Cambridge O Level7707

Capital and revenue expenditure and receipts

Accounting 7707 Chapter Notes

What this chapter covers

Capital and revenue expenditure and receiptsAccounting for depreciation and disposal of non-current assetsOther payables and other receivablesIrrecoverable debts and allowance for irrecoverable debtsValuation of inventory
ShareWhatsAppPost
Capital and revenue expenditure and receipts notes

Unable to load PDF

The notes viewer could not load. Please refresh the page.

Read online free. Download a watermarked copy with a free account.

Read the notes

The full Capital and revenue expenditure and receipts notes as text: skim, search, and jump between subtopics.

~11 min read

In this chapter

  1. 1Understanding Capital Expenditure
  2. 2Understanding Revenue Expenditure
  3. 3Capital and Revenue Receipts
  4. 4Error: Treating Capital as Revenue Expenditure
  5. 5Error: Treating Revenue as Capital Expenditure

1. Understanding Capital Expenditure

Capital expenditure is money spent by a business to buy, improve, or extend the life of its non-current assets. Non-current assets are items that will be used in the business for more than one year, like vehicles, machinery, or buildings. This type of spending is considered an investment to increase the business's earning potential. Crucially, it includes not just the purchase price but all costs to get the asset ready for use, such as delivery fees, installation charges, and legal costs. Capital expenditure is not an expense in the income statement; instead, it is recorded on the statement of financial position, increasing the value of non-current assets.

Key term

Non-Current Asset: An item of value owned by a business which is intended for use on a long-term basis, typically for more than one year, to help generate revenue.

Examiner insight

Examiners look for a clear understanding that capital expenditure goes beyond the sticker price of an asset to include all costs necessary to bring it to its intended working condition.

Common pitfall

Students often forget to include associated costs like delivery, installation, and legal fees as part of the total capital expenditure for a new asset.

Worked example 13 marks

A business buys a new packaging machine. The costs incurred are: Machine price $15,000; Delivery charge $500; Installation by a specialist engineer $1,000; Annual maintenance contract $800; Wages for the business's own staff to learn to use it $300. Calculate the total capital expenditure.

  1. 1

    Step 1: Identify costs related to acquiring and preparing the asset for use. These are capital expenditure.

  2. 2

    Step 2: The price of the machine is a capital cost: $15,000.

  3. 3

    Step 3: The delivery charge is necessary to get the asset to the premises, so it is a capital cost: $500.

  4. 4

    Step 4: The installation cost is necessary to make the asset operational, so it is a capital cost: $1,000.

  5. 5

    Step 5: The annual maintenance contract and staff training wages are running costs, not costs of acquisition. They are revenue expenditure.

  6. 6

    Step 6: Sum the capital costs: $15,000 (Price) + $500 (Delivery) + $1,000 (Installation) = $16,500.

  7. 7

    Final Answer: The total capital expenditure is $16,500.

Recap

  • Capital expenditure is for acquiring or improving non-current assets.
  • It includes all costs to get the asset into a usable condition (e.g., delivery, installation).
  • Capital expenditure is recorded in the statement of financial position.
  • It is a long-term investment, not a day-to-day running cost.

Quick check

  1. Is the purchase of a new factory building capital or revenue expenditure?1 mark
  2. Are legal fees for the purchase of that factory building capital or revenue expenditure?1 mark

2. Understanding Revenue Expenditure

Revenue expenditure is the money spent on the day-to-day running of a business. These are short-term costs whose benefits are used up within the current accounting period (usually one year). Unlike capital expenditure, it does not create a new asset or improve an existing one. Instead, it maintains the existing earning capacity of the business. All revenue expenditures are recorded as expenses in the income statement and are deducted from revenue to calculate the profit for the year. Examples include rent, wages, utility bills, inventory purchases, and repairs and maintenance.

Key term

Revenue Expenditure: Costs incurred for the daily operations of a business, which are expensed in the income statement in the period they occur.

Fun fact

For a company like Google, the cost of building a new data centre is capital expenditure, but the millions spent on electricity to run it is all revenue expenditure.

Worked example 14 marks

For each item, state whether it is capital expenditure (CAP) or revenue expenditure (REV).a) Paying the monthly electricity bill.b) Buying a new computer for the office.c) Repairing a broken window in the office.d) Building an extension to the warehouse.

  1. 1

    a) Paying the monthly electricity bill is a day-to-day running cost. Answer: REV.

  2. 2

    b) Buying a new computer adds a new non-current asset to the business. Answer: CAP.

  3. 3

    c) Repairing a broken window maintains the asset (the office), it does not improve it or create a new one. Answer: REV.

  4. 4

    d) Building an extension significantly improves and adds value to an existing non-current asset (the warehouse). Answer: CAP.

Recap

  • Revenue expenditure is for the day-to-day running of the business.
  • It includes costs like rent, wages, utilities, and repairs.
  • Revenue expenditure is recorded as an expense in the income statement.
  • It maintains assets, it does not improve them.
  • The benefit of revenue expenditure is used up quickly, within one year.

