Chapter 3

Capital Expenditure and Expenditure

When preparing final accounts it is important to distinguish between capital and revenue expenditure.

Capital expenditure can be defined as expenditure incurred on the purchase, alteration or improvement of fixed . For example, the purchase of a car to be use to deliver goods is capital expenditure. Included in capital expenditure are such costs as:  Delivery of fixed assets;  Installation of fixed assets;  Improvement (but not repair) of fixed assets;  Legal costs of buying property;  Demolition costs;  Architects fees;

Revenue expenditure is expenditure incurred in the running / management of the business . For example, the cost of petrol or diesel for cars is revenue expenditure. Other revenue expenditure:  Maintenance of Fixed Assets;  Administration of the business;  Selling and distribution .

Capital Expenditure is shown on the , while Revenue Expenditure is an in the and Loss account. It is important to classify these types of expenditure correctly in the system. For example: if the cost of the car was shown as an expense in the Profit and Loss account, then the net profit would be reduced, meanwhile, the Balance Sheet would not show the car as a Fixed . Therefore, incorrect treatment of expenditure will result:

1 Capital Expenditure treated as Increase Expenses Decrease in Fixed Assets Revenue Expenditure Decrease Net Profit in the Balance Sheet 2 Revenue Expenditure treated as Decrease Expenses Increase in Fixed Assets Capital Expenditure Increase Net Profit in the Balance Sheet.

Only by allocating capital expenditure and revenue expenditure correctly between the Profit and Loss account and the Balance Sheet can the Final Accounts reflect accurately the of the business. The chart below shows the main items of capital expenditure and revenue expenditure associated with three major fixed assets – buildings, vehicles and computers.

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Capital Expenditure Revenue Expenditure Buildings cost of building general maintenance cost of extension repairs carriage on raw materials used redecoration the new building legal fees labour cost of own employees to build new premises installation of utilities in the new premises e.g. water and electricity.

Vehicles net cost, including any optional extras fuel delivery costs road licence number plates painting company logo licence for the new vehicle insurance any changes to the vehicle that servicing and repairs increases its value. Computers net cost discs installation and testing printing paper modifications, including memory insurance upgrades, low cost computer programmes installation of special wiring cost of air conditioning staff training computer programmes (if the cost of such programmes is high)

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Exercises

1a. Explain briefly the distinction between Capital and Revenue Expenditure.

1b. State whether the following transactions of a Sports Club should be classified as Capital Expenditure or Revenue Expenditure:

i. The redecoration of the club premises. ii. The installation of a new wine bar. iii. The building of an extension to the club dressing rooms. iv. The purchase of wine and spirits. v. The purchase of a record player for use in the club lounge.

2. Mario Abela decided to modernise his premises so that more customers would be attached and so that the work could be carried out more efficiently.

During the year ended 30 April 1999, the following took place: (a) An extension to the office was built, Lm15,600 was paid for materials, and Lm22,340 for labour. Lm125 was paid for legal fees for permission to extend building. (b) The original premises were redecorated Lm2,600. (c) A new, powerful computer was purchased to process the office’s accounts and other administration. The computer cost Lm5,300. (d) 50 new smaller computers were purchased at a total cost of Lm97,600 and sold to customers. (e) The original premises had some old electrical wiring renewed at a cost of Lm1670, and some additional power points installed at a cost of Lm760, so that more computers could be demonstrated to customers. (f) Other running expenses for the year totalled Lm67,400.

You are required to classify the above transactions under Capital expenditure and Revenue Expenditure.

3. Lorry Ellul buys new machinery on 1 November 1999 for Lm10,000. He pays for this by taking out a bank loan, for which he is charged Lm1,200 interest during the year ended 31 October 1999. The installation of the machinery cost him Lm450 for labour and Lm75 for materials. As the machinery is specialised, its purchase cost him an additional Lm80 in legal fees. During the year ended 31 October 1999 he spent Lm500 on power to operate the machinery, Lm8,500 on the wages of the machine operator and Lm9,250 on the materials used in production. You are required to distinguish the above items between capital and revenue expenditure.

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4. Joe Psaila bought a new computer for his office on 1 May 1999. The computer cost Lm2,500, and he paid an installation charge of Lm100. He also paid Lm900 for software for the computer. He agreed to pay Lm300 for an agreement covering his computer for repairs and maintenance for three years from 1 May 1999.

During the year ended 30 April 1999, he paid wages of Lm12,000 to his computer operator, and he estimates that the power used by the computer cost Lm20.

You are required to: a. List the items given above as either Capital Expenditure or Revenue Expenditure ; b. Give two reasons for the importance of correctly distinguishing between the two types of expenditure.

5. For the business of R.Debono, a food merchant, classify the following items between capital and revenue expenditure :

(a) repairs to meat slicer; (b) new tyre for van; (c) additional shop counter; (d) renewing sign writing on shop; (e) fitting partitions in shop; (f) roof repairs; (g) installing thief detection equipment; (h) wages of shop assistant; (i) new register; (j) repairs to office safe; (k) installing new freezers.

6. Distinguish the following items between capital and revenue expenditure:

(a) interest on loan to purchase computer; (b) cost of software; (c) cost of paper; (d) wages of computer operator; (e) cost of adding extra memory to the computer; (f) cost of floppy discs used during the year; (g) cost of adding air conditioning to the computer room.

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