Capital Expenditure, Revenue Expenditure and Deferred Revenue Expenditure

Before Final Accounts can be prepared correctly, every item of expenditure and receipt in the trial balance must first be correctly classified — because this classification decides where an item appears (Trading Account, Profit and Loss Account, or Balance Sheet) and, if placed wrongly, will distort both the profit figure and the balance sheet.

Capital Expenditure. Expenditure incurred to acquire a fixed asset, or to improve/increase the earning capacity of an existing fixed asset, whose benefit is expected to last for more than one accounting year. Examples: purchase of machinery, furniture, buildings, or motor vehicles; expenses on installation/erection of new machinery; and expenditure that substantially extends the life or capacity of an existing asset (e.g., an addition/extension to a building). Capital expenditure is shown as an asset in the Balance Sheet, not as an expense in the Trading or Profit and Loss Account — though the wear-and-tear it suffers each year (depreciation) IS charged as a Profit and Loss Account expense.

Revenue Expenditure. Expenditure incurred in the normal, day-to-day running of the business, whose benefit is consumed within the same accounting year. Examples: purchase of goods for resale, wages, salaries, rent, carriage, printing and stationery, and ordinary repairs that merely keep an existing asset in working condition (not improve it). Revenue expenditure is charged fully to the Trading Account or Profit and Loss Account of the year in which it is incurred.

Deferred Revenue Expenditure. A revenue expenditure that is unusually large in amount and whose benefit is expected to extend over several years, even though it is not itself a fixed asset — for example, heavy advertisement expenditure for launching a new product, whose benefit will be felt for the next 3–4 years. Rather than charging the entire amount to the Profit and Loss Account of the year it was spent, only the proportionate part relating to the current year is charged as an expense, and the remaining, unexpired portion is carried forward and shown as an asset in the Balance Sheet (to be written off over the following years). …