Capital and Revenue Expenditure

How profit is calculated

Revenue MinusCost of Goods Sold= Gross ProfitMinusExpenses= Net Profit

The matching/accruals principle

• This basic principle of accounting states that in determining a firm’s profit, any income should be matched with the expenditure involved in creating that income

Example

• A firm is trying to calculate it’s monthly profit figures.

• Electricity is paid quarterly…… $1,200 is paid every January, April, July and October

• Should electricity expenses be recorded as $0 for February?

Example

• A firm has spent $20,000 on raw materials in the current financial year.

• However there was $7,000 of stock at the start of the year and $4,000 at the end of the year….. What amount should be recorded as the raw materials cost?

Types of Expenditure

• Expenditure is when a business spends money.• We categorise business expenditure into

either:• Capital Expenditure• Revenue Expenditure

Capital Expenditure

• Occurs when the business spends money on purchasing fixed assets, or adding to the value of existing assets

Revenue expenditure

• Spending money on day to day running costs for the business

Joint Expenditure

• Occasionally an expense will be partially capital and partially revenue expenditure.

• For example building work that is patially a repair and partially an improvement

Capital or Revenue?

Purchasing Premises

Capital or Revenue?

Repairs to machinery

Capital or Revenue?

Rent

Capital or Revenue?

Extension of office block

Capital or Revenue?

Electricity

Capital or Revenue?

Buying new Machinery

Capital or Revenue?

Adding Air Conditioning to a room

Capital or Revenue?

Redecorating offices

Why?

• Fixed assets are going to stay in the business for a long period of time

• For example: It would therefore be unfair to count the purchase of a van as an expense for 2007 when it would continue to be used for the next 3 years.

• If we did this expenses figures would be too high for 2007 and too low for the other 2 years

• This would make profit look too low in 2007 and too high in the other years

Expenditures and accounts

• Revenue Expenditure – Is recorded as an expense on the profit and loss account

• Capital Expenditure – Is recorded as an increase in Asset in the Balance Sheet and the expense will be spread over the useful life of the asset in the form of Depreciation