Key Concepts
So far you have recorded the purchase of a non-current asset. But a business also spends money keeping and improving its assets — repairs, servicing, upgrades. Every payment connected to a non-current asset is one of two types:
| Capital expenditure | Revenue expenditure |
|---|---|
| Cost to buy a non-current asset and bring it to its intended use, or to improve it (increase its capacity, extend its useful life, or make it work better) | Cost to operate, repair, and maintain the asset in its normal working condition |
| Provides benefits for more than one year | Provides benefits used up within one year |
| Recorded as a non-current asset (Statement of Financial Position) | Recorded as an expense (Statement of Financial Performance) |
Why the difference matters.Capital expenditure is not charged as an expense all at once. Because the asset's benefit lasts several years, its cost is spread over those years as depreciation (the yearly expense that spreads a non-current asset's cost across its useful life — covered in the next section) — this matches the cost to the income the asset helps earn each year (the matching theory). Revenue expenditure is used up this year, so the whole amount is charged as an expense this year.
Improvement vs repair. Spending on a non-current asset after it is bought is capital expenditure if it improves the asset — increasing its capacity or useful life, or making it work better. Ordinary repairs that just keep the asset running as before, without improving it, are revenue expenditure.
Naming the revenue expenditure account.Revenue expenditure connected to a non-current asset is usually debited to "[asset] expense" (e.g. Motor vehicle expense, Office equipment expense) — unless the cost already has its own recognised expense name, such as Insurance expense for insurance.
Materiality theory
If the amount spent on an item is very small compared with the size of the business's income, profit, assets, or equity, the business may record it as revenue expenditure (an expense) even though it could last more than a year. The amount is too small to affect anyone's decisions, so there is no need to treat it as a non-current asset. This is the materiality theory.
Worked Example — materiality. Saffron Trading made a profit of $900,000 this year; Odd Lot Trading made a profit of $9,000. Both bought an identical office printer for $2,000 that will last a few years.
- The printer's benefit lasts several years, so strictly it is capital expenditure (a non-current asset).
- For Saffron Trading, $2,000 is tiny next to a $900,000 profit. By the materiality theory, it may record the $2,000 as an expense (Dr Printing expense / Cr Cash at bank) — too small to matter.
- For Odd Lot Trading, $2,000 is large next to a $9,000 profit, so it should record the printer as a non-current asset (Dr Office equipment / Cr Cash at bank) and depreciate it.
Effects of wrongly classifying expenditure
Getting the classification wrong gives the wrong figures in the financial statements:
| Classification error | Effect on expenses | Effect on profit | Effect on non-current assets |
|---|---|---|---|
| Revenue expenditure wrongly recorded as capital (an expense recorded as a non-current asset) | Understated | Overstated | Overstated |
| Capital expenditure wrongly recorded as revenue (a non-current asset recorded as an expense) | Overstated | Understated | Understated |
Because profit is added to the owner's capital, a wrong profit also gives the wrong figure for equity in the same direction (overstated profit → overstated equity, and vice versa).
Capital = buy or better (cost to buy + improve the non-current asset; provides benefits for more than one year). Revenue = run or repair (cost to operate/repair/maintain the non-current asset; provides benefits for less than one year). If in doubt, ask: does this make the asset bigger, last longer, or work better? If yes → capital. If it just keeps it running → revenue.
Because the benefit lasts more than one year (it extends the van's life), this is capital expenditure. It is added to the cost of the van (Dr Motor vehicles), not charged as a repair expense.
If, instead, Anand had spent $400 servicing the van to keep it running as normal, that would be revenue expenditure — an expense for the year (Dr Motor vehicle expense).
Treating every payment about an asset as capital. Routine servicing and repairs that just maintain the asset are revenue expenditure (an expense).
Ignoring materiality. A purchase that is very small compared with the business's profit, assets, or equity may be expensed even if it lasts more than a year — applying the materiality theory.
Getting the effect direction wrong. Recording capital expenditure as an expense overstates expenses and understates profit and non-current assets.