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CMA Foundation · Fundamentals of Financial and Cost Accounting · Capital and Revenue Transactions

Nair Industries incurred Rs 4,00,000 on a major overhaul of a machine. Rs 3,00,000 of this raised its output capacity permanently, and Rs 1,00,000 merely restored it to normal working order. It also paid Rs 20,000 for wages of workers who installed the capacity-raising parts, included separately from the above. What amount is capital expenditure and what is revenue expenditure?

Capital expenditure is Rs 3,20,000 and revenue expenditure is Rs 1,00,000. The capacity-raising Rs 3,00,000 plus Rs 20,000 installation wages are costs of improving the asset. The Rs 1,00,000 only restores normal working condition, so it is charged to profit and loss.

  1. ACapital Rs 3,20,000; Revenue Rs 1,00,000Correct
  2. BCapital Rs 4,00,000; Revenue Rs 20,000
  3. CCapital Rs 3,00,000; Revenue Rs 1,20,000
  4. DCapital Rs 4,20,000; Revenue nil

Explanation

Spending that raises capacity is capital, and wages for installing those parts are a cost of bringing the improvement into use, so capital = 3,00,000 + 20,000 = Rs 3,20,000. Restoration of normal working order of Rs 1,00,000 is revenue. Option Rs 3,00,000/1,20,000 wrongly treats the installation wages as revenue.

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