When we look on to expenditures, we can find that there are different types of expenditures. It can be either long term or short term, recurring or fixed etc. But when we look on to the nature of expenses, we can find that the expenses can be divided into two
For all types of businesses it is very important to differentiate between capital and revenue expenditure as
Capital expenditure is usually an expenditure, the impact will be for long term
Revenue expenditure usually for an accounting year.
So first we need to understand what is expenditure?
In ordinary sense, it means spending on something, either in cash or exchange of valuable items for goods or services. We usually understand an expenditure as a payment to acquire an asset, but that may not be the case always. Let us understand
Usually capital expenditures means the expenses we incurr on high value items which can be used for longer periods. This type of assets will not be consumed in a financial year or two. By spending money on this increases the earning capacity , but on continuous usage the money value of the asset decreases.
This reduction in the money value is called as depreciation and accounted for. The money wrote off usually denotes the value of the assets reduced in that particular year. The depreciation which is written off, act as the fund to replace the asset after the life time ends.
There different types of capital expenditure, for example
Plants and machinery
Softwares and IT assets
Other fixed assets
In contrast to the capital expenditure, revenue expenditures are not the high-value items, instead, they are the routine expenditures that takes place in the normal business. In other words, this kind of expenditure maintains fixed assets.
Unlike capital expenditure, earnings do not increase but stay maintained in revenue expenditure. The assets get consumed in an accounting year and no future benefits are available. Also, the prices of assets remain fixed. The assets are consumed in less than a year so there is a need to purchase them again. This is a recurring type of expenditure. There are two sub-categories of revenue expenditures:
Direct Expenses: These include the cost of manufacturing of raw material to turn it into a finished product. For instance, Productive wages and salaries to workers, shipping costs, legal expenses, electricity, and water bills, fuels costs, rent, commissions, packaging charges.
Indirect Expenses: These connect with only selling and distributing goods other than manufacturing. For example, salaries, depreciation, machinery, items of furniture and fixing, etc.
To conclude, we can say that it is very important to differentiate between expenses as capital and revenue. This will help in accounting expenses depends on their impact on improving earning capacity as well just keeping the firm floating. Capital expenditure is long term investment that benefits the business and revenue expenditure is a periodic investment which keeps the business running.