A business organization incurs expenditures for various purposes during its existence. Some of these expenditures are meant to bring in more profits for the organization while some expenditures may involve investment strategies to bolster maintenance or business expansions which could help in long run. Also, Based on the nature of the expenditure, they are categorized as Capital Expenditure and Revenue Expenditure.
Moreover, Business entities need to identify the costs incurred by way of these categories to account for them accurately.
Also, being familiar with their fundamentals and point of differences will help manage them more effectively and enable sustainable earnings.
What is Capital Expenditure?
Capital expenditures or CAPEX are for long term benefits. These expenditures serve the purpose of increasing the capacity or capabilities of the long term asset by either enhancing or adding new assets to the organization.
Capital expenditure is mostly on assets. For Example: land, equipment, furnishings or vehicles that help to drive benefits by increasing the operating capability.
Generally, CAPEX influences a firm’s short-term and long-term financial standing. Also, it helps to boost its overall operations over the years. The formula of CAPEX is–
Capital expenditure = Net increase in PP & E + Depreciation Expense
Moreover, These expenditures form part of the asset side of the balance sheet also denoted in cash flow statement. Also, organization can charge depreciation on CAPEX every year. It is one of the prominent differences between capital expenditure and revenue expenditure.
Types of Capital Expenditure
Following are 3 distinct groups of Capital expenditure:
- Expenses that a firm incurs to lower cost.
- Expense that help to boost overall earnings.
- Expenses made on non-economic grounds.
In terms of outlay, Following are headers of CAPEX:
- Routine Expenditure
- Major projects
What is Revenue Expenditure?
Revenue expenditure or OPEX is the expenditure to manage the day to day functions of a business. However, such costs do not result in asset creation. Also, the benefits resulting from OPEX is up to one accounting year.
Further, Revenue Expenditures does not result in an increase in the earning capacity of the business. However, it helps in maintaining the existing earning capacity. For example, wages & Salary, Printing & Stationery, Electricity Expenses, Repairs and Maintenance Expenses, Inventory, Postage, Insurance, taxes, etc.
Moreover, factors like the nature of the business operation, the purpose of a venture, frequency of activities, etc. prove useful in categorizing expenses as OPEX.
Also, Revenue Expenditures will be part of Profit & Loss Account, it will not to be shown under the Balance Sheet.
Types of Revenue Expenditure
Revenue expenditure can be categorized under 2 distinct groups as follows:
- Direct expenses
- Direct Expenses refers to the expenditure different from direct material cost and direct labour cost, spent on the production of product or provision of service.
- Moreover, These types of expenses are mostly relating to the production process. For example – direct wages, freight charge, import duty, commission, rent, legal expenses and electricity cost.
- Indirect expenses
- Indirect Expenses covers all those expenses which are not part of direct material, direct wages and direct expenses. Basically, these are the costs which benefit the entire firm as a whole and not just one department or segment of the business
- Also, They include expenses like selling salaries, repairs, interest, commission, depreciation, rent and taxes, among others.
- Such costs may also include the money spent during the management of recurrent administrative expenses.
Difference between Capital and Revenue Expenditure
The table below mentions differences between capital expenditure and revenue expenditure –
|Parameters||Capital Expenditure||Revenue Expenditure|
|Definition||Capital expenditure is to acquire assets or to improve the quality of existing ones.||Revenue expenditure is to maintain their everyday operations.|
|Purpose||Such expenses boost earning capacity.||Such expenses help to sustain profitability.|
|Time span||Capital expenses are for the long-term.||Revenue expenses are for a shorter-duration and are mostly limited to an accounting year.|
|Capitalization of expenses||Capital expenses are capitalized.||Revenue expenses are not capitalized.|
|Treatment in accounting books||CAPEX is stated in a firm’s Cash Flow Statement. Also, It appears in the Balance Sheet of a company under fixed assets.||OPEX is stated in a firm’s Income Statement but it is not reported in its Balance Sheet.|
|Treatment of depreciation||Depreciation of assets is charged on capital expenses.||Depreciation of assets is not levied on revenue expenditure.|
|Occurrence||Typically, CAPEX is not quite frequent.||OPEX are frequent expenses.|
|Yield||The yield of these expenses is not upto to a year and is usually long-term in nature.||The yield of these expenses is mostly upto to the current accounting period.|
|Examples||Purchase of Machinery or patent, copyright, installation of equipment and fixture, etc.||Wages, salary, utility bills printing and stationery, inventory, postage, insurance, taxes as well as maintenance cost, among others.|
Hence, both capital expenditure and revenue expenditure are vital for the sustainable profitability of a business venture. Furthermore, revenue expenses are a periodic investment which does not result in immediate or delayed benefit. However, it is used to keep operations running uninterruptedly.
Moreover, capital expenditure is long-term investment that proves beneficial for a firm. Business entities must understand that they need to adopt effective strategies to monitor and regulate these expenses to boost overall profitability significantly.
Capital expenditures are incurred to acquire physical assets whereas Revenue expenditures are operating expenses to run the daily operations.
Yes, For example if a company purchases a storage facility, the cost to purchase such storage facility is capital expenditure and the cost of painting, refurbishing or other decorations is revenue expenditure.
In maintaining accounting records it important to distinguish between capital and revenue expenditure because treatment of both the expenditures differ in the financial statements.