Section A: Key terms and recall
Define capital expenditure. [2 marks]
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Capital expenditure is money spent by a business to acquire or improve a non-current asset, such as buildings, machinery, or vehicles, which will provide benefits over a long period. [2 marks]
Define revenue expenditure. [2 marks]
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Revenue expenditure is money spent by a business on its day-to-day running costs, such as salaries, rent, or raw materials, which are used up within the same accounting period. [2 marks]
Give one example of capital expenditure and one example of revenue expenditure. [2 marks]
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Example of capital expenditure: Purchasing a new delivery van. Example of revenue expenditure: Paying monthly electricity bills. [1 mark each]
Define capital receipts. [2 marks]
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Capital receipts are amounts of money received by a business from the sale of non-current assets or from investments, which are not part of the business's regular trading activities. [2 marks]
Define revenue receipts. [2 marks]
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Revenue receipts are amounts of money received by a business from its regular trading activities, such as sales of goods or services, or from interest on bank deposits. [2 marks]
Section B: Applying your knowledge
Classify the following as either capital expenditure (C) or revenue expenditure (R):
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- Purchasing a new computer for the office: C - Paying for monthly internet services: R - Building a new warehouse: C - Paying annual insurance premiums: R [1 mark each]
Classify the following as either capital receipts (C) or revenue receipts (R):
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- Selling old office furniture: C - Receiving rent from a property owned by the business: R - Selling goods to customers: R - Receiving money from the sale of a delivery van: C [1 mark each]
Explain why it is important to correctly classify expenditure and receipts as either capital or revenue. [3 marks]
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Correct classification ensures that the business's financial statements accurately reflect its financial position and performance. Capital items are recorded in the statement of financial position, while revenue items are recorded in the statement of profit or loss. Incorrect classification can lead to misleading financial information, which can affect decision-making by business owners, investors, and other stakeholders. [3 marks]
A business incorrectly treated a capital expenditure of $5,000 as revenue expenditure. Explain the effect of this error on the statement of profit or loss and the statement of financial position. [4 marks]
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The statement of profit or loss will show a lower profit or a higher loss because the capital expenditure has been deducted as an expense. The statement of financial position will show a lower value for non-current assets and a higher value for retained earnings, as the expense has been deducted from profit. [4 marks]
Section C: Explain and analyse
A business sold a piece of machinery for $10,000. The machinery had originally cost $15,000 and had accumulated depreciation of $8,000. The business incorrectly treated the sale proceeds as revenue receipts. Explain the effect of this error on the statement of profit or loss and the statement of financial position. [6 marks]
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The statement of profit or loss will show a higher profit because the sale proceeds have been included as income. The statement of financial position will show a higher value for retained earnings and a lower value for non-current assets, as the proceeds have been added to profit and the cost of the machinery has not been deducted. The correct treatment would be to deduct the net book value of the machinery (cost less accumulated depreciation) from the sale proceeds and record the profit or loss on disposal as a revenue item. [6 marks]
A business purchased a new delivery van for $20,000 and incorrectly treated the cost as revenue expenditure. Explain the effect of this error on the statement of profit or loss and the statement of financial position. [6 marks]
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The statement of profit or loss will show a lower profit or a higher loss because the cost of the van has been deducted as an expense. The statement of financial position will show a lower value for non-current assets and a higher value for retained earnings, as the expense has been deducted from profit. The correct treatment would be to record the cost of the van as a non-current asset and to depreciate it over its useful life. [6 marks]
Section D: Challenge
A business has the following transactions for the year ended 31 December 2023:
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Statement of Profit or Loss for the year ended 31 December 2023 Revenue: Sales of goods: $100,000 Rent received: $6,000 Total Revenue: $106,000 Expenses: Raw materials: $20,000 Electricity: $2,400 Salaries: $30,000 Insurance: $1,200 Total Expenses: $53,600 Profit for the year: $52,400 Capital Expenditure: Computer: $3,000 Warehouse: $50,000 Delivery van: ($8,000) Total Capital Expenditure: $45,000 Capital Receipts: Office furniture: $1,500 Total Capital Receipts: $1,500 Net Capital Expenditure: $43,500 [10 marks]