Businesses usually have two types of spending such as Revenue Expenditure and Capital Expenditure. Here is an example how accountants can correctly record these two types of spending into Final Accounts.
Revenue Expenditure
Revenue expenditure is any day-to-day spending on assets that that help to generate Sales Revenue.
These spending will give short-term benefits to the business within one year.
They will be recorded in Profit and Loss Account (P&L Account) reducing the year’s profits. Only unsold stock at the end of the trading year will be entered into Cost of Goods Sold (COGS) under ‘closing stock’.
Capital Expenditure
Capital expenditure is any spending on Fixed Asset bought and retained in the business in the long-term.
These assets will have a useful life of more than one year. Capital expenditure is not recorded in Profit and Loss Account (P&L Account) in the year the asset is bought.
Because the value of Fixed Assets is rather huge, hence it might reduce the year’s profits to 0 which will make the business pay no Corporate TAX.
Instead, the value of a Fixed Asset is ‘depreciated’ over its expected lifespan. To put it simply, the purchase cost of an asset is divided by the duration of its useful life. And only then, this smaller amount called ‘depreciation’ is considered as a business expense. It belongs to Fixed Costs (FC) because it recurs in the same amount throughout the useful life of that asset.
Example 1: A hamburger restaurant buys minivans. CAPITAL EXPENDITURE: A hamburger restaurant purchases two new minivans to deliver hamburgers around the city. These minivans are expected to last for ten years. In accounting terms, purchasing a minivan is obviously Capital Expenditure on Fixed Assets lasting longer than one year as they will be kept and used by the business for several years. REVENUE EXPENDITURE: The petrol used to fill in the tanks will be day-to-day spending because the hamburgers need to be delivered to customers every day, and minivans cannot run without fuel. So, petrol will be revenue expenditure as it is used up in the process of using the vans in daily activities of the business.
Important point to consider about Revenue Expenditure and Capital Expenditure
The total cost of purchasing the Fixed Asset (capital expenditure) cannot be recorded as an expense in Profit and Loss Account (P&L Account), but it has to be depreciated.
Otherwise, this year’s profits will be low, or even 0, as a result of the entire cost of the Fixed Asset being recorded straight away. The government will definitely do not agree. And profits in later years will be higher because they do not bear any of the charge of this purchase.
Also, by considering the Fixed Asset as an annual expense, they will not appear under Fixed Assets on the Balance Sheet. This would lower the value of the business below its real worth.
