Contents: 7 sections
Cambridge IGCSE Accounting 0452 · Core and Extended
Syllabus points
- Distinguish between capital and revenue expenditure.
- Distinguish between capital and revenue receipts.
- Calculate and comment on the effect of incorrect treatment on profit and on the statement of financial position.
The distinction
Capital expenditure is money spent buying a non-current asset, or improving one so that it does more than before. It goes into the statement of financial position and is written off gradually as depreciation.
Revenue expenditure is the day-to-day running cost of the business: keeping assets working, and everything else spent to trade. It goes in full into the income statement for the period.
The test has two parts. Does the spending give a benefit beyond this year, and does it improve the asset rather than maintain it? Both point the same way for a genuine capital item.
What counts as part of the cost
Capital expenditure is more than the purchase price. Everything spent getting the asset ready for use is capitalised:
- The purchase price, after trade discount.
- Delivery and carriage.
- Installation and testing.
- Legal fees on buying property.
- Alterations needed to make the asset usable.
What is not capitalised, even on the same invoice:
- Insurance and the road licence on a vehicle.
- Fuel, oil and other running costs.
- Training staff to use the machine.
- Repairs and maintenance once it is working.
The dividing line is the moment the asset becomes ready for use. Before that, it is capital; after that, it is revenue.
A machine has a list price of $30 000 with 10% trade discount, delivery of $800, installation of $1 500, and a first-year maintenance contract of $700.
The capitalised cost is 27 000 plus 800 plus 1 500, which is $29 300. The maintenance contract of $700 is revenue expenditure.
Receipts
The same split applies to money coming in.
- Capital receipts come from selling a non-current asset, from the owner introducing capital, or from taking out a loan.
- Revenue receipts are the trading income of the period: sales, rent received, commission received, discount received.
Selling an old van for $2 500 is a capital receipt and does not go into sales. Only the profit or loss on disposal, which is the difference between the proceeds and the carrying amount, affects the income statement.
Getting it wrong
This is where the marks are, because one misclassification damages both statements at once.
| Error | Profit | Non-current assets | Capital |
|---|---|---|---|
| Capital expenditure treated as revenue | Understated | Understated | Understated |
| Revenue expenditure treated as capital | Overstated | Overstated | Overstated |
Take the second row concretely. A repair of $4 000 debited to the motor vehicles account: the income statement is missing $4 000 of expense, so profit is $4 000 too high, and motor vehicles is $4 000 too high in the statement of financial position.
The damage does not stop there. The $4 000 will now be depreciated, so every future year's depreciation charge is too high as well, and the error keeps rolling forward until the asset is disposed of.
Both errors are errors of principle, so the trial balance still balances and nothing draws attention to them.
Borderline cases
- Repainting an existing shop: revenue, it maintains.
- Painting a newly built shop for the first time: capital, it completes the asset.
- Replacing a broken window: revenue.
- Adding a new storeroom: capital, the building does more.
- Replacing an engine with an identical one: revenue, it restores.
- Fitting a bigger engine that increases the load carried: capital, it improves.
- Wages of the firm's own workers who built a new counter: capital, because they created a non-current asset.
That last one surprises people. Wages are usually revenue, but wages spent constructing an asset are part of the asset's cost.
Always say why. "Capital, because it increases what the asset can do rather than maintaining it" earns the mark; the single word often does not.
Common mistakes
- Capitalising insurance, licence, fuel or training on a new asset.
- Treating the proceeds of an asset sale as sales revenue.
- Saying the trial balance would reveal the error.
- Giving the effect on profit and forgetting the effect on assets.
- Treating a loan received as income.
- Forgetting that overstating an asset also overstates future depreciation.