Basic Considerations In Determining Capital and Revenue Expenditures
- Nature of business: The nature of business is a very important criterion in separating expenditure between capital and revenue. E.g., for a trader dealing in furniture, purchase of furniture is revenue expenditure but for any other trader, the purchase of furniture should be treated as a capital expenditure and shown in the Balance Sheet as an asset.
- Purpose of expenses: The expenditure incurred for a major repair of the assets so as to increase its productive capacity is capital in nature. On the other hand, if it is incurred in the course of normal maintenance of the assets, i.e., to maintain the asset in its present operating condition, it is revenue expenditure.
- Materiality: Relative size of the amount involved is another important consideration between revenue and capital expenditure. The materiality of the amount may be a deciding factor to consider it as revenue or capital expenditure, even if they do not fall within the purview of capital or revenue nature. For example, expenditure incurred for purchase of a small calculator may be charged to Profit and Loss Account in consideration of materiality though the calculator gives benefit for more than a year.
- Recurring nature of expenditure: The expenses which arise frequently in an accounting year are said to be of revenue nature whereas non-recurring expenditures are generally classified as capital expenditures. E.g. payment of rent is classified as revenue expenditure as it is incurred at regular intervals whereas the purchase of an asset, which is not a frequent activity, is therefore classified as a capital expenditure.
- Effect on revenue generating capacity of business: The expenses which help to generate income/revenue in the current period are revenue in nature and should be matched against the income earned in the current period. On the other hand, if the expenditure helps to generate revenue over more than one accounting period, it is generally called a capital expenditure. Only that part of the expenditure which relates to the earning of revenue in the current period is recognised as an expense in the current period.
Example: Purchase of barren land, Charging of depreciation, etc.