Which costs are capitalised into property, plant and equipment, and how is the distinction between capital and revenue expenditure made?
Identify the costs capitalised into property, plant and equipment and distinguish capital from revenue expenditure
A focused answer to the H2 Principles of Accounting outcome on property, plant and equipment. Capitalising the cost of bringing an asset into use, the capital versus revenue distinction, subsequent expenditure, and the effect on profit.
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What this dot point is asking
SEAB wants you to identify which costs are capitalised into property, plant and equipment (PPE) and to distinguish capital expenditure from revenue expenditure. This decision determines whether a cost sits on the statement of financial position as an asset or hits the income statement as an expense, so it directly affects profit. The central insight is that the cost of an asset is everything needed to bring it into working condition, while ongoing running costs are expensed as they are consumed.
The answer
What is capitalised
The cost of an item of PPE includes all costs of bringing it to the location and condition necessary for it to operate as intended:
| Include in cost (capitalise) | Exclude (expense as revenue) |
|---|---|
| Purchase price, net of trade discount | Maintenance and repairs |
| Delivery and handling | Staff training to use it |
| Installation and assembly | Insurance and running costs |
| Site preparation | General administration |
| Professional fees to acquire | Abnormal wastage |
Trade discounts are deducted to reach the purchase price. The capitalised cost becomes the basis for depreciation.
Capital versus revenue expenditure
- Capital expenditure acquires, builds or improves a non-current asset and benefits more than one period. It is capitalised and depreciated over the asset's life.
- Revenue expenditure is spending on day-to-day operations, consumed within the period. It is expensed immediately in the income statement.
The same idea applies to subsequent expenditure: a repair that merely maintains the asset is revenue; an improvement that enhances the asset (extending its life or capacity) is capital.
Why the distinction matters
Misclassifying expenditure misstates both profit and assets. Treating capital expenditure as revenue understates this year's profit and the asset base, then overstates profit later (no depreciation on an unrecorded asset). Treating revenue expenditure as capital does the opposite, overstating profit and assets now. Because both keep the trial balance in balance, these are errors of principle that other checks must catch.
Examples in context
Example 1. A delivery van plus signwriting. A firm buys a van for \30,000\ to paint its logo on the side. Both are capital expenditure: the van is the asset and the signwriting is part of bringing it into the firm's intended use, so \32,000$ is capitalised. The annual road tax and fuel, by contrast, are revenue expenditure, expensed as the benefit is consumed.
Example 2. Improving versus repairing a building. Repainting an office is revenue expenditure (maintaining the asset), but adding an extension that increases floor space is capital expenditure (enhancing the asset). The extension is capitalised and depreciated; the repaint is expensed. Drawing this line correctly keeps both the asset's carrying amount and the year's profit faithfully stated.
Try this
Q1. Classify each as capital or revenue: legal fees to buy land, annual building insurance, a new wing added to a factory, replacing a broken window. [2 marks]
- Cue. Legal fees to buy land - capital; annual insurance - revenue; new wing - capital; replacing a broken window - revenue (a repair).
Q2. A machine has list price \60,000\ delivery and \5,000$ for the first year's servicing. State the capitalised cost. [2 marks]
- Cue. Capitalise list price and delivery = 60\,000 + 4\,000 = \64,000\ servicing is revenue expenditure, expensed.
Q3. Explain why wrongly capitalising a repair overstates profit. [3 marks]
- Cue. The repair (revenue) is put on the balance sheet as an asset instead of being expensed, so this year's expenses are too low and profit too high, and assets are overstated.
Exam-style practice questions
Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Original7 marksA company buys a machine. Costs are: list price \80\,000\; delivery \2\,000\; a maintenance contract for the first year \4\,000\. Calculate the amount to capitalise and state the treatment of any excluded costs.Show worked answer →
Capitalise the costs of bringing the asset to the location and condition necessary for use, net of trade discount.
| Item | Capitalise? | \$ |
|---|---|---|
| List price | Yes | 80,000 |
| Trade discount | Deduct | (5,000) |
| Delivery | Yes | 2,000 |
| Installation | Yes | 3,000 |
| Maintenance contract | No (revenue) | - |
| Staff training | No (revenue) | - |
Amount to capitalise = 80\,000 - 5\,000 + 2\,000 + 3\,000 = \80,000$.
The maintenance contract (\4,000\) are revenue expenditure, expensed in the income statement, because they do not bring the asset into its working condition; they are ongoing running costs.
Markers reward the netting of trade discount, capitalising delivery and installation, excluding maintenance and training as revenue, and a capitalised cost of \80,000$.
Original5 marksExplain the difference between capital and revenue expenditure and the effect on profit and the statement of financial position if a \20\,000$ machine purchase is wrongly treated as revenue expenditure.Show worked answer →
Capital expenditure is spending to acquire or improve a non-current asset, expected to benefit more than one period; it is capitalised as an asset and depreciated. Revenue expenditure is spending on the day-to-day running of the business, consumed within the period; it is expensed immediately.
If a \20,000$ machine (capital) is wrongly treated as revenue expenditure:
- Profit is understated this year by the full \20,000$, because the whole cost is expensed instead of only one year's depreciation.
- Non-current assets on the statement of financial position are understated by the carrying amount of the machine (close to \20,000$ in year one).
- In later years profit is overstated, because no depreciation is charged on an asset that is not recorded.
This is an error of principle that the trial balance would not detect. Markers reward the definitions, the understatement of profit and assets in year one, and the reversal in later years.
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