It is necessary for companies and businesses to differentiate between capital and revenue expenditures. While capital expenditures relate to large investments, revenue expenditures are smaller, day-to-day operating expenses. However, the differentiation between both of these isn’t as straightforward. There are some factors that companies can use to differentiate between their expenses.
Before understanding the differences between capital and revenue expenditures, it is crucial to know what they are. By understanding their basic definitions, the differentiation between them becomes straightforward.
What is Capital Expenditure?
Capital expenditures are all expenses borne by a company towards significant capital investments. Usually, companies make capital expenditures for several reasons. These may include acquiring and maintaining the operational capacity of an asset. Companies may also use capital expenditures to expand their operations and grow their business.
Capital expenditures are necessary for long-term profit generation. Companies use capital expenditure with long-term returns in consideration. Similarly, these expenditures provide benefits for several accounting periods. Companies incur capital expenditure to buy fixed assets, which usually include property, plant, and equipment. These may consist of assets such as land, building, vehicle, machinery, etc.
The purpose of making capital expenditures is to increase a company’s earning potential. These are different from revenue expenditures that companies use to address daily operational needs. Capital expenditure, due to their long-term purpose, also come with a higher cost to a company. In contrast, revenue expenditures are relatively inexpensive or lower in value.
Companies also need a source of finance to address their capital expenditure needs. They may either use debt or equity finance to cover that cost. Of these, which one a company uses depends on its needs or requirements. However, companies usually consider the cost of capital when deciding on which source of finance to use.
What is Revenue Expenditure?
Revenue expenditure refers to all expenses that companies incur toward operational needs. These are operating expenses that are necessary for the daily running of operations. Unlike capital expenditures, revenue expenditures are lesser in value. These are short-term expenses that companies use for a specific accounting period and generate revenues for that period.
Revenue expenditures may come in various forms. For example, these may include salaries and wages, rent, utilities, etc. Revenue expenditure may also relate to assets in case of repair and maintenance. However, these expenses are different from capital expenditures. Unlike capital expenditure on assets, revenue expenditure does not enhance or restore an asset’s capacity.
As mentioned, revenue expenditures do not require high capital requirements. Companies can finance these expenditures from capital generated internally. Similarly, companies may use short-term finance options, such as credit or overdraft, to fund revenue expenditures. As with capital expenditure, a company’s requirements may dictate which source of finance it may use.
Capital Expenditure Vs Revenue Expenditure?
There are many differences between capital and revenue expenditure. Companies must understand these differences to separate capital from revenue expenditures. Once they do so, they can make the accounting treatment accordingly. The differences are as below.
The primary difference between capital and revenue expenditure comes from their definition. Capital expenditure includes expenses incurred to acquire an asset or enhance an existing asset’s capacity to expand its useful life. Revenue expenditures, on the other hand, are expenses incurred in maintaining a company’s daily operations.
As mentioned, capital expenditures are long-term and last for several years. On the other hand, revenue expenditure relates to a single period.
Capital expenditures, as the name implies, are expenses that companies must capitalize on. On the other hand, companies expense out revenue expenditures. On that basis, companies must also depreciate capital expenditure unless it is land.
Impact on profits
Both capital and revenue decrease a company’s profits in several ways. Capital expenditures do so through depreciation or impairment. Revenue expenditure, on the other hand, directly contributes to expenses. However, capital expenditures can also increase profitability in the future.
What is the accounting treatment for Capital Expenditure?
Once a company differentiates between capital and revenue expenditure, it must capitalize the capital expenditure. They can do so through the following double entry.
|Dr||Capital Expenditure (Asset)|
The capital expenditure incurred becomes a part of the company’s balance sheet. On the other hand, it also results in a decrease in assets or an increase in liabilities based on the finance source. The capital expenditure stays on the company’s balance sheet until its useful life is over.
What is the accounting treatment for Revenue Expenditure?
As mentioned, companies must expense out their revenue expenditures. Therefore, they must use the following accounting treatment.
|Dr||Revenue Expenditure (Expense)|
The revenue expenditure increases a company’s expenses for a single accounting period. On the other hand, it also increases liabilities or decreases assets based on the finance source.
Companies incur various types of expenditures in their operations. Companies must differentiate between capital and revenue expenditure. These are different in several aspects, such as their definition, lifespan, capitalization, impact on profits, and others. For capital expenditures, companies need to increase their assets and capitalize them. In contrast, they must expense out the revenue expenditures.