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Capital expenditure- It refers to business spending on acquiring of non-current assets that is expected to contribute future economic benefits such as generation of income. In accounting treatment Capital expenditure are recorded as entities assets thus this would be reflected in statement of financial position. Capital expenditures include property acquired for business use, computers, furniture and fittings. On the contrary revenue expenditure refers to the amount incurred in acquiring goods and services that are necessary for daily business operations. Revenue expenditure results in short term business benefits that are utilized within a short period Revenue expenditure is recorded as expenses the statement of comprehensive income. They are recorded as repairs and maintenance that is charged directly as maintenance expenses, water and electricity and also any expense incurred to sustain the revenue recognition of non-current assets.
Difference between Capital and revenue expenditure
According to the Financial Accounting Standards Board (FASB) and the conceptual accounting framework as a consistent system of unified aims and basics that leads to reliable accounting policies that stipulates the purpose and the nature of Capital and revenue expenditure in financial accounting. Capital expenditure and revenue expenditure are accounted for as per the standards as follows
Difference between capital expenditure and revenue expenditure
Capital expenditure Revenue expenditure
Capital expenditure has a long term effect that is be utilized in more than one accounting period.
Revenue expenditure is of short term effect that can be utilized within the present accounting period.
In capital expenditure assets are purchased and the assets value is upgraded to a higher worth
In Revenue expenditure there is no change in the number of assets or the worth of the assets.
Capital expenditure is once in a while and its expenditure is irregular.
Revenue is expensed regularly thus it repeatedly occurs.
Capital expenditure involves acquiring of Capital assets that exist physically in the business.
Revenue expenditure does not exist physically.
Capital expenditure advances the position of the business concern.
Revenue expenditure only facilitates maintenance of the business concern.
Part of capital expenditure is reflected in the statement of comprehensive income. The part reflected is depreciation.
The whole amount of revenue expenditure is reflected in the income statement account.
The capital expenditure appears in the statement of financial position until the expenditure benefits is fully utilized
Outstanding expenditure, and prepaid expenditure does not be reflected in the statement of financial position.
Purpose of depreciation
Depreciation- it refers to the rate of wear and tear of the business assets. It is treated as an expense in the statement of comprehensive income and it is then accumulated and charge in the statement of financial position against the asset. Depreciation is provided for in the financial statements to match the assets productive cost to the revenue realized from its utilization. Depreciation is used to facilitate the requirement of the generally accepted accounting principle (GAAP) that require the business firms to match the period cost incurred against the revenue realized in the same period.
Effects of depreciation on fixed assets
Depreciation reduces the value of the fixed asset throughout its useful life. As the assets are utilized to generate income in the business, the assets losses value (depreciate) and thus the deprecated value is deducted from the cost of the assets. The value of wear and tear then is calculated as per the requirement of the accounting policies and charged in the income statement. According to the accounting policies depreciation is calculated basing on different rates such as 25% for motor vehicles and 10% for plant and machineries.
Reasons for charging depreciation in the income statement
Depreciation is charged in the statement of comprehensive since the statement should show a reflection of the business effectiveness and prowess on the of the business state of financial condition. Since depreciation is an expense, it should be reflected in the income or profit and loss statement as a reduction on the business income. Failure to charge depreciation in the statement of comprehensive income will lead to overstated profits since the wear and tear loss as not been accounted for in the income statement.
Accruals and prepayments
Business accounting is based on the accruals concept, which requires that revenues be recognised when earned, not when receive and expenses are recognised when incurred, not when paid for. It is this concept that leads to accruals and prepayment.
Accruals-they are monetary transaction such as accounts receivable, interest expenses, tax liability and utility charges that has not been gathered for in the financial period. International accounting framework personifies the accounting for non cash items such as goodwill and allows the business entities assess the amount yet to be recovered in accrual basis. Accruals are accounted for as Accrued liabilities in the statement of financial position as current liabilities and are added to non-current liabilities. Under accrual concept, the recording unpaid expenses as no discretional rule that governs the realization of the liability. The business entities are only required to make the prudent estimation on the accruals recorded but if the accrued liability is not realized then it is treated as bad debt expense that is charge against the income in the statement of comprehensive income. Accrued revenue is accounted for in the in the books of account as income although the money as not been recovered.
Prepayments refer to the amount paid advance and accounted for by recording in the income statement before they are utilized. Prepaid expenses are generally realized and accounted before the amount is consumed. Business financial obligations can be paid in advance as prepayments expense in the business. Tax obligations, credit charges can be settle by prepayments. The prepayments are as current assets in the statements of financial position.
Importance of making adjustments for accruals and prepayments
According to the financial accounting Standards Board (FASB) and the general accepted accounting principles accounting frameworks adjustments on prepayment and accruals are necessary for consistency of accounting statements. The adjustment resulting from realised income should be made to facilitate prober accounting and promote transparency in the accounting statements. The adjustments would also controls fraudulent activities that come as misappropriation of unadjusted incomes. The standards requires that income received and expenses incurred in advance should be realized before their utilization, this would require adjustments of the income or expenses utilized or realized to comply with the matching principle.