Answer to Question #6794 in Finance for Mathew

Question

How can revenue expenditure turn into capital expenditure?

Answer 1

Some expenditures although of revenue nature basically, are directly connected with fixed assets and spent directly on the acquisition of fixed assets. Such expenditures are added to the cost of assets and are called "Capitalized Expenditures". For example, we buy a second-hand plant for $50,000. This is undoubtedly a capital expenditure. A further sum of $5,000 is spent on its repair and overhauling in order to bring the plant into proper working order. Expenditure on account of repair and overhauling, although revenue by nature, will be treated as Capital Expenditure in this case and will be debited to plant account not to Repairs A/c. Thus, a revenue expenditure which increases the utility or productive capacity of an asset, is treated as capitalized expenditure. Below are a few examples of such expenditure:

(a) Expenditure on installing an asset. i.e. installation charges.

(b) Expenditure on repair to property, if the production capacity or utility of the property is increased. It may, however, be noted that sometimes a new asset may require some repair after its purchase but before it is installed and put into operation. Cost of such repair, although it may not increase the production capacity of the asset, will be treated as a capitalized expenditure.

(c) Expenditure incidental to purchase of fixed assets, e.g. freight, clearing charges, customs duty, carriage, octroi duty, import duty on assets purchased.

(d) Expenditure on removal of old property.

(e) Cost of repair to second-hand assets: Repair is a revenue expenditure. But the cost of repair after buying a second-hand asset to bring them into proper working condition is treated as Capitalized Expenditure.

(f) Wages: It is a revenue expenditure but if paid for installation of a machine or plant, then it is treated as a capitalized expenditure.

(g) Legal Charges: Legal charges i.e. lawyer's fee, court fee in connection with the purchase of asset of permanent nature are regarded as capital expenditure.

(h) Interest: Interest paid is generally a revenue expenditure. But in some industries like iron & steel, cement industry etc., a concern has to wait for a long period before it starts operation. Interest for such period on capital and loan is treated as capital expenditure.