When Revenue Expenditures are not regarded as Revenue Expenditures?

There are some items of expenditure which are revenue by nature, yet they are not regarded as revenue expenditure. Such expenditures may be divided into two groups:

1. Deferred revenue expenditure
2. Capitalized revenue expenditure

1. Deferred Revenue Expenditure:

This is a revenue expenditure, the benefit of which is not confined to one accounting year - it extends to future accounting year or years also. However, this expenditure does not result in the acquisition of any fixed asset. For example, heavy advertisement expenditure is incurred on introduction of a new product in the market. This is a revenue expenditure in nature and the benefit is enjoyed by the business over a number of years, but no asset of permanent nature is acquired. A portion of this expenditure is treated as revenue expenditure chargeable in the current accounting year and the remaining portion is temporarily treated as capital expenditure and shown on the Asset side of the Balance Sheet. Below are a few examples of such expenditure:

(a) Expenditure incurred to the formation of a joint stock company i.e. Preliminary Expenses.

(b) Expenditure on research and experiment connected with the introduction of a new product.

(c) Heavy expenditure on advertisement for marketing a new product.

(d) Heavy expenditure on repairs to property.

(e) Expenditure on removal of business from one place to another place.

2. Capitalized Expenditure:

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.

Note:
From the above discussion, the distinction between 'deferred revenue expenditure' and 'capitalized expenditure' may be noted. The amount of deferred revenue expenditure is generally heavy and it is spread over a number of years. But capitalized expenditure is added in full to the cost of concerned asset, whatever may be the amount of expenditure. Hence there is no question of apportioning the expenditure over a number of years.

Example:

State with reasons whether the following should be considered as deferred revenue expenditure or capitalized expenditure.

1. Preliminary expenses paid in the formation of a company.

2. Heavy advertisement expenses paid to introduce a new product in the market.

3. Wages paid for the installation of a machinery.

4. Carriage paid on the purchase of a machinery.

5. Cost of overhauling and painting a second-hand truck newly-purchased.

6. Research and experimental expenses to introduce a new product.

Solution:

Note: Both deferred revenue expenditure and capitalized expenditure are shown on the asset side of the Balance Sheet.

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