Question

Explain the rules for deciding whether an expenditure is of capital nature.

Answer 1

Capital Expenditure refers to the acquiring of a permanent or fixed asset that is continuously used in a business to generate revenue. Any amount spent on the asset that increases production or lowers production costs can also be considered capital expenditure.

Rules for Determining Capital Expenditure:

1. Expenditures for land, buildings, machinery, investments, patents, and furniture are considered permanent or fixed assets. Capital Expenditures refer to fixed assets used in a company for profit rather than sales. For example, purchasing furniture is considered a capital expenditure, although buying and selling furniture is not.
2. Capital expenditures refer to expenses incurred to repair or replace an asset. For example, if old equipment is purchased for ₹ 10,000 and repairs and installation cost ₹ 2,000, the entire expenditure is calculated per capita.
3. Capital expenditure refers to spending on an existing asset to develop or expand the business by expanding its earning potential or lowering production costs. Capital expenditures include machine installations, building additions, and facility improvements.
4. Capital expenditure occurs when the benefits of an expenditure are spread over multiple periods rather than being spent all at once. For example, extensive advertising expenses were incurred.
5. Capital expenditure refers to any expenses that raise the earning capability of a fixed asset. For example, consider the cost of air conditioning at a cinema.
6. Capital expenditure refers to the cost of raising capital for profit-making purposes. For example, underwriting commissions and broking fees.

Items of Capital Expenditure:

1. Cost for land, building, plant and machinery.
2. Cost of leasing land and building.
3. Cost of manufacturing or purchasing furniture and fittings.
4. Cost for office cars, vans, lorries or vehicles.
5. Cost of installing lights, fans, etc.
6. Cost of erecting plant and machinery.
7. Cost of Trademarks, Patents, Copyrights, Patterns and Designs.
8. Preliminary expenses.
9. Cost of goodwill.
10. Cost of adding to and extending existing fixed assets.
11. Cost of development for mining and plantations.
12. Cost of invention.
13. Increasing fixed asset capacity incurs additional costs.
14. Administrative costs in industrial firms incurred during building.