UPSC Prelims 2022 Q9: Capital vs Revenue Expenditure — Explained
With reference to the expenditure made by an organisation or a company, which of the following statements is/are correct?
1. Acquiring new technology is capital expenditure.
2. Debt financing is considered capital expenditure, while equity financing is considered revenue expenditure.
Select the correct answer using the code given below:
- 1 only
- 2 only
- Both 1 and 2
- Neither 1 nor 2
Answer: (a) 1 only
Statement-wise explanation
- 1: correct — Capital expenditure is money a business spends to buy a fixed asset, or to add value to one, when the asset's useful life runs beyond one accounting year (RBI Bulletin definition). New technology bought for long-term use fits this test. Examples include machinery that embodies the technology, a patent, a licence or technical know-how. Its cost goes on the balance sheet as a tangible or intangible fixed asset and is depreciated or amortised over its life. It is not charged to the profit and loss account in one year.
- 2: incorrect — Debt financing and equity financing are ways of raising money. They are sources of funds, not expenditure of any kind. In NCERT Class XII Accountancy (Cash Flow Statement), money from issuing shares, debentures, loans and bonds is an inflow under financing activities. Capital expenditure, by contrast, falls under investing activities. On the balance sheet, debt is a liability and equity is shareholders' funds. Only the interest paid on debt is a revenue expense. The amount borrowed is never an expense.
How to eliminate
Both statements can be settled from basic accounting. Statement 2 has a built-in giveaway: 'financing' means raising money, not spending it, so calling debt or equity any kind of expenditure is a category error. Splitting the two by type, with debt as capital and equity as revenue, has no basis either. Equity and long-term debt both fund long-term assets. That rules out every option that includes statement 2 and leaves '1 only' or 'neither'. For statement 1, apply the one rule worth remembering: spending whose benefit lasts more than one accounting year and creates an asset is capital expenditure. New technology passes that test, so statement 1 stands.
Know more
Capital vs revenue expenditure in company accounts
A company's spending is classified by how long the benefit lasts and whether it creates an asset.
| Capital expenditure | Revenue expenditure | |
|---|---|---|
| Test | Creates or improves an asset; benefit lasts more than one accounting year | Day-to-day running cost; benefit used up within the year |
| Where recorded | Balance sheet, as a fixed or intangible asset | Profit and loss account, as an expense |
| Treatment | Depreciated or amortised over its useful life | Charged in full in the same year |
| Examples | Land, buildings, plant, machinery, new technology, patents, software licences | Salaries, rent, power, repairs, raw materials, interest |
Financing is a separate question. The cash flow statement (AS-3, NCERT Class XII) groups cash flows into three activities:
- Operating: revenue income and revenue expenses.
- Investing: buying and selling fixed assets, which is where capital expenditure appears.
- Financing: issuing shares, debentures and loans, and repaying them.
So debt and equity show where the money came from, while capital and revenue expenditure show where it went. Interest on a loan is a revenue expense, and repaying the principal reduces a liability. Dividends paid on equity are an appropriation of profit, not an expense.
Government accounts use a wider test. In the Union Budget, capital expenditure is spending that creates an asset or reduces a liability, so repaying government debt counts as capital expenditure. Government borrowing itself is a capital receipt, not expenditure. Don't mix up the company and government frameworks.
In the news
The Union Budget 2022-23 (1 February 2022) raised the Centre's capital expenditure outlay by 35.4% to ₹7.50 lakh crore. That put 'capex' at the centre of economic coverage in the months before the June 2022 Prelims, and UPSC used the term to test the basic accounting distinction.
NCERT Concepts to Revise
- Capital expenditure: Statement 1 depends on what makes spending 'capital'. Note that the government definition here also counts debt repayment, which is wider than the company test.
- Revenue expenditure: Revenue expenditure is the other half of the split the statements use, so its asset-free, running-cost nature must be clear.
- Capital receipts: Shows that raising debt is treated as a receipt that creates a liability, which is useful for judging how financing should be classified.