Chapter 1: Capital and Revenue Items Flashcards
Define capital expenditure.
Capital expenditure is expenditure which results in the acquisition of non-current assets or an improvement or enhancement of their earning capacity.
What are non-current assets?
Non-current assets are those which will be kept in the entity for more than one year.
How does capital expenditure appear in the financial statements?
Capital expenditure is not charged as an expense in the statement of profit or loss (although a depreciation charge will usually be made to match the capital expenditure against the income that it generates over the useful life of the asset; depreciation expense is show in the statement of profit or loss)
Define revenue expenditure. (2)
Revenue expenditure is revenue which is incurred either:
1) For trade purposes. This includes purchases of raw materials or items for resale, expenditure on wages and salaries, selling and distribution expenses, administrative expenses and finance costs; or
2) To maintain the existing earning capacity of non-current assets.
How does revenue expenditure appear in the financial statements?
Revenue expenditure is charged to the statement of profit or loss of a period, provided that it relates to the trading activity and sales of that particular period.
Example: Revenue Expenditure
If a business buys 10 steel bars for £200 (£20 each) and sells either of them during a reporting period, it will have two steel bars left at the end of the period. The full £200 is revenue expenditure but only £160 is the cost of goods sold during the period. The remaining £40 (cost of two units) will be included in the statement of financial position as ‘inventory’ valued at £40.
Example: Capital Expenditure
A business purchases a building for £300,000. It then adds an extension to the building at a cost of £100,000. After a few months, the business needs to have a few broken windows mended, its floors polished and some missing roof tiles replaced. These cleaning and maintenance jobs cost £900.
In this example, the original purchases (£300,000) and the cost of the extension (£100,000) are capital expenditure, because they are incurred to acquire and then improve a non-current asset.
The other costs of £900 are revenue expenditure, because these merely maintain the building and thus do not increase its ‘earning capacity’.
Capital expenditure can include costs incurred in bringing a non-current asset to its final condition and location, such as legal fees, duties and carriage costs borne by the asset’s purchaser, plus installation costs.
Repair, maintenance and staff costs in relation to non-current assets are revenue expenditure.
Define capital income.
Capital income includes proceeds from the sale of non-current assets.
The profits (or losses) from the sale of non-current assets are included in the statement of profit or loss for the reporting period in which the sale takes place. For instance, the business may sell machinery or property which it no longer needs.
Define revenue income. (3)
Revenue income includes income derived from:
1) The sale of trading assets, such as goods held in inventory
2) The provision of services
3) Interest and dividends received from business investments
Give an example of two types of capital transaction.
How do capital transactions appear in the financial statements?
An example capital transaction involves raising additional funds from the owner(s) of the business or raising and repaying loans.
These transactions add to the cash assets of the business and create corresponding capital or liabilities (loans).
When a loan is repaid, it reduces the liabilities (loan) and the assets (cash).
None of these transactions would be reported through the statement of profit or loss.
Why is the distinction between capital and revenue items important?
Calculating profit for any reporting period depends on the correct and consistent classification of revenue or capital items.
