In accounting there are two main mandatory financial statements and these report the financial position and the financial performance of a company. These two financial statements are known as the balance sheet and the profit and loss account respectively. The balance sheet is the home to all capital expenditures and all revenue expenses are recorded in the profit and loss account.
Failure to distinguish the difference between revenue expenses and capital expenses can lead to a misleading picture of both the financial performance and financial position being reported or presented to the users of accounting information.
In book-keeping and accounting there is a type of error known as the error of principle. This error occurs when capital expenditure is treated as revenue expenditure in the books of accounts and vice versa. When a firm deliberately misclassifies revenue expenditure as capital expenditure this may be viewed as creative accounting which is morally and ethically wrong. Below these two concepts are explored further.
Revenue expenditure is outlay or expenses incurred in the day to day running of a company. In most cases revenue expenditure involves the procurement of services and goods that will be used within a financial year. Revenue expenditure does not improve or increase the income generating abilities of a company rather at best it leads to the maintenance of the current organisational revenue generating capacity.
All expenses of a revenue nature are recorded in the profit and loss account as either operating expenses, marketing and selling expenses and administrative expenses. Revenue expenses play a role in determining the profit earned or a loss by a company.
Revenue expenses are routine and recurring in nature and some examples of revenue expenditure include payments in staff wages and salaries, heating and lighting, depreciation, legal and professional fees, travel and subsistence, insurance, administrative expenses, most of marketing and public relations expenses, audit fees, office supplies, staff training costs, staff recruitment costs and minor or immaterial items of equipment.
Capital expenditure represents outlay on fixed assets. Capital expenditure can be outlay of resources on the investment of long-term income generating capability of the company. Investment in fixed assets will lead to an increase or improvement in the investing company’s revenue generating capacity. Capital expenditure can also be in the form of significant acquisitions or purchases of more expensive items of equipment that will last longer than a financial year.
All capital expenditure is recorded on the balance sheet. Capital expenditure will be depreciated or amortised annually to ensure that an expense is charged to the profit and loss account to reflect the capital expenditure’s usage by the company.
Some of the examples of capital expenditure include outlay on land and buildings, plant and equipment, vehicles, computer equipment, product development costs, finance leases and software development costs.