Based on their duration, expenses can be categorised as capital expenditure and revenue expenditure. Business entities need to identify the costs incurred by way of these categories to account for them accurately. Also, being familiar with their fundamentals and point of differences will help manage them more effectively and in turn, enable sustainable earnings.
What is Capital Expenditure?
Capital Expenditure or CAPEX make up those funds which are put to use to acquire, maintain or upgrade long-term assets. Typically, such expenses do not occur frequently and are incurred to boost a company’s proficiency in the long-term.
Some potent capital expenses include – purchasing tangible assets like plant, plot, equipment, furniture, fixtures, etc. and intangible assets like – patent, license or trademark.
Generally, CAPEX influences a firm’s short-term and long-term financial standing and also helps to boost its overall operations over the years. The formula of CAPEX is given as –
Capital expenditure = Net increase in PP & E + Depreciation Expense
The same is stated in a firm’s Cash Flow Statement and is also acknowledged in its Balance Sheet, right under the header of fixed assets. It must be noted here that capital expenditure is capitalised. Further, depreciation is charged on CAPEX every year and is among the prominent differences between capital expenditure and revenue expenditure.
Types of Capital Expenditure
Capital expenditure is divided into these 3 distinct groups –
- Expenses that a firm incurs to lower cost.
- Expenses that help to boost overall earnings.
- Expenses made on non-economic grounds.
In terms of outlay, CAPEX is distributed under these headers –
- Routine Expenditure
- Major projects
With this in the account, let us proceed to become familiar with the fundamentals of revenue expenses to gain a better understanding of the distinction between capital and revenue expenditure.
What is Revenue Expenditure?
Revenue expenditure or OPEX accounts for those expenses that a firm incurs during its course of operation. It can be defined as the total expenses that are incurred by firms through their course of production activities. Under normal circumstances, such costs do not result in asset creation, and the benefits resulting from OPEX is limited to one accounting year.
Typically, they are not responsible for generating or boosting the profit earning capacity of a company. Regardless, they play a key role in the aspect of managing operational activities and assets more optimally and are also considered vital for generating revenue within a given accounting period.
Some of the many revenue expenditure examples include – rent, salaries, wages, commission, freight charges, etc. Notably, factors like the nature of the business operation, the purpose of a venture, frequency of activities, etc. prove useful in categorising expenses as OPEX.
As far as accounting treatment is concerned, revenue expenditure for an accounting period is stated in a firm’s Income Statement. However, the same is not reported in the firm’s Balance Sheet. Also, such expenses may be applicable for tax deductions in a given accounting period because of their recurrence. It must also be noted that OPEX is not capitalised and depreciation is not levied on such expenses.
Types of Revenue Expenditure
In a general sense, types of revenue expenditure can be categorised under 2 distinct groups, namely –
- Direct expenses
These types of expenses are mostly incurred through the production process. The most common direct expenses include – direct wages, freight charge, import duty, commission, rent, legal expenses and electricity cost.
- Indirect expenses
These expenses pertain to the sale and distribution of finished goods or services. They include expenses like selling salaries, repairs, interest, commission, depreciation, rent and taxes, among others. Such costs may also include the money spent during the management of recurrent administrative expenses.
With that information, let’s proceed to find out how similar or different capital expenses and revenue expenses are from one another.
Capital and Revenue Expenditure Examples
Take a look at the examples below to understand the placement of capital and revenue expenditure in the books of accounts –
- Capital Expenditure Example
Suppose this is an excerpt of the Income Statement of ADZ Ltd. as on 30th March 2018
|Cash flow from operating activities||4,37,86,000|
|Cash flow from investing activities||-1,10,08,800|
|Net change in cash||3,27,77,200|
|Opening cash balance||6,09,31,100|
|Closing cash balance||9,01,18,800|
|Free cash flow|
|Operating cash flow||4,73,87,000|
|Free cash flow||3,13,43,700|
- Revenue Expenditure Example
Suppose this is an excerpt of the Balance Sheet of Sunflower Ltd. as on 30th March 2019
|Cost of revenue||3,51,20,600|
|Selling general and administration||1,64,00,300|
|Total operating expenses||2,23,00,300|
Difference between Capital and Revenue Expenditure
The table below highlights the prominent differences between capital expenditure and revenue expenditure –
|Parameters||Capital Expenditure||Revenue Expenditure|
|Definition||Capital expenditure is the money spent by a firm to acquire assets or to improve the quality of existing ones.||Revenue expenditure is the money spent by business entities to maintain their everyday operations.|
|Time span||Capital expenses are incurred for the long-term.||Revenue expenses are incurred for a shorter-duration and are mostly limited to an accounting year.|
|Treatment in accounting books||CAPEX is stated in a firm’s Cash Flow Statement. It also appears in the Balance Sheet of a company under fixed assets.||OPEX is stated in a firm’s Income Statement but is not necessarily reported in its Balance Sheet.|
|Purpose||Such expenses are borne by a company to boost its earning capacity.||Such expenses are borne by a company to sustain its profitability.|
|Yield||The yield of these expenses is not limited to a year and is usually long-term in nature.||The yield of these expenses is mostly limited to the current accounting period.|
|Occurrence||Typically, CAPEX is not quite recurrent.||OPEX makes up recurrent expenses.|
|Capitalisation of expenses||Capital expenses are capitalised.||Revenue expenses are not capitalised.|
|Treatment of depreciation||Depreciation of assets is charged on capital expenses.||Depreciation of assets is not levied on revenue expenditure.|
|Examples||Purchase of Machinery or patent, copyright, installation of equipment and fixture, etc.||Wages, salary, utility bills printing and stationery, inventory, postage, insurance, taxes and maintenance cost, among others.|
Hence, both capital expenditure and revenue expenditure are vital for the sustainable profitability of a business venture. Mostly, revenue expenses are a periodic investment which does not result in immediate or delayed benefit. However, it is used to keep operations running uninterruptedly.
Alternatively, capital expenditure is considered to be a long-term investment that proves beneficial for a firm. Business entities must understand that they need to adopt effective strategies to monitor and regulate these expenses to boost overall profitability significantly.