Capital and revenue expenditure: practice questions

How to approach these questions

Capital and revenue expenditure questions test judgement. Read the requirement to see what is asked. You may have to classify a list of items or explain the difference.

You may also have to correct an error where one type was treated as the other. Then show the effect on profit and on the statement of financial position. Underline the verb. "State", "classify", "explain" and "calculate the effect on profit" each need a different response, and a correct answer to the wrong one earns nothing.

Then hold on to the single distinction behind everything. Capital expenditure buys or improves a non-current asset that benefits the business over several years. Revenue expenditure is the day-to-day cost of running the business and keeping those assets working, used up within the current period.

Go item by item and apply one test. Does the cost bring a new long-lasting asset into the business, or add to the value or capacity of an existing one? If so, it is capital.

If it only maintains, repairs or runs what the business already has, it is revenue. Take a delivery van bought for RM40,000. The purchase price is capital because it acquires a lasting asset.

The legal fees, delivery charge and the cost of painting the business name on it before first use are also capital. They are needed to bring the asset into working condition. But RM600 spent later on servicing, and the fuel and road tax, are revenue, because they keep an existing asset running.

Write a one-line reason beside each classification. It protects you when the marker wants the reasoning as well as the label.

Examiners choose borderline items deliberately, so learn the recurring pairs. Repairs to a machine are revenue, but an improvement that raises its output is capital. Installation and set-up costs on new equipment are capital, because they get the asset ready.

A maintenance contract afterwards is revenue. A useful line is the moment the asset is first ready for use. Spending up to that point is usually capital.

Spending after it is usually revenue. When an item could split, such as a builder's bill that includes both an extension and some redecoration, split it and treat each part on its own merits.

When the question asks about the effect of getting it wrong, be systematic. If revenue expenditure is wrongly recorded as capital, expenses are understated, so profit is overstated. A non-current asset also appears that should not exist, so assets are overstated.

If capital expenditure is wrongly recorded as revenue, expenses are overstated, profit is understated, and the asset is missing from the statement of financial position. Suppose RM5,000 of machine repairs were capitalised in error. Profit for the year is overstated by RM5,000 and non-current assets are overstated by RM5,000.

If a depreciation charge was also taken on that false amount, the profit effect changes slightly. State the direction, the amount and both statements affected.

Layout and vocabulary carry marks. If asked to classify, a two-column table headed "capital" and "revenue" is clear and quick. If asked to explain the effect, write full sentences naming the figure that moves and the direction.

Do not say vaguely that "profit is wrong". Use correct terms, such as expense for an income statement charge.

Finally, check each classification against the principle behind it. Capitalising a cost spreads it over the years it benefits through depreciation. That fits the matching concept.

Expensing a revenue cost charges it now because its benefit is used up now. If your treatment means today's profit carries a cost that belongs to future years, or the reverse, you have probably classified it wrongly.

If you keep misjudging borderline items, one of our teachers can go through a list of tricky examples with you and explain the reasoning behind each one. Book a trial class