error:

1. SPL Error: Because they treated the $50,000 as a Revenue Expense, the total expenses recorded on the SPL are too high by $50,000.
2. Profit Error: High expenses lead to the calculated Net Profit being understated (too low).
3. SFP Error (Assets): They did not record the new machine as a Non-Current Asset. Therefore, the total Non-Current Assets on the SFP are understated (too low) by $50,000.
4. SFP Error (Capital): Since the Profit was understated (too low), and Profit increases Capital, the overall Owner's Capital in the SFP is also understated (too low).

Encouragement: Don't worry if this seems tricky at first! Remember the chain reaction: Misclassification -> Wrong Expense -> Wrong Profit -> Wrong Capital/Assets.

3.4 Common Mistake: Treating RevEx as CapEx (Asset)

This error is less common but still serious. Let's say a business spends $500 on routine repairs (RevEx). They mistakenly add this cost to the value of a Non-Current Asset (CapEx).

Step-by-Step Consequences of the Error:

1. SPL Error: Because they did not record the $500 as a Revenue Expense, the total expenses recorded on the SPL are too low by $500.
2. Profit Error: Low expenses lead to the calculated Net Profit being overstated (too high).
3. SFP Error (Assets): They incorrectly added the $500 to the value of an asset. Therefore, the total Non-Current Assets on the SFP are overstated (too high).
4. SFP Error (Capital): Since the Profit was overstated (too high), the overall Owner's Capital in the SFP is also overstated (too high).