Cambridge IGCSE Accounting · 0452
Chapter 4: Accounting Procedures — Part 1
Section 4.1 · Capital and Revenue Expenditure and Receipts
This chapter covers the essential technical adjustments required to ensure that financial statements provide a “true and fair” view of a business. Mastering these procedures is critical, as they form the basis for most year-end adjustments in the final accounts.
Correctly distinguishing between capital and revenue items is vital because it determines whether an item appears in the Statement of Financial Position (as an asset) or the Income Statement (as an expense), directly impacting the calculation of profit.
Capital Expenditure
Definition: Capital expenditure is money spent by a business to purchase non-current assets (fixed assets) or to improve their earning capacity. These assets are intended for long-term use and are not bought for the purpose of resale.
Initial Purchase Rule: Any cost incurred to get a non-current asset ready for use at the time of its first purchase must be treated as capital expenditure.
Examples:
- Purchase price of a building or vehicle.
- Legal fees for purchasing property.
- Transport/carriage costs of a new asset.
- Installation and testing costs of new equipment.
- Costs to train employees to use a new computer system for the first time.
Revenue Expenditure
Definition: Revenue expenditure is money spent on the daily running expenses of the business. These costs are “used up” within one accounting period.
Examples:
- Rent and rates for a building.
- Repairs and maintenance of vehicles (after they have been used for a while).
- Redecorating an existing building.
- Electricity, wages, and fuel costs.
Capital and Revenue Receipts
- Capital Receipts
- Money received from sources other than day-to-day trading.
Examples: Selling a non-current asset or receiving a long-term bank loan. - Revenue Receipts
- Income arising from day-to-day trading activities.
Examples: Sales of inventory or rent received from tenants.
Incorrect Treatment and Its Effects
If a transaction is misclassified, both the Profit for the Year and the Statement of Financial Position will be incorrect.
| Error Type | Effect on Profit for the Year | Effect on Assets (SFP) | Effect on Owner's Equity |
|---|---|---|---|
| Capital recorded as Revenue (e.g., Equipment recorded as Stationery) | Understated | Understated | Understated (via lower profit) |
| Revenue recorded as Capital (e.g., Repairs recorded in Vehicle a/c) | Overstated | Overstated | Overstated (via higher profit) |
| Capital receipt recorded as Revenue (e.g., loan as Sales) | Overstated | No effect on assets | Overstated |
| Revenue receipt recorded as Capital (e.g., rent received as loan) | Understated | Liabilities overstated | Understated |
Worked Example 1: Classifying Mixed Expenditure
A business pays $18,500 for a delivery van. The invoice shows:
- Van purchase price: $16,000
- Delivery of van to premises: $800
- First-year insurance on van: $700
- Repainting company logo on van: $1,000
| Item | Classification | $ |
|---|---|---|
| Van purchase price | Capital | 16,000 |
| Delivery of van (carriage on asset) | Capital | 800 |
| First-year insurance | Revenue | 700 |
| Repainting logo (advertising) | Revenue | 1,000 |
Total capital expenditure = $16,800 (van + delivery). Total revenue expenditure = $1,700.
Worked Example 2: Carriage Inwards Trap
A trader buys inventory for $5,000 and a new packing machine for $2,400. Carriage inwards of $150 relates to the inventory; carriage of $60 relates to delivering the machine.
- Inventory cost (revenue/cost of sales): $5,000 + $150 = $5,150
- Machine cost (capital/non-current asset): $2,400 + $60 = $2,460
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