Spending on a business is capital expenditure when it buys a non-current asset or improves what that asset can do. It is revenue expenditure when it keeps the asset working as it already was, or pays for the day-to-day running of the business. Exam questions give you a short description of the work and expect you to choose and justify one treatment.
This is the first skill in capital and revenue treatment. Everything later in the module, from profit effects to depreciation, depends on making this choice from the facts.
How do you decide from the facts?
Read the description of the work, then ask three questions in order.
- Does it acquire an asset, or add something that was not there before? A new machine, an extra room or a new delivery van is capital.
- Does it increase capacity, quality or useful life? An upgrade that lets the asset do more, or last longer, is capital.
- Does it only restore or maintain? Repairs, servicing, replacing worn parts and redecoration are revenue.
Costs that bring a new asset into use are part of its cost. Delivery, installation and legal fees on buying property are capital. Running costs such as fuel, insurance and electricity are always revenue.
The double entry follows the choice: debit the asset account for capital, or an expense account for revenue. In both cases the credit is the bank or cash account if it was paid at once.
Worked example
Sinar Bakery pays a contractor RM 7,200 by bank transfer. The invoice lists four items.
| Item on the invoice | RM |
|---|---|
| Fix a leaking water pipe in the kitchen | 320 |
| Repaint the shop walls | 880 |
| Supply and fit an additional oven | 5,400 |
| Delivery and installation of the oven | 600 |
Step 1, test each line. The pipe repair restores what existed, so it is revenue. Repainting maintains the premises, so it is revenue. The additional oven adds capacity that the bakery did not have, so it is capital. Delivery and installation bring that oven into use, so they are capital too.
Step 2, total each group. Revenue: 320 + 880 = RM 1,200. Capital: 5,400 + 600 = RM 6,000.
Step 3, check against the invoice. 1,200 + 6,000 = 7,200, which agrees with the amount paid.
Step 4, record it. Debit Equipment RM 6,000. Debit Repairs and maintenance RM 1,200. Credit Bank RM 7,200. The debits total RM 7,200, equal to the credit.
The mistake to watch for
A frequent slip is to let the amount decide.
Mistaken answer: “Replacing the worn tyres on the delivery van cost RM 1,100, which is a lot of money, so it is capital expenditure.”
The student treated a big bill as a big asset.
New tyres replace worn ones, so the van is no better than before the wear began. The work maintains the van, so the RM 1,100 is revenue expenditure. Compare that with fitting a refrigeration unit to the van for RM 9,000: this gives the van a new ability, so it is capital.
The correction is to replace “is it big?” with “what does the work do to the asset?”. Size can help you sense that something is unusual, but it never decides the answer.
Check yourself
Try these on paper, then open each answer.
1. Classify each payment as capital or revenue: (a) RM 380 to service a delivery van’s engine; (b) RM 2,100 to add a metal roof extension to the storeroom; (c) RM 75 to replace a broken door handle.
Show answer
(a) Revenue: servicing maintains the van. (b) Capital: the extension adds storage space that did not exist. (c) Revenue: replacing a broken handle restores what was there.
2. Taman Print buys a second-hand machine for RM 7,000, pays RM 500 to move and install it, and pays RM 120 for a first-year servicing contract. What is the cost of the machine in the ledger?
Show answer
The installation is needed to bring the machine into use, so it is capital: 7,000 + 500 = RM 7,500. The servicing contract is revenue expenditure of RM 120 and is not part of the machine’s cost.
3. A student says, “RM 5,000 is too large to be a repair, so it must be capital.” Which test should replace this reasoning?
Show answer
Ask what the work does. If it only restores the asset to its earlier condition, it is revenue however large the amount. It becomes capital only when the work adds capacity, quality or useful life, or buys the asset itself.
Where this leads next
The same decision applies to money coming in, so move on to separating a capital receipt from recurring income. When you are ready to test all five lessons together, use the capital and revenue practice set, and try different transactions in the double-entry and ledger trainer.
Some students can classify a clean example but lose the thread when an invoice mixes two kinds of work. Our teachers can work through that pattern in online one-to-one Accounting tuition.