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Expenditure means spending money to acquire items. Items could be goods or services. The type of item acquired is what is called capital expenditure or revenue expenditure. 4.1 Capital expenditure

When a business spends money to buy non current assets and subsequently adding value to them is called capital expenditure. For example, acquiring land, buildings, vehicles etc.

4.2 Adding Value

Adding value means spending money on an existing asset in order to improve its

performance or increase production capacity. E.g. carrying out renovations on machinery in order to increase production capacity.

4.3 Other capital expenditure

Included in capital expenditure are amount spent on non current assets to put them in a workable condition. Such amounts may include

- Transport costs to bring them into business premises - Legal costs incurred in acquiring buildings

Any other costs incurred before non current assets could be put to use. 4.4 Revenue expenditure

This is expenditure incurred on the running of the business on a day to day basis as the business is carrying on its trading activities. It is also incurred in maintaining the non current assets.

Examples may include:

- Repairing machinery

- Replacing broken window panes to a building - Electricity expenses in running machinery - Petrol costs in running the vehicle

- Purchase of goods for resale

4.5 Warning

What is to be called capital or revenue expenditure will depend on what the business is dealing in. If for example the business is buying and selling vehicles to make profits, purchase of a vehicle will be revenue expenditure. But if it buys a vehicle to be used in business, that will be capital expenditure.

EXAMPLE

Baobab is in business as a general retailer. He bought a vehicle for use in his business at a cost of K2,000. In bringing the vehicle to his premises he incurred transport costs of K500, customs duty of K700. Before he could use the vehicles, the vehicles had to be serviced and this costed K50.

When the vehicle was in use, he insured it against theft and fire and this cost K100. In running the vehicle fuel costs amounted to K150, and replaced tyres with new ones and this cost K70. He decided to put in a musical system which cost K40. Insurance cover to bring the vehicle into business premises amounted to K80.

Required:

(a) Identify items which are capital expenditure and what will be the cost the vehicle in the books.

(b) Identify revenue expenditure SOLUTION

K K

Capital expenditure Revenue expenditure

Cost of vehicle 2,000 Insurance charges 100

Transport costs 500 fuel costs 150

Customs duty 700 new tyres 70

Service charges 50 ___ Music systems 40 320 Insurance cover 80 ______ Cost of vehicle 3,370 in books ACTIVITY 4.1

Give reasons why expenditure in activity 4.1 has been identified to be capital expenditure and revenue expenditure.

4.6 Joint expenditure

A builder was engaged to do some work on the business buildings. The whole work was to cost K40,900 broken down as follows:

- K 30,000 to add an extension on building

- K 10,000 for wages of the builder for extension only

- K 900 to replace a few broken windows and some missing tiles.

The case above is an example of joint expenditure. In this case capital expenditure should be separated from revenue expenditure. Thus

K 30,000 extension to building K 10,000 wages

K 40,000 would be capital expenditure 4.7 Capital and revenue income

Income is proceeds coming into the business. Where income is coming from is what would be identified as capital or revenue income.

(a) Capital income

Capital income are proceeds arising from the sale of non current assets and long term investments. The profits or losses from the sale of non current assets are included in the income statement for the year in which the sale took place. Example: suppose a machinery is bought for K10,000, and four years later sold for K8,000. The K10,000 would be treated as capital expenditure and K8,000 capital income. The loss K2,000 (10,000 – 8,000) would be shown in income statement.

(b) Revenue income

This is income generated in the normal cause of running the business. Included are:

- revenue from ordinary trading (sales) - interest received

- dividends received

- discount received

- commission received etc. ACTIVITY 4.2

A business obtains a loan from the bank to finance the purchase of a non current asset. The business would be paying interest annually.

ACTIVITY 4.3

Classify each of the following items as ‘Capital’ or ‘Revenue’ expenditure or income. (a) Purchase of leasehold premises

(b) The annual depreciation of leasehold

(c) Solicitors fee in connection with the purchase of leasehold premises

(d) The costs of adding extra storage capacity to a mainframe computer used in the business (e) Computer repairs and maintenance costs

(f) Profit on the sale of an office building. (g) Revenue from sales by credit card (h) The cost of new machinery

(i) Customs duty charged on the machinery when imported into the country (j) Carriage costs of transporting the new machinery

(k) The cost of installing the machinery in the business premises (l) The wages of machine operators

4.8 Treatment of “Capital” and “Revenue” expenditure and machines in financial statements. (a) Capital expenditure

Capital expenditure is shown in balance sheet under non current assets. (b) Revenue expenditure and income

This is stated in the income statement (c) Capital income

Capital income does not include raising capital from the owner(s) of the business, or raising and repaying loans. These transactions add to the cash assets of the business, thereby creating a corresponding increase in capital or loan. When the loans is repaid, it reduces the liability (loan) and the asset of cash.

4.9 Incorrect treatment

If capital expenditure is treated as revenue expenditure or revenue expenditure is treated as capital expenditure, then:

- Both balance sheet figures and income statement figures will be wrong

- Profit will be over stated if revenue expenditure is treated as capital expenditure and non current assets will also be overstated

- Profit will be understated if capital expenditure is treated as revenue expenditure and non current assets in the balance sheet will be understated.