Capitalizing vs Expensing Explained. Financial Accounting ch 8 p 4
Hello and welcome to the session this is professor forehead and this session we're going to look at revenue versus capital expenditure this topic is pretty challenging in the real world and not a clear-cut answer for it for us today we'll try to simplify matters this topic is covered in introductory accounting course the CPA exam the far section as .
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And looking for that extra 7 to 10 points I can help you with that so let's go back and review what issues do we have to deal with when we buy plan TAS at first we have to determine the cost of the plant asset compute the cost then we have to determine allocate the cost of the period benefited and this is depreciation we already talked about .
This topic talked about this topic in this session we're going to look at topic 3 and topic 3 is account for subsequent expenditure what does that mean well as what subsequent expenditure it means after you buy the asset when you spend money on the asset how are you going to treat this expenditure and the next .
Topic we would look at the topic of disposal so in this session we'll focus on number 3 let's assume you purchase this truck this truck is obviously an asset right it's a delivery truck it's an asset you're using it for business let's assume not like that let's not assume you're gonna have to fill it up with gas change the oil maintain it all .
Of these are considered subsequent expenditures so here's what's gonna happen you spend money on this truck and every time you spend money really every time you spend money there are three things that you have to worry about either you are spending your money to pay off debt like a payable or a liability of some .
Sort or the other two options you have to determine whether that expenditure is an expense or whether that expenditure is in asset so you have to determine is this an expense or is this an asset so again if you fill it out with gasoline well it's an expense because you're going to consume that gasoline fairly quickly it's not gonna provide any .
Future benefit to you if you change the oil if you do a tune-up on that truck it's basically the same concept it's gonna be expensed well let's assume you added a lift let's look at this lift and you spend $2,500 it doesn't matter what the amount is but let's assume you spent you spent money to add this lift to this truck .
Guess what happened now what you did is you increase the capacity of this vehicle increase its capacity now it can produce more it can be used to produce more unit to deliver more goods and services why because now you can lift heavy stuff to that truck now how do you treat such expenditure now that becomes an asset so we need to learn the rules .
When do we treat an expenditure as a revenue expenditure which we treat it as an expense and if it's an expense we have to understand it goes on the income statement therefore it reduces your profit or it reduces your income a capital expenditure like the lift its treated as an asset eventually it goes to the .
Income statement but slowly through depreciation so what is revenue expenditure well once you hear the word revenue expenditure kind of think about think about an expense it does not materially increase the plant asset life or capability for example if you fill out your gap your your your truck with yes it doesn't increase your capacity it .
Just it's you have to use it to maintain its current capacity otherwise the truck will not will not will not drive okay record it as an expense in the current period so those expenditure are recorded as an expense they are reported on the income statements which in turn reduces your net income so revenue expenditure are .
Reported on the income statement as expenses capital expenditure on the other hand provide longer than one period so this lift that we added to the truck that we installed it usually it's gonna be with us for several years at least it's recorded as an asset so if we paid for the truck $30,000 and we added this left now we .
Add the 2500 to the truck air set and reported on the balance sheet now will it go to the income statement yes it goes through depreciation the topic that we talked about in the prior session so this is this is the difference between revenue and capital expenditure now the now how do we know something is a revenue or a capital expenditure well we .
Have to break it down into two categories either an ordinary repair or a betterment and extraordinary notice here that's extraordinary but still repair but it's extraordinary so if the expenditure if we are spending money on something and it's considered ordinary repair ordinary repair means it's maintaining the normal operating .
Condition of the asset does not increase its capacity or productivity does not extend its life if that's the case like changing the oil doing a tune-up replacing the battery on the car okay so anything that doesn't that meets those qualification they are considered revenue expenditure which is an expense it's an expense any expenditure that's .
Considered betterment and extraordinary repair it's considered a capital expenditure aka an asset expenditure it's treated as an asset how do we know something is an asset it's a major overhaul or a partial replacement let's assume you replace the engine of that truck with a better bigger and more powerful engine then yes that's an .
Extraordinary or a betterment for the truck therefore it's treated as an asset or this new engine it's gonna extend the life beyond its original estimate that's also a better man therefore it's treated as an asset so the last thing we want to do is want to look at an actual journal entry to see what things look like so let's assume we spent nine thousand five .
Hundred on order any ordinary maintenance in our manufacturing facility alright well what do we do we debit repair expense because we repair the facilities the equipment and we credit cash so those repairs are ordinary they're necessary to keep those equipment in in a working condition let's assume we spent 1,800 to improve a .
Machine so we bought we bought a new unit that's added to our current capacity and that new we added that new unit to an existing unit but it increases its life and capacity well if we paid 1,800 we debit the machinery not an expense so how do you determine whether it's considered to repair old machinery this is what the judgment .
Comes into place that's why in the real world as when I started this session I said it's not an easy answer so in the real wood those are not easy answers whether it's a revenue or capital expenditure and I can tell you a few things what companies do sometimes companies might have a cut-off policy what is the cutoff policy they might .
Have a policy that says anything that's below $5,000 we always expense it just we don't have to worry about it always expense it you know anything above 5,000 we have to look into it whether it's a capital or a revenue expenditure and I could assure you that in the real world this topic is very challenging business owners they they question you about why .
Did you treat this this expenditure as an expense versus an asset or an asset versus an expense so if a business wants to get a loan from the bank they want you to treat your expenditure as assets right but if they want to show lower profit for taxes they want to treat it as an expense so it gets a little bit hairy and I I can I can talk from .
Experience because when I was in practice we had couple clients that always challenged us not sure challenges or questioned us about expenditures such as whether it's a capital expenditure or or a revenue expenditure conservatism says you know if you have any doubt expense it they have especially for gap if we're talking about financial .
Accounting and reporting any doubt expensive because if you have to choose between an asset and an expense be conservative and expensive now for tax purposes it's a different story you have to follow the IRS rules this is basically revenue versus expended in the next session we would look at the last topic in Catalan tacit and that's .
When we dispose of the asset so after we use the asset what do we have to do with it we dispose it as always I'd like to remind you to like this recording share it put it in playlists please visit my website if you're looking for additional resources especially to pass your CPA exam and stay safe during these days where the coroner virus is out there .
Good luck and study hard