Explain what is meant by capital and revenue expenditure, indicating why the distinction is important.

Capitalisation and Depreciation

Explain what is meant by capital and revenue expenditure, indicating why the distinction is important.

According to Hall et al. (2009), expenditures below could be separated into two categories – capital expenditure and revenue expenditure. Generally speaking, a start-up needs finance which is say – the initial expenditure-- to buy such as raw materials, and equipment. If getting successes, it can earn money back from sales; however, it needs to be used to repeat what they have done with initial expenditure, i.e. continuously to buy raw materials and other settlements (Hall et al., 2009). What’s more, businesses will be expended when the owners want to. Therefore, extra money will be needed over the previous sales scale to obtain larger premises, more equipment and workforce.

To put it simple, Perks & Leiwy (2010) indicated that capital expenditure is spending on items which will be shown on the balance sheet. Due to it adds to the purchase of fixed assets, under which the heading ‘non-current assets’, also, including the maintenance and repair of buildings and machines which are as depreciation as well. These amounts are carried forward as part of the next year’s opening statement of accounting position due to its contribution on several periods’ revenues (Thomas & Ward, 2009). Appearing on the income statement, showing the payments for goods and services which immediately against profit, are considered as revenue expenditure (Perks & Leiwy, 2010). Revenue expenditure represents business costs or expenses; however, the maintenance and repair of buildings and machines are included (Perks & Leiwy, 2010; Hall et al., 2009; Stickney, Weil & Davidson, 1991)

Owing to there are some grey areas between capital expenditure and revenue expenditure, temptations sometimes appear to make capital expenditure treatment look like revenue expenditure. There are enhancement of profits come with higher asset results showing on the balance sheet when depreciation expenditure is made more like as improvements to fixed assets.

To start a cafe, for example, it needs coffee machines, a shop and other fixed assets all fall into capital expenditure. Besides, coffee bean, wages are all examples for revenue expenditure.

a. Explain what is meant by depreciation and why it is used in accounting for ...

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To start a cafe, for example, it needs coffee machines, a shop and other fixed assets all fall into capital expenditure. Besides, coffee bean, wages are all examples for revenue expenditure.

a. Explain what is meant by depreciation and why it is used in accounting for fixed assets.

Depreciation is a measure of the allocation of inevitably scope for differences of view on the useful economic life of non-current assets’ value that has been used up in the specific financial period (Perks & Leiwy, 2010; Hall et al., 2009; Thomas & Ward, 2009; Black, 2009). For instance, a coffee machine has a useful economic life of six years to make coffee, but during this six year, its owner need to spend some money on it to maintain coffee quality it makes. Hall et al. (2009) stated that, depreciation helps accurate accounts, valuing the business, matching benefits with costs and make an allowance for itself. According to depreciation is calculated how much to allow for each fixed asset by using the balance sheet and the profit and loss account. The balance sheet shows their original value without being depreciated, whereas the profit and loss account shows the original used-up areas each year.

b. Explain the main causes of depreciation.

As noted by Hall et al. (2009), there are four possible causes of depreciation.

Firstly, machinery, tools and equipment all have been used after suffering wear out, tear up or other reduction over a period (Hall et al., 2009). As an example, heel of a shoe will definitely suffer a lot of wear and tear sooner or later. And these kind of things will have to be took place in the end.

Secondly, obsolescence through technological change often causes assets depreciated (Thomas & Ward, 2009). Typically, IT products, for instance, there is a new type of mobile phone launch on sale in every few months. The new one has no doubt been improved than the old one. Some consumers will buy a new one even though their previous mobile still work.

Then, goods which are lack of maintenance could be a cause of depreciation (Hall et al., 2009). And the last cause is the passing of time. It means, for example, food in supermarket will be re-priced when their expiry date is getting closer and closer.

References

Black, G. (2009). Introduction to Accounting and Finance. 2nd Edition. Harlow: FT Prentice Hall.

Hall, D., Jones, R., Raffo, C., Anderton, A., Chambers, I. & Gary, D. (2009). Bussiness Studies. 4th Edition. Essex: Pearson Education.

Mclaney, E., & Atrill, P. (2008). Accounting: An Introduction. 4th Edition. Harlow: Financial Times Prentice Hall.

Perks, R. & Leiwy, D. (2010). Accounting: Understanding and Practice. 3rd Edition. London: McGraw-Hill Education.

Stickney, C.P., Weil, R.L., & Davidson, S. (1991). Financial Accounting: An Introduction to Concepts, Methods, and Uses. 6th Edition. Fort Worth: Harcourt Brace Jovanovich College.

Thomas, A., & Ward, A.M. (2009). Introduction to Financial Accounting. 6th Edition. London: McGraw-Hill Education.