Question

Mehra & Sons purchased a second hand light motor Vehicle at a cost of Rs 2 lacs. Additionally, various accessories costing Rs50000 were also purchased along with the Vehicles which are required to be replaced on a yearly basis. Mr. Mehra wants to write off the overall outflow in Income statement Discuss, whether he is correct or not? Discuss the need to differentiate between the capital and revenue items? How these items are to be treated in the financials of the company? Give reasons supporting the same. Elaborate in minimum 1000 Words .

Answer 1

Income Statement: The Income Statement is one of a company’s core financial statements that shows their profit and loss over a period of time. The profit or loss is determined by taking all revenues and subtracting all expenses from both operating and non-operating activities.

Income statement format

Revenue

– Cost of Goods Sold Expense

= Gross Profit (or Loss)

– Operating Expenses (R&D, selling & adm., depreciation, etc)

= Operating Income

Other Income/Expenses

+ investment income

– Interest Expense

– Taxes

+/- Non Recurring Events (Extraordinary items)

= Profit or Net Income

In Given question purchase of motor Vehicle increasing an asset to the company as it is a capital expense so when you purchase the equipment, all entries made to account for the purchase appear on your balance sheet, not your income statement because it is not a revenue expense and accessories costing Rs50000 will be recorded in Income Statement as it is revenue expense.

Journal entry

Motor Vehicle Dr. 200000

To Cash A/C 200000

The differences between capital expenditures and revenue expenditures include whether the purchases will be used over the long-term or short-term. Revenue expenditures are typically referred to as ongoing operating expenses. Capital expenditures are typically one-time large purchases of fixed assets that will be used for revenue generation over a longer period.

Capital expenditures represent major investments of capital that a company makes to maintain or, more often, to expand its business and generate additional profits. Capital expenses are for the acquisition of long-term assets, such as facilities or manufacturing equipment

Revenue expenses are shorter-term expenses that are broken down into two categories:\

1. Expenditures for generating revenue include expenses required to meet the ongoing operational costs of running a business

2. Expenditures for maintenance of revenue-generating assets include the ordinary repair and maintenance costs that are necessary to keep the asset in working order without substantially improving or extending the useful life of the asset

Difference

BASIS FOR COMPARISON	CAPITAL EXPENDITURE	REVENUE EXPENDITURE
Meaning	The expenditure incurred in acquiring a capital asset or improving the capacity of an existing one, resulting in the extension in its life years.	Expenses incurred in regulating day to day activities of the business.
Term	Long Term	Short Term
Capitalization	Yes	No
Shown in	Income Statement & Balance Sheet	Income Statement
Outlay	Non-recurring	Recurring
Benefit	More than one year	Only in current accounting year
Earning capacity	Seeks to improve earning capacity	Maintain earning capacity
Matching concept	Not matched with capital receipts	Matched with revenue receipts

Treatment of Capital expenditures and Revenue expenses:

Capital expenditure = Shown as a non-current asset in the balance sheet

Revenue expenditure = Shown as an expense in the income statement

Example:

a) Cost of overhauling and painting a recently bought old van.

(b) Cost of pulling down an old building in order to replace it by a new one.

(c) The cost of removing plant and machinery to new site.

(d) Payment made to purchase an existing business.

(e) Carriage paid on purchase of goods.

Required:

State with reasons whether the above items of expenditures are capital or revenue in nature:

Solution (1):

(a) Capital Expenditure = When a second hand asset is purchased then any expenditure incurred to put it into working order will be treated as capital expenditure.

(b) Capital Expenditure = This is a capital expenditure as it is a part of the total cost of the building.

(c) Capital Expenditure = The removal of the business to the new site will enhance the income earning capacity of the business; this expense will be treated as capital expenditure.

(d) Capital Expenditure = Purchase of business means purchase of its assets and liabilities; therefore, it is a capital expenditure.

(e) Revenue Expenditure = The expenditure is related to purchase of goods for resale, which itself is a revenue expense, therefore, carriage is also a revenue expense.