Quick check

  1. Is paying for repairs to a delivery van capital or revenue expenditure?1 mark
  2. Is paying the salary of the van driver capital or revenue expenditure?1 mark

3. Capital and Revenue Receipts

Just as spending is split into capital and revenue, so is income. Revenue receipts are income generated from the normal, everyday activities of the business. This is the main income for the business and is recurring. Examples include sales revenue from selling goods, fees earned from providing a service, rent received from a tenant, or interest received on a bank account. All revenue receipts are shown in the income statement. Capital receipts are money received from sources other than the normal course of business. They are usually one-off and non-recurring. The main example is the money received from selling a non-current asset. Other examples include receiving a loan from a bank or an owner investing more capital into the business. Capital receipts are not included in the income statement as revenue.

Key term

Revenue Receipt: Income generated from the normal trading activities of the business, such as sales, fees, and rent received.

Worked example 14 marks

Ravi is a retailer. Classify each of the following items as a capital receipt, revenue receipt, capital expenditure, or revenue expenditure.a) Proceeds from the sale of an old delivery vehicle.b) Purchase of goods for resale.c) Rent received from subletting part of his shop.d) Legal fees on the purchase of a new warehouse.

  1. 1

    a) Proceeds from the sale of an old delivery vehicle: Selling a non-current asset is not a normal trading activity. This is a Capital Receipt.

  2. 2

    b) Purchase of goods for resale: Buying inventory is a day-to-day running cost of a retail business. This is a Revenue Expenditure.

  3. 3

    c) Rent received from subletting part of his shop: This is income earned from an asset the business owns. This is a Revenue Receipt.

  4. 4

    d) Legal fees on the purchase of a new warehouse: This is a cost associated with acquiring a new non-current asset. This is a Capital Expenditure.

Recap

  • Revenue receipts are income from normal business operations (e.g., sales).
  • Revenue receipts are recorded in the income statement.
  • Capital receipts are income from non-trading sources (e.g., selling an NCA).
  • Capital receipts are not recorded as revenue in the income statement.
  • Other capital receipts include bank loans and capital injections from the owner.

Quick check

  1. A business sells goods for $1,000 cash. Is this a capital or revenue receipt?1 mark
  2. The same business gets a $10,000 bank loan. Is this a capital or revenue receipt?1 mark

4. Error: Treating Capital as Revenue Expenditure

This is a common mistake known as an 'error of principle'. It occurs when an item of capital expenditure (e.g., buying a new machine) is incorrectly recorded as a revenue expenditure (e.g., in the 'repairs' account). This has a significant impact on the financial statements. Because a large expense has been incorrectly added to the income statement, the total expenses are overstated. This leads to the profit for the year being understated. Simultaneously, because the new non-current asset was never recorded on the statement of financial position, the total value of non-current assets is also understated.

Correct Profit = Reported Profit + Misclassified Capital Expenditure

Correct Non-Current Asset Value = Reported NCA Value + Misclassified Capital Expenditure

Key term

Error of Principle: An accounting error where a transaction is recorded in the wrong type of account, such as treating a capital expenditure as a revenue expenditure.

Examiner insight

Examiners expect candidates to explain the dual effect of this error on both the income statement (profit) and the statement of financial position (non-current assets).

Common pitfall

Students correctly identify that profit is understated but forget to mention the second effect: that non-current assets are also understated.

Worked example 14 marks

A business bought a new laptop for $1,500. The bookkeeper incorrectly debited the 'Office Expenses' account. The draft profit for the year was $30,000 and non-current assets were valued at $50,000. Calculate the correct profit for the year and the correct value of non-current assets.

  1. 1

    Step 1: Identify the error. A capital expenditure of $1,500 was treated as a revenue expenditure.

  2. 2

    Step 2: Calculate the effect on profit. Expenses were overstated by $1,500, so profit was understated by $1,500.

  3. 3

    Step 3: Calculate the correct profit. Correct Profit = $30,000 (Reported Profit) + $1,500 (Error) = $31,500.

  4. 4

    Step 4: Calculate the effect on non-current assets. The laptop was not added to assets, so non-current assets are understated by $1,500.

  5. 5

    Step 5: Calculate the correct non-current asset value. Correct NCA Value = $50,000 (Reported Value) + $1,500 (Error) = $51,500.

  6. 6

    Final Answer: The correct profit is $31,500 and the correct value of non-current assets is $51,500.

Recap

  • Treating capital expenditure as revenue expenditure understates profit.
  • This error also understates the value of non-current assets.
  • Expenses are overstated in the income statement.
  • To correct the error, you must add the amount back to both profit and non-current assets.

Quick check

  1. If CapEx is treated as RevEx, are assets overstated or understated?1 mark
  2. If CapEx is treated as RevEx, is profit overstated or understated?1 mark

5. Error: Treating Revenue as Capital Expenditure

This is the opposite error of principle. It happens when a revenue expenditure (e.g., paying for office repainting) is incorrectly recorded as a capital expenditure (e.g., added to the 'Buildings' account). This error also distorts the financial statements. By incorrectly moving an expense out of the income statement, the total expenses are understated, which leads to the profit for the year being overstated. At the same time, the value of non-current assets on the statement of financial position is artificially inflated by adding a cost that is not a genuine asset, so non-current assets are also overstated.

