Capital vs Revenue Expenditure, the Ledger & the Trial Balance
Telling capital expenditure from revenue expenditure, the general ledger and its classification, posting and balancing ledger accounts, preparing a trial balance, its purposes and its limitations (errors it can't detect), with a full worked example.
1Capital vs revenue expenditure
Spending on fixed assets is either capital or revenue expenditure. The distinction matters because only capital expenditure is included in the cost of the fixed asset. Revenue expenditure is an expense in the income statement.
| Capital expenditure | Revenue expenditure | |
|---|---|---|
| Definition | Costs of acquiring a fixed asset, plus later spending that increases its earning capacity | Costs that maintain (rather than enhance) the asset's earning capacity |
| Includes | Purchase cost, delivery, legal charges, installation, upgrades, replacements: all costs of bringing the asset to its present location and condition | Repairs, maintenance, repainting, renewals |
| Frequency | Usually one-off | Regular, recurring |
| Benefit period | Several accounting periods | A relatively short period |
| Accounting | Added to the asset's cost (statement of financial position), then depreciated | Expensed in the income statement in the period incurred |
A company buys a machine to make biscuits.
- Purchase and installation = capital expenditure.
- Later repairs and maintenance = revenue expenditure. They only maintain the machine; they don't increase what it can earn.
Ask: does it create or improve an asset (more capacity, longer life, new capability), or is it the cost of acquiring and installing it? Then it's capital. Does it just keep the asset running as before? Then it's revenue.
| Item | Type | Why |
|---|---|---|
| Buying a van | Capital | Acquisition |
| Petrol for the van | Revenue | Running cost |
| Repairs to the van | Revenue | Maintains |
| Extra headlights on the van | Capital | Improvement |
| Rs 1,500 on a machine: Rs 1,000 improvement + Rs 500 repairs | 1,000 capital + 500 revenue | Split by nature |
| Painting the outside of a new building | Capital | Part of getting the new asset ready for use |
| Altering a new van's interior to increase capacity | Capital | Increases earning capacity |
| Vehicle revenue licence for an existing van | Revenue | Recurring running cost |
| Cost of installing a new machine | Capital | Installation |
| Hiring a refrigeration plant | Revenue | Hire is not ownership |
| A car bought for resale by a motor dealer | Revenue (inventory / purchases) | It's trading stock, not a fixed asset |
| Acquiring patent rights | Capital | An intangible asset |
| Legal fees for a factory extension | Capital | Cost of the extension |
2The general ledger
The general ledger is the complete record of financial transactions and events. It holds the account information needed for the financial statements, with accounts for assets, liabilities, capital, income and expenses.
Modern classification of ledger accounts:
- Asset accounts: land, building, machinery, debtors, cash, bank
- Liability accounts: creditors, bank loan
- Capital account: capital, drawings
- Income accounts: sales, rent income, discount received
- Expense accounts: purchases, rent, wages, discount allowed
Posting from the primary books
- Day-book totals go to the main accounts (e.g. sales journal total → Cr Sales). Individual lines go to personal accounts (each debtor Dr).
- Cash-book entries go to the opposite side of the other account. A receipt on the cash book's debit side is credited to the paying account.
- General journal entries are posted as stated.
3The trial balance
A trial balance is a list of the closing balances of ledger accounts on a certain date. It is the first step towards preparing financial statements.
- Debit balances: assets, expenses, drawings.
- Credit balances: liabilities, capital, income.
- If everything is recorded and extracted correctly, total debits = total credits.
Purposes
- A working paper for preparing financial statements.
- Confirms that every debit has a matching credit (double entry).
- Confirms balances were accurately extracted from the ledger.
- Helps identify and correct errors before the statements are prepared. Fixing errors afterwards takes much longer.
Limitations
- It only confirms that total debits equal total credits.
- It can agree despite errors. An incorrect debit can be offset by an equal incorrect credit. A transaction never recorded at all leaves both sides missing, so the totals still agree.
- Omission
- Commission
- Principle
- Original entry
- Reversal
- Compensating
Memory hook: "One Cat Purrs On Red Cushions".
4Worked example: posting to the ledger and extracting a TB
Transactions
| Date | Transaction |
|---|---|
| May 1 | Started with cash Rs 800 and Rs 2,200 in the bank |
| May 2 | Bought goods on credit: J Wasantha 610, P Gayan 214, M Tilan 174 |
| May 4 | Sold goods on credit: J Shihan 340, G Bopage 720 |
| May 6 | Paid rent by cash 180 |
| May 9 | J Shihan paid his account by cheque 340 (banked the same day) |
| May 12 | Paid by cheque: M Tilan 174, J Wasantha 610 |
| May 15 | Paid carriage by cash 38 |
| May 21 | Sold goods on credit to G Botheju 810 |
| May 31 | Paid rent by cheque 230 |
Key ledger balances
- Cash: 800 − 180 − 38 = 582 Dr
- Bank: 2,200 + 340 − 174 − 610 − 230 = 1,526 Dr
- Purchases: 610 + 214 + 174 = 998 Dr
- Sales: 340 + 720 + 810 = 1,870 Cr
- Rent: 180 + 230 = 410 Dr
- J Shihan, M Tilan, J Wasantha: fully settled, so nil
Trial balance as at 31 May 2019
| Account | Dr (Rs) | Cr (Rs) |
|---|---|---|
| Cash | 582 | |
| Bank | 1,526 | |
| Capital | 3,000 | |
| Purchases | 998 | |
| Sales | 1,870 | |
| Creditor – P Gayan | 214 | |
| Debtor – G Bopage | 720 | |
| Debtor – G Botheju | 810 | |
| Rent | 410 | |
| Carriage | 38 | |
| Total | 5,084 | 5,084 |
Type ledger balances (Name, amount, Dr/Cr), one per line. The tool sorts and totals them.
The biggest exam task here is a full cycle:
- Opening balances
- Transactions
- Journals (including petty cash and trade/cash discounts)
- Ledger accounts
- Balance them
- Trial balance
Remember:
- Trade discount is deducted before recording (e.g. 500,000 rice less 10% = 450,000).
- Cash discounts go to the discount columns.
- A vehicle donated by the owner is Dr Motor vehicle / Cr Capital (general journal).
- The petty cash reimbursement equals the total spent.
Also expect capital vs revenue classification and TB purposes and limitations.
5Quick revision sheet
| Concept | Remember it as |
|---|---|
| Capital expenditure | Acquire or enhance an asset (purchase, delivery, legal, installation, upgrade, replacement); capitalised |
| Revenue expenditure | Maintain (repairs, maintenance, repainting, renewals); expensed |
| General ledger | Complete record; asset, liability, capital, income, expense accounts |
| Posting | Day-book totals to main accounts; individual lines to personal accounts; cash book entries to the opposite side |
| Trial balance | List of closing balances; first step to the financial statements |
| Dr side | Assets, expenses, drawings |
| Cr side | Liabilities, capital, income |
| Purposes | Working paper · double-entry check · extraction check · find errors early |
| Limitations | Agrees despite omission, commission, principle, original entry, reversal, compensating errors |
| Worked example | Printing firm TB totals 5,084 |
?Self-check quiz
10 questions on this week. Answer them all, then press Check my answers. Your best and latest scores are saved and shown on the subject page.