Capital and revenue expenditure
When drawing up the profit and loss account and balance sheet, it is important to remember the difference between capital and revenue expenditure. Firms raise capital from shareholders and other sources and this is spent on buying premises, plant and equipment etc. The finance raised and the corresponding capital expenditure are recorded in the balance sheet. Other spending takes place on current assets used directly in the production of finished goods, such as raw materials, packing materials and stocks of spare parts. This is called revenue expenditure.
Unfortunately, there are some crossovers between the profit and loss account and the balance sheet which we will examine during this section. The exceptions are shown in italics in the following definitions:
- Capital expenditure - the spending of funds to buy fixed assets with a long life, such as land or buildings. This spending is recorded in the balance sheet, although the depreciation of these assets is included in the profit and loss account as an expense.
- Revenue expenditure - the use of funds to buy current assets, such as stocks, or to pay operating expenses such as salaries and wages. These are recorded in the profit and loss account. However, stocks that remain at the end of the company year are recorded in the balance sheet, because they are assets that can be sold by the business in the next financial year.