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Capital vs Revenue Expenditure and Receipts for UPSC EPFO APFC: Deferred Revenue Expenditure, AS 26 and 10 MCQs
Learn the tests, work through classic examples, and see how AS 26 changed the old idea of deferred revenue expenditure.
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Why this topic keeps appearing in APFC papers
In plain language: Capital spending is used to buy or improve a long-term earning asset, such as a machine or a building. Revenue spending keeps everyday operations going, such as rent, ordinary repairs or staff salaries. The same idea applies to money coming in: a loan or the sale of a machine is a capital receipt; sales and interest received are revenue receipts.
The APFC syllabus lists General Accounting Principles, and the commission likes questions where one small fact flips the answer: wages are revenue expenditure, but wages paid to install a new machine are capital expenditure. These are cheap marks if you learn the logic and expensive mistakes if you memorise lists. The same logic also sits behind Union Budget questions on capital and revenue receipts, which appear under the economy portion.
The rule of thumb: capital expenditure creates or improves an earning asset, and revenue expenditure keeps the business running as it is. Capital items go to the Balance Sheet (and reach the Profit and Loss Account slowly through depreciation); revenue items are charged to the Profit and Loss Account of the same year.
Four tests to classify any expenditure
1. Nature of the asset
Spending to acquire, construct, extend or improve a fixed asset is capital. Spending to maintain it in its existing condition is revenue. Adding a new floor to a factory is capital; repainting the existing floors is revenue.
2. Period of benefit
If the benefit lasts beyond the current accounting year, the item may be capital. If it is used up within the year, it is usually revenue. This test is not enough on its own. A large advertising campaign may benefit later years, but AS 26 still requires it to be expensed when incurred unless a recognisable asset is acquired or created.
3. Effect on earning capacity
Expenditure that increases capacity, cuts operating cost or extends the useful life of an asset is capital. Expenditure that merely restores normal working is revenue.
4. Recurring or non-recurring
Revenue items are usually recurring (rent, salaries, power); capital items are usually one-off. Treat this test as supporting evidence only, because a heavy one-time repair can still be revenue.
Classic examples table
| Item | Treatment | Reason |
|---|---|---|
| Wages paid for installing new machinery | Capital | Brings asset to working condition |
| Carriage inward on a new machine | Capital | Part of asset cost |
| Carriage inward on goods purchased for resale | Revenue | Part of cost of goods; charged to Trading Account |
| Repairs to second-hand machinery before first use | Capital | Puts the asset into usable condition |
| Routine repairs and servicing of machinery | Revenue | Maintains existing condition |
| Legal fees and stamp duty on purchase of land | Capital | Cost of acquiring the asset |
| Extension of factory building | Capital | Increases capacity |
| Whitewashing an office in regular use | Revenue | Maintenance |
| Replacing a worn-out tyre of a delivery van | Usually revenue | Typically day-to-day servicing or a small part under AS 10, charged as repairs and maintenance. Replacement of a significant part of an asset may be capitalised if the recognition criteria are met, with the replaced part derecognised. |
| Depreciation, rent, insurance, salaries | Revenue | Recurring running costs |
| Purchase of computer software licence for several years | Capital (intangible) | Benefit over several years, if AS 26 recognition criteria are met |
| Research costs | Expense when incurred | AS 26 requires research (or the research phase) to be expensed. Development may be capitalised only if all the recognition criteria in AS 26 are met. Classification therefore depends on facts, not on the size of the spend. |
Deferred revenue expenditure and AS 26
Deferred revenue expenditure is revenue in nature (no tangible asset is created) but so heavy, and its benefit so long, that older practice spread it over three to five years. Older textbooks often used examples such as a large product-launch advertising campaign, preliminary expenses of forming a company, and heavy research spending, and spread them over a few years.
