Class Notes: 4.
1 Capital and Revenue Expenditure and Receipts
What Are Capital and Revenue Items?
In accounting, we divide transactions into capital and revenue
items to ensure accurate financial reporting. Let’s explore these
concepts step by step.
1. Capital Expenditure
Definition: Money spent by the business to buy or improve non-
current assets (assets that last for more than one year). These
assets help the business operate over the long term.
Examples:
Buying machinery, buildings, or vehicles for the business.
Adding a new floor to a building.
Recording:
Capital expenditure is shown as an asset in the Statement of
Financial Position (Balance Sheet).
Why It’s Important:
It provides long-term benefits and is not part of the business's day-
to-day operations.
2. Revenue Expenditure
Definition: Money spent on the everyday running expenses of the
business. These costs are related to operating the business within
the current year.
Examples:
Paying for electricity or water bills.
Routine maintenance or repairs for machinery.
Staff wages.
Recording:
Revenue expenditure is recorded as an expense in the Income
Statement.
Why It’s Important:
It provides short-term benefits and helps the business continue its
daily activities.
3. Capital Receipts
Definition: Money the business receives from selling its non-
current assets or raising funds.
Examples:
Selling old machinery or vehicles.
Issuing shares to raise capital.
Recording:
Capital receipts are recorded in the Statement of Financial Position
(Balance Sheet).
These are not regular business income, so they do not appear in
the Income Statement.
Why It’s Important:
Capital receipts help the business fund its operations or buy new
assets.
4. Revenue Receipts
Definition: Money the business earns from its normal operations.
Examples:
Sales revenue (money earned from selling goods).
Rent received if the business rents out property.
Interest earned on bank deposits.
Recording:
Revenue receipts are recorded in the Income Statement as part of
the business’s profit calculation.
Why It’s Important:
Revenue receipts represent the day-to-day earnings of the
business.
How Do Capital and Revenue Items Differ?
Quick Summary
Capital Expenditure: Buying or improving long-term assets Recorded as an asset.
Revenue Expenditure: Day-to-day costs Recorded as an expense.
Capital Receipts: Money from selling assets or raising capital Recorded as a liability or
Revenue Receipts: Income from regular business activities Recorded as income.
Depreciation (Introduction)
What is Depreciation?
Depreciation is the loss in value of a non-current asset over time
due to:
Wear and tear (e.g., machinery gets used and wears out).
Obsolescence (e.g., old technology replaced by new).
Passage of time (e.g., patents losing value as their expiry date
approaches).
Why Do We Need Depreciation?
To match costs with revenue: Spread the cost of a non-current
asset over its useful life.
To ensure the financial statements are accurate:
If we don’t account for depreciation, the value of assets in the
Statement of Financial Position will be overstated.
Profits in the Income Statement will also be overstated.
Methods of Depreciation
There are three common methods to calculate depreciation:
1. Straight-Line Method
The same amount of depreciation is charged every year.
Formula:
Depreciation per year = Cost - Residual Value \ Useful Life
Useful life: How long the asset is expected to be used.
Example:
A machine costs $10,000, has a residual value of $2,000, and a
useful life of 4 years.
Depreciation = .
$2,000 is charged as depreciation each year.
Best For: Assets that wear out evenly over time (e.g., buildings,
furniture).
2. Reducing Balance Method
A fixed percentage is applied to the remaining value (Net Book
Value) of the asset each year.
Results in higher depreciation in earlier years and less in later
years.
Formula:
Depreciation per year = Net Book Value (NBV) x Depreciation Rate
(%)
- A car costs $10,000, and the depreciation rate is 20%.
- Year 1: 10,000 x 20% = 2,000. NBV = 10,000 - 2,000 = 8,000.
- Year 2: 8,000 x 20% = 1,600. NBV = 8,000 - 1,600 = 6,400.
Best For: Assets that lose value quickly, such as vehicles or
technology.
3. Revaluation Method
Depreciation is calculated as the difference in value of the asset at
the start and end of the year, plus any purchases during the year.
Formula:
Depreciation = Opening Value + Purchases- Closing Value
- At the start of the year, a farm has equipment worth $5,000.
- Purchases during the year: $1,000.
- At the end of the year, the equipment is worth $4,000.
- Depreciation = 5,000 + 1,000 - 4,000 = 2,000.
Best For: Assets like tools, livestock, or farm equipment that are
easier to revalue than to calculate individually.
Recording Depreciation
1. Income Statement:
Depreciation is recorded as an expense, reducing profits.
2. Statement of Financial Position:
The value of the asset is reduced by accumulated depreciation to
show the asset's Net Book Value (NBV).
Quick Summary
1. Straight-Line: Equal amount every year.
2. Reducing Balance: Higher depreciation in earlier years.
3. Revaluation: Based on opening, purchases, and closing values.