How do we decide whether spending is an asset or an expense?
Distinguish capital expenditure from revenue expenditure and explain the effect of getting it wrong
A simple answer to the N(A)-Level Principles of Accounts outcome on capital and revenue expenditure. The difference between the two, how each is recorded, and how a wrong classification affects profit and assets.
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What this dot point is asking
SEAB wants you to tell capital expenditure from revenue expenditure and to explain what goes wrong if they are mixed up. This decision controls whether spending becomes an asset or an expense, so it shapes both the profit and the balance sheet. The central insight is lasting benefit: spending that buys or improves a non-current asset is capital, while spending used up running the business is revenue.
The answer
Capital expenditure
Capital expenditure is spending to buy, add to, or improve a non-current asset that will benefit the business for more than one year. It is recorded as a non-current asset in the statement of financial position, not as an expense. It includes the purchase price plus costs of getting the asset ready, such as delivery and installation.
Revenue expenditure
Revenue expenditure is spending on the day-to-day running of the business, used up in the period. It is recorded as an expense in the income statement. Examples are wages, rent, fuel, and repairs that simply maintain an asset.
The repair-versus-improvement test
The trickiest cases are repairs and improvements:
- A repair keeps an asset working as before, so it is revenue expenditure.
- An improvement or extension makes the asset better or bigger, so it is capital expenditure.
| Spending | Classification |
|---|---|
| Buying machinery | Capital |
| Installing machinery | Capital |
| Servicing machinery | Revenue |
| Extending a building | Capital |
| Repainting a building | Revenue |
Why the split matters
Getting it wrong distorts both statements. Treating capital spending as an expense understates profit and understates assets; treating revenue spending as an asset overstates profit and overstates assets. This is an error of principle because the wrong type of account is used.
Examples in context
Example 1. Improving versus maintaining. A restaurant spends \5,000\ fixing a leaking tap (revenue, a repair). The extension adds lasting value and goes on the balance sheet, while the tap repair simply keeps things working and is charged to profit. Sorting them correctly keeps both the asset value and the profit honest.
Example 2. The cost of getting an asset ready. A business buys a machine for \10,000\ to have it delivered and installed. Both amounts are capital, so the machine is recorded at \10,800\ were charged as an expense, profit would be understated and the asset undervalued, which shows why set-up costs belong with the asset.
Try this
Q1. State whether buying a new computer is capital or revenue expenditure. [1 mark]
- Cue. Capital expenditure, because a computer is a non-current asset with lasting benefit.
Q2. A business repaints its shop for \1,200$. Classify this and state where it is recorded. [2 marks]
- Cue. Revenue expenditure (upkeep, not an improvement), recorded as an expense in the income statement.
Q3. Explain the effect on profit of treating revenue expenditure as capital expenditure. [2 marks]
- Cue. Profit is overstated, because spending that should be an expense is recorded as an asset and so is left out of the income statement.
Exam-style practice questions
Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Original6 marksClassify each as capital or revenue expenditure: (a) buying a delivery van; (b) petrol for the van; (c) installing new shelving; (d) repairing a broken window; (e) extending the shop; (f) repainting the shop walls.Show worked answer →
(a) Buying a delivery van: capital expenditure (a non-current asset).
(b) Petrol for the van: revenue expenditure (a running cost used up).
(c) Installing new shelving: capital expenditure (a non-current asset, including installation).
(d) Repairing a broken window: revenue expenditure (maintains the asset, no lasting improvement).
(e) Extending the shop: capital expenditure (improves and adds to the asset).
(f) Repainting the shop walls: revenue expenditure (upkeep, not an improvement).
What markers reward: capital for buying or improving non-current assets, revenue for running costs and repairs, with the repair-versus-improvement distinction handled correctly.
Original5 marksA business wrongly recorded \3\,000$ spent on a new machine as a repair expense. Explain the effect on the profit and on the assets for the year.Show worked answer →
The \3,000$ is capital expenditure (a new machine, a non-current asset) but was treated as revenue expenditure (a repair expense).
Effect on profit: profit is understated by \3,000$, because an expense was charged that should not have been.
Effect on assets: non-current assets are understated by \3,000$, because the machine was not recorded as an asset.
(Strictly, depreciation on the machine would also be missing, but the main effects are understated profit and understated assets.)
What markers reward: identifying it as capital wrongly treated as revenue, profit understated by \3,000\.
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