Introduction to Revenue Expenditure
Revenue expenditure refers to expenses incurred in the day to day running of the business. These are recurring in nature and are allocated to the profit and loss account of the same year. Unlike capital expenditures, these are not carried forward to future years. The benefit of the revenue expenditures is received in the same accounting year itself. The expenses vary from the costs in producing a commodity to the cost of selling or any of the expenses incurred in paying the rent or regular expenses of the entity. It also includes costs incurred to maintain the capital expenditures i.e. maintenance cost of machinery every year.
Examples of Revenue Expenditure
Examples of Revenue Expenditure is as follows:
Example #1 – Depreciation on a Machinery
One of the examples of revenue expenditure which could serve as a contrast to the capital expenditures is that of depreciation done on an annual basis on a capitalized asset. The initial expenditure on the machinery would be a capital expenditure and would be reported on the balance sheet at the amount paid to acquire it. On an annual basis, there would be depreciation charged on the machinery at 10%. This depreciation charged would be revenue in nature and would form part of the profit and loss account at the year-end. Below is an example of one of the purchases of the machinery and the consequent depreciation at the year-end.
- Company A bought machinery on 1st Jan 2016 for $1200
- The concern is supposed to depreciate the asset at 10% per annum
- Below are the journal entries that would be passed for the accounting of the machinery during the course of the year 2016
Example #2 – Cost of Labor
Revenue expenditures can be classified in two forms. Direct and indirect. The Indirect form has already been covered in example 1 in the form of expenditures that are required to maintain a piece of machinery, equipment or the business in general.
The Direct form of revenue expenditures are those incurred in the raw material, labor or other forms of production that are compulsorily required to have the product or service established. Unless these take place, there are no direct factors available to have got the finished product or services for the purpose of selling and thereby conducting the prime business.
The cost of labor in this regard becomes an important component. These are wages that are paid to the factory workers to carry on the production. These might be calculated on a daily, hourly or weekly rate and paid to them on a weekly basis or as of a month-end. Again, it is important to establish the important factors around the wages like overtime payment and bonuses. These have to be paid in addition to the regular rates.
A concern could calculate the gross profit in its working if it reduces the direct material and labor cost from the sales that have taken place.
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Example #3 – Rent paid
Every business establishment occupies a physical place to conduct its business. For this place, it has to pay a fixed amount on a regular basis. This is called rent.
The rent may be paid on a regular basis like every month or once in a quarter. The important aspect to be noted about rent is that there is a contractual obligation to pay the amount even if the business is not conducted in the said place for any reason. The rental agreement will determine if there needs to be paid any addendum to the already established base rent for any construction or changes that the property occupier makes. Usually, the agreement is for a fixed period of time which needs to be renewed after the expiration of that period. Also, there could be a clause for a fixed percentage increase on an annual basis.
Again, it is important to note that the revenue expenditure as rent is recognized on an accrual basis irrespective of when the rent is actually paid. So, for example, if the rent is paid in advance it is proportioned over the actual time of the occupation of the property or if the rent is not paid till the end of the year, the rent is recognized on an accrual basis even though it might not have been actually paid.
Conclusion
It is important to establish whether a particular expense is revenue expenditure or not. These are charged to the profit and loss account and directly determine the profit or loss in a calculation in a particular period. The following features though not exhaustive helps to determine whether a particular expense could be categorized as revenue
- The expenses are not done for the capitalization of an asset i.e. purchase of a new car. Rather it takes place to maintain the asset on an everyday basis e.g. expenses incurred on the repairs of the said asset
- It is recurring in nature. The revenue expenditure is not one time in nature. They have to be incurred either on a regular or a need basis.
- The benefit of a revenue expenditure does not percolate to the next accounting year. The current year would be the beneficiary of an expense payment e.g. rent. If at all the expense is supposed to provide benefits in the next year, then it should be capitalized over the period of benefit.
In case, revenue expenditure is wrongly booked, the entry would have to be reversed to reflect it in the correct form. This could be done either in the current year or through pre-period time adjustments in the next accounting year.
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