calculate and comment on the effect on profit of incorrect treatment

4.1 Capital and Revenue Expenditure & Receipts

What’s Capital vs Revenue?

Think of your school’s budget like a pizza 🍕.

• Capital Expenditure (CapEx) = buying the pizza oven that will bake pizzas for months. It’s a big one‑off cost that gives benefits over many years.
• Revenue Expenditure (RevEx) = buying the dough, cheese, and sauce each week. These costs are used up quickly and give benefits only for that week.

Capital vs Revenue Receipts

Receipts are the money that comes in. They can also be split into two types.

• Capital Receipts – money that increases the company’s equity, e.g. selling a piece of land.
• Revenue Receipts – money that is earned from normal business activities, e.g. sales of goods.

Common Mistakes

Students often mix the two up. Let’s see how it changes profit.

Calculating the Impact on Profit

Profit is calculated as:

$Profit = Revenue - Expenses$

If a capital item is treated as an expense, the “Expenses” side gets larger, so profit shrinks.

If a capital receipt is treated as revenue, the “Revenue” side gets larger, so profit grows.

Example Problem

1. Company buys a computer for $2,400. It will be used for 3 years.
2. It is mistakenly recorded as a revenue expense.
3. Original profit before the purchase: $12,000.
4. Calculate the new profit.

Solution:

New profit = $12,000 - $2,400 = $9,600. The profit is lower by $2,400 because we treated a capital cost as an immediate expense.

Key Takeaways

• Capital items give long‑term benefits and should be capitalised.
• Revenue items are short‑term and should be expensed immediately.
• Misclassifying either way distorts the profit figure.
• Always check the nature of the item before recording it.

Remember: Treating a big purchase as a small snack will make your financial “pizza” look smaller than it really is! 🍕📉