Correct Profit = Reported Profit - Misclassified Revenue Expenditure

Correct Non-Current Asset Value = Reported NCA Value - Misclassified Revenue Expenditure

Key term

Overstated Profit: A reported profit figure that is higher than the true profit due to an accounting error, such as under-recording expenses.

Examiner insight

A high-scoring answer will clearly state that profit is overstated because expenses were understated, and that non-current assets are overstated because a cost was incorrectly added to them.

Common pitfall

Forgetting that if an item is incorrectly capitalized, it might also be incorrectly depreciated, which adds a second layer to the error. For IGCSE, focus on the primary error first.

Worked example 14 marks

A business paid $700 for repairs to its machinery. The bookkeeper incorrectly debited the 'Machinery at Cost' account. The draft profit for the year was $45,000 and the value of machinery was reported as $20,700. State the effect of this error on profit and non-current assets, and calculate the correct figures.

  1. 1

    Step 1: Identify the error. A revenue expenditure of $700 was treated as a capital expenditure.

  2. 2

    Step 2: State the effect. Expenses were understated, so profit for the year is overstated. The value of non-current assets is also overstated.

  3. 3

    Step 3: Calculate the correct profit. The $700 repairs should have been an expense. Correct Profit = $45,000 (Reported Profit) - $700 (Error) = $44,300.

  4. 4

    Step 4: Calculate the correct non-current asset value. The $700 was incorrectly added to the machinery's value. Correct NCA Value = $20,700 (Reported Value) - $700 (Error) = $20,000.

  5. 5

    Final Answer: Profit was overstated by $700 and non-current assets were overstated by $700. The correct profit is $44,300 and the correct machinery value is $20,000.

Recap

  • Treating revenue expenditure as capital expenditure overstates profit.
  • This error also overstates the value of non-current assets.
  • Expenses are understated in the income statement.
  • To correct the error, you must subtract the amount from both profit and non-current assets.

Quick check

  1. If RevEx is treated as CapEx, are assets overstated or understated?1 mark
  2. If RevEx is treated as CapEx, is profit overstated or understated?1 mark

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Define 'capital expenditure' and provide two distinct examples.3 marks
  2. A business incurred the following costs: Purchase of new office furniture $3,000; Wages paid to sales staff $15,000; Annual insurance premium for the office $1,200; Repainting the office walls $500. Complete a table indicating whether each item is capital or revenue expenditure.4 marks
  3. Jaya buys a new delivery van. The list price is $20,000. She also pays $500 for delivery, $800 to have the company logo painted on the side, and $400 for the first year's road tax. Calculate the total capital expenditure and the total revenue expenditure.4 marks
  4. A business's draft profit for the year is $82,000. It is then discovered that the purchase of a new computer for $1,200 had been incorrectly recorded in the 'Stationery' expense account. Calculate the correct profit for the year and state the effect of the error on non-current assets.4 marks
  5. A business's reported non-current assets are $125,000 and its profit for the year is $60,000. It is discovered that $4,000 spent on extending the warehouse was accidentally debited to the 'Repairs and Maintenance' account. What will the correct non-current asset and profit figures be after correcting this error?4 marks
  6. Explain why the cost of installing a new machine is treated as capital expenditure, while the cost of servicing that same machine a year later is treated as revenue expenditure.4 marks
  7. For each transaction, state whether it is a capital expenditure, revenue expenditure, capital receipt or revenue receipt: 1. Sale of goods on credit. 2. Owner invests a further $10,000 into the business bank account. 3. Purchase of a new machine by cheque. 4. Payment of the quarterly electricity bill.4 marks
  8. A business incorrectly capitalises $2,000 of revenue expenditure. Which of the following is true? A) Profit is overstated and non-current assets are understated. B) Profit is understated and non-current assets are overstated. C) Profit and non-current assets are both overstated. D) Profit and non-current assets are both understated.1 mark
  9. A company's draft accounts show a profit of $54,300. An audit reveals two errors: 1) Repairs to a machine costing $1,800 were incorrectly added to the cost of non-current assets. 2) The purchase of a new piece of equipment for $5,000 was debited to the purchases account. Calculate the company's correct profit for the year.5 marks
  10. A business sells its old motor vehicle, which had a net book value of $3,000, for $2,500 cash. It also receives $150,000 from sales of inventory during the year. Identify the value of the capital receipt and the value of the revenue receipts.3 marks

Go deeper

Practise and revise with member-only material for this chapter.

Workbook

Exam-style practice questions with full worked solutions.

Unlock with a plan

Chapter at a Glance

A single-page summary of every key idea for fast revision.

Unlock with a plan

Free notes are just the start.

Unlock every Workbook and Chapter at a Glance, and generate your own worksheets and predicted papers.

Explore plans

Related chapters

The purpose of accountingThe double entry system of book-keepingThe trial balanceSole tradersCalculation and understanding of accounting ratiosAccounting concepts