Capital (CAPEX) and Revenue expenditure
The Matching concept
The matching concept requires that expenses shall be recorded in the same period in which revenue (earned because of that expense) is recorded.
Matching is the whole process of measuring periodic earnings with expenses incurred to make those earnings possible.
In other words, the revenue earned by an enterprise during a period can be measured only when it is compared to the expenses incurred while earning that revenue.
Revenue is the total amount earned from the sale of goods or services, along with the income from interest, profits, and any other sources of income.
It is very crucial to understand here that cost is not the same as an expense because expenses are costs or resources consumed against which income has been earned during the accounting period. Thus cost does not become an expense unless the goods or services in question are exchanged. Therefore only those costs against which economic benefits have been obtained and resultantly revenues have been earned during the accounting period, are considered expenses.
For example, if the rent for the period of November 20X7 is paid in January 20X8, then the rent should be taken as
the expense of services provided in November 20X7 and,
not as the expense for the period of January 20X8 despite the fact that the cash transaction was carried out in January 20X8.
Implications of Matching concept
Due to the matching concept, expense accounts are further classified into two classes;
We know that because of the Matching concept costs incurred in a period are further classified into capital (CAPEX) and revenue expenditure.
Capital expenditure (CAPEX)
Before you start this topic, you need to know that ‘Capital Expenditure’ has nothing to do with the owner’s capital account. While both are long-term investments, one made by the business (capital expenditure), and the other by the owners (Capital), they are, inadvertently, two very different things.
Capital expenditures (also called CAPEX) are those expenses, which are incurred to take economic benefits (earn revenue) from more than a single accounting period. For example, purchasing plant and machinery, or purchasing office buildings. The usual intention while purchasing an office building will be to use this for many years maybe till the business lasts. As such long-term expenses are incurred with the intention to produce revenue for more than a single account period, CAPEX is treated as an asset. However, the portion of this expenditure used in the current year is expensed out by the means of depreciation or amortization.
Revenue expenditure
Costs that are incurred to run day-to-day business (e.g. paying electricity bills), and consumed to earn revenue in that specific accounting period are treated as expenses for that period.
The difference between CAPEX and revenue expenditure can be simplified by this example. Buying a van costs money. The van will be in use for many years and, therefore, is a capital expenditure and accounted for as an asset. However, paying for the use of gasoline in the van is an expense.
For the above discussion, we can say that since capital expenditures result in assets, therefore reported in the balance sheet whereas revenue expenditures are the costs consumed during the period, hence become the part of profit and loss account for the period.
Differences between CAPEX and revenue expenditure
The examples in the table below show the difference in the two types of expenditure for better understanding.
|
Expenditure |
Type of Expenditure |
|
1. Buying a van |
Capital |
|
2. Petrol costs for van |
Revenue |
|
3. Repairs to the van |
Revenue |
| 4. Putting extra headlights on the van |
Capital |
|
5. Buying machinery |
Capital |
|
6. Electricity costs of using machinery |
Revenue |
|
7. Spent $1,500 on machinery: $1,000 was for an item (improvement) added to the machine, and $500 was for repairs |
Capital $1,000 Revenue $500 |
|
8. Painting outside of the new building |
Capital |
|
9. Three years later – repainting outside of the building in (8) |
Revenue |
Later in this chapter, we will discuss another application of the matching concept, where the sales and purchase of goods and inventories are accounted for as income and expense instead of the asset.