Current standards largely do not allow that treatment. AS 26 paragraph 56 requires expenditure on start-up activities (including preliminary expenses such as legal and secretarial costs of establishing a legal entity, pre-opening costs, and pre-operating costs), training, advertising and promotional activities, and relocating or reorganising an enterprise to be recognised as an expense when incurred, unless the start-up expenditure is included in the cost of an item of fixed asset under AS 10. Research is always expensed when incurred (AS 26 paragraph 41). Ind AS 38 takes the same broad view. Limited exceptions remain where an item actually meets asset-recognition criteria: for example, qualifying development costs, an acquired licence or trademark that meets the definition of an intangible asset, or a prepayment for goods or services not yet received (AS 26 paragraph 57). Share-issue expenses and certain borrowing-related costs fall outside the scope of AS 26 and follow their own rules; do not treat them as automatically the same as preliminary expenses. So if a question asks for the current accounting treatment of preliminary expenses or a launch advertising campaign, the usual answer is “charged to the Profit and Loss Account in the year incurred”. If it asks only for the traditional textbook concept, the answer is “deferred revenue expenditure written off over a few years”.
Capital vs revenue receipts
Capital receipts either create a liability or reduce an asset; revenue receipts arise from normal operations and do neither.
| Capital receipts | Revenue receipts |
|---|---|
| Capital introduced by the owner | Sales of goods and services |
| Loans raised from a bank | Commission, discount and rent received |
| Sale proceeds of a fixed asset or investment | Interest and dividend received |
| Issue of shares or debentures | Bad debts recovered |
The Union Budget uses the same idea. Borrowings, recovery of loans and disinvestment proceeds are capital receipts. Tax revenue (income tax, corporation tax, GST) and non-tax revenue (dividends from public sector enterprises, interest receipts, fees) are revenue receipts.
Profit or loss on selling a fixed asset is a capital profit or capital loss. Current practice includes the gain or loss in the statement of profit and loss on derecognition, but AS 10 states that such gains should not be classified as revenue under AS 9. It is therefore not treated as an operating (revenue) profit.
Effect of misclassification
| Error | Effect on profit | Effect on assets |
|---|---|---|
| Capital expenditure treated as revenue (for example, machinery debited to Repairs) | Understated | Understated |
| Revenue expenditure treated as capital (for example, repairs debited to Machinery) | Overstated | Overstated |
Auditors watch the second error closely, because capitalising revenue costs is a common way to dress up profit. That links this topic directly to vouching of fixed assets, covered in our vouching, verification and internal control notes for APFC.
High-yield traps
- “Wages” alone is revenue; “wages for installation or construction” is capital.
- Repairs needed to make a newly acquired second-hand asset usable are usually capitalised as part of cost. After the asset is capable of operating as intended, day-to-day repairs and maintenance are revenue, though replacement of a significant part may be capitalised if AS 10 recognition criteria are met.
- Carriage inward on goods is revenue (Trading Account); carriage on a new asset is capital.
- Depreciation is a revenue expense even though it relates to a capital asset.
- Sale proceeds of an old machine are a capital receipt, not sales revenue.
- Under AS 26 paragraph 56, preliminary, training, advertising and relocation costs are generally expensed when incurred, not amortised over five years, unless a true asset (including a prepayment or qualifying development) is recognised, or the cost belongs in PPE under AS 10.
10 practice MCQs with score analysis
Attempt all ten, then press Submit. You will see correct, wrong and unattempted counts, your percentage and explanations.
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FAQ
Is depreciation capital or revenue expenditure?
Revenue. Depreciation is the portion of a capital asset’s cost charged to the Profit and Loss Account each year, so it is a non-cash revenue expense.
Can preliminary expenses still be written off over five years?
Not under current accounting standards. AS 26 and Ind AS 38 require preliminary and start-up costs of that kind to be expensed when incurred, unless they form part of the cost of PPE under AS 10 (or Ind AS 16). A five-year spread is the older accounting practice. A separate income-tax deduction may still be available under Section 35D of the Income-tax Act for specified preliminary expenses; tax treatment does not decide the accounting entry.
Is the purchase of goods for resale capital expenditure?
No. Goods bought for resale are stock-in-trade, and their cost goes to the Trading Account as revenue expenditure.
Are dividends from public sector enterprises a capital receipt for the Government?
No. They are non-tax revenue receipts. Disinvestment proceeds from selling the Government’s stake are the capital receipt.