The Hindu Business Line : Capital versus revenue expenditure

Where, as a result of an expenditure i) a new identifiable asset is created; ii) the life of an existing asset is increased beyond its original estimated economic life; or iii) profitability of the entity is increased.

As a result, the asset account is to be debited and carried to balance-sheet under the head ‘fixed assets’. Where a liability is cleared off, the reduced value is carried to the balance-sheet.

The frequency or value of the expenditure does not determine whether the expenditure is capital or revenue in nature. There could be non-recurring revenue expenditure or a recurring capital expenditure.

Inaugural expenditure is revenue in nature, which happens only once in the lifetime of the entity, whereas if an entity keeps on adding facilities, or computers or furniture, it would be recurring expenditure which is capital in nature.

Similarly, it is not necessary for capital expenditure to be of a high value. It could be of small value, say, a motor for a machine or an accessory for a fixed asset (such as a computer table or a fluorescent lamp).

If a CD player is bought to fit in a car, it would be capital expenditure, but if heavy expenditure such as on overhauling of machinery, painting a car and changing its upholstery, etc., is incurred, it does not qualify as capital expenditure.

Capital becomes revenue

There are provisions in the Companies Act to treat capital expenditure as revenue, where the unit value of an asset is less than Rs 5,000. Accordingly, if an entity buys 20 air-coolers, each costing less than Rs 5,000, it is justified in debiting the entire cost of such coolers to profit and loss account in the year of purchase.

However, provisions of this nature do not exist in the Income Tax Act.

Concept of materiality

The concept of materiality comes into operation while dealing with capital expenditure of small value. In fact, purchase of CDs, pen drives, calculators, even books qualifies to be capital expenditure by nature of the transaction and going by the terms of AS 10. But based on the concept of materiality, they are expensed out through the profit and loss (P&L) account.

Fixed asset

A fixed asset is one which is held and used by the entity in the course of its revenue generation. The entity does not deal in those items. A motorcar or an apartment would be fixed asset for the buyer, while it constitutes a current asset to the dealer or builder. A fixed asset need not be immovable. There could be movable fixed assets (such as a motorcar). Ownership and exclusiveness are essential to constitute a fixed asset. It is permissible to have a joint ownership of a fixed asset.

At times, entities might be required to bear the expenditure in providing a facility, but the ownership vests with others. It is possible for an entity being asked to bear the cost of poles for transmission of power to its unit.

The cost of these poles is met by the entity but it does not retain the ownership. Similarly, the entity may be required to bear the cost of laying an approach road to connect it to the main road. The road does not belong to the entity.

There was an instance where a cement manufacturing unit located along a railway track observed its employees losing lives in their effort to cross the track in their hurry to report to work in time. The unit came forward to bear the cost of constructing an over-bridge across the railway track. The bridge was dedicated to the nation. The over-bridge is not the exclusive property of the entity.

It would not be justified in carrying such expenses as fixed assets in their financial statements since exclusive ownership does not exist. There is no ownership or sense of belonging to the facility provided.

Extraordinary item?

If such expenditure is normal in the course of business, such as laying a pipeline or to erect poles, which is incidental to setting up of the facility, it would not be an extraordinary item as per the terms of AS 5. But, the over-bridge is certainly not in the normal course of the business and qualifies to be an extraordinary item. Therefore, whether or not such expenditure constitutes an extraordinary item depends on the given circumstances and varies on a case-to-case basis.

AS 10 does not permit such expenditure (not resulting in creation of an asset) to be disclosed as fixed asset. Such expenditure is justified to be indicated as a “capital expenditure not resulting in an asset”.

Two points merit attention:

A note is to be given about the nature of the asset and a statement that such expenditure does not result in any fixed asset.

The capital expenditure to be amortised over the period over which the entity derives benefit out of such capital expenditure or over a period of five years.

In the above example, the entity would not be justified in disclosing the expenditure incurred on the over-bridge as a fixed asset in its financial statements. The utility of the over-bridge to the entity is for a long duration. In such a situation the cost should be written off over a period of five years.

It would not be proper to disclose it as miscellaneous items to the extent not written off.

(The author is a Hyderabad-based chartered accountant.)

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