Accountants may come across several transactions where the classification is challenging. One of these instances includes differentiating between assets and expenses. In accounting, assets include resources owned or controlled by an entity. These resources result in the inflow of economic benefits in the future. Usually, assets include inventories, cash, property, plant, equipment, receivables, etc.
On the other hand, expenses are not resources. Instead, they represent the outflow of economic benefits during a period. While not fundamentally the opposite, assets and expenses differ significantly. However, some transactions may confuse accountants on the classification within those categories. For example, an improvement to a building owned by a company may meet both definitions.
On top of that, accounting standards may not directly specify the classification of a specific item. Therefore, accountants must determine how to account for that item through accounting principles. For that, they must understand the difference between capital and revenue expenditures. Both include an outflow of economic benefits. However, companies must capitalize on the former.
What is a Capital Expenditure?
Capital expenditure is an expense on fixed assets. It does not include items such as repair and maintenance. Instead, capital expenditures are costs incurred on acquiring a fixed asset. Similarly, it may relate to improving assets or their useful life. Capital expenditures become a part of a company’s total assets in the balance sheet.
A capital expenditure includes funds used to purchase, improve or maintain long-term assets. Usually, companies incur these expenses to improve the efficiency or capacity of the fixed asset. In addition to these, companies can still spend funds on those assets. However, those costs do not become a part of the capitalized expenditures. Therefore, they do not constitute capital expenditure.
Capital expenditures also impact assets for a longer period. Usually, these costs can impact an asset’s capacity or efficiency for several accounting periods. Another name used to describe these costs includes CapEx or capital expenses. In accounting, capital expenditure is a balance sheet item through capitalization. These expenses can also relate to the income statement. However, they occur through depreciation, amortization or impairment.
Overall, a capital expenditure is an expense incurred to acquire, improve or maintain fixed assets. These expenses are crucial to generating revenues in the long term. Due to the matching principle in accounting, companies cannot write these expenses off in a single period. Instead, they can spread these costs over several periods through other methods. Companies capitalized on capital expenditures instead of treating them as an expense.
What is a Revenue Expenditure?
Revenue expenditure is an expense incurred in the normal running of a business or operations. These expenses occur daily and become a part of operating expenses. Usually, revenue expenditures are more common and unpredictable. Companies incur these costs due to producing their products and services. Therefore, another name used for these expenses is operational expenditures.
Revenue expenditures are lower than capital expenditures. Usually, these expenses involve fewer limitations than the latter. Companies use revenue expenditures to generate revenues. In that aspect, they are similar to capital expenditure. However, revenue expenditure relates to a specific period rather than spread over several. On top of that, companies can match them with the specific revenues they help generate.
Unlike capital expenditure, companies cannot capitalize on revenue expenditure. Accounting standards require them to write these expenses off in the income statement. Therefore, they do not become a part of the balance sheet directly. Instead, they enter the income statement and contribute to operating expenses. Companies charge these expenses to the income statement directly.
Overall, revenue expenditures are expenses incurred for operational activities. These expenses are crucial in generating revenues and relate to a specific period. On top of that, they also help maintain the existing assets that help make revenues. Revenue expenditures may include selling, marketing and maintenance expenses. The accounting treatment of revenue expenditure and capital expenditure are significantly different.
What is a Betterment in Accounting?
A betterment in accounting refers to a cost incurred toward improving the quality of an asset. Therefore, it differs from expenses to repair and maintain those assets. The term betterment also explains how it relates to accounting. In essence, companies make the underlying asset better through the costs incurred for betterment. Therefore, it enhanced the resource on which companies bear the costs.
A betterment also refers to costs incurred to extend an asset’s useful life. When companies acquire a fixed asset, they estimate this useful life. Usually, the resource becomes inactive at or before this date. However, companies can extend it through several methods. As mentioned, these methods fall under capital expenditures. Therefore, betterment is a type of capital expenditure.
However, some people may term all expenses incurred on assets as a betterment. As mentioned above, the distinction between those expenses is crucial. Any costs that improve the asset’s value or increase its useful life fall under capital expenditures. Therefore, companies must capitalize them to the cost of the underlying fixed asset. Companies must also spread these costs out over the asset’s useful life.
Any costs incurred on an asset that do not achieve the above results will not constitute a betterment. Instead, they will fall under revenue expenditures. Although some costs may make assets better aesthetically, they are not betterments. For example, repair and maintenance are crucial for buildings or other properties. However, these do not improve their value or increase their useful life.
Overall, a betterment includes an expense that companies bear toward enhancing an asset’s value. It may also relate to increasing its useful life. Both these descriptions fall under the criteria for capital expenditures. Therefore, companies must capitalize betterment expenses. Any costs that do not meet the above definition will not constitute a betterment. Consequently, companies must write them off instead.
What is the accounting treatment of Betterment?
In accounting, betterment is a capital expenditure. Therefore, companies must capitalize them in the financial statements. More specifically, they become a part of an asset’s cost in the balance sheet. Once companies capitalize those costs, they may spread them out in the income statement as an expense. As mentioned, this process occurs through depreciation or amortization. In some cases, impairment also applies to those costs.
Therefore, the accounting treatment of betterment is straightforward. Companies must increase their assets in the balance sheet. In exchange, they must create liability or decrease another asset. The latter part of this treatment depends on the type of transaction. Overall, the journal entries for betterment include the following.
|Betterment (Asset account)||XXXX|
|Accounts payable or Cash/Bank||XXXX|
As mentioned, however, these journal entries apply to costs that meet the definition of a betterment. Any expenses incurred on assets that don’t satisfy the criteria will fall under revenue expenditure. Therefore, the accounting treatment for those expenses will differ.
A company, ABC Co., owns a building constructed a decade ago. The company initially estimated its useful life to be 50 years. Currently, the building has a remaining useful life of 40 years. ABC Co. spends $10,000 in cash on enhancing the building during the accounting period. The company believes these costs will increase the remaining useful life to 60 years.
The cost of the building falls under the definition of betterment. Therefore, ABC Co. must record it as a capital expenditure. Consequently, ABC Co. will use the following journal entries to record the betterment of the building.
|Building a/c (Betterment)||$10,000|