With reference to the expenditure made by an organisation or a company, which of the following statements is/are correct ?

1. Acquiring new technology is capital expenditure.

2. Debt financing is considered capital expenditure, while equity financing is considered revenue expenditure.

Select the correct answer using the code given below :

The correct answer is 1 only.

Key PointsCapital expenditure

• It is the expenditure by the government for the development of fixed assets.
• If an item has a useful life of more than one year, it is capitalized (i.e., can be considered CapEx). Capital expenditure is a payment for goods or services recorded - or capitalized - on the balance sheet.
• Capital expenditure is used to create assets or to reduce liabilities.
• It consists of: Long-term investments by the government in creating assets such as roads and hospitals, and
• The money was given by the government in the form of loans to states or repayment of its borrowings.
• Therefore, Acquiring new technology is considered a capital expenditure as it will generate profit in the future time and helps in the creation of new assets. Hence, Statement 1 is correct.
• Debt Financing and equity financing are considered under capital expenditure. Hence, Statement 2 is not correct.

Important Points1. Capital Expenditure (CapEx)

• Definition: Expenses incurred to acquire, enhance, or extend the life of physical assets, which provide benefits over a long period. Examples include land, buildings, machinery, and infrastructure.
• Purpose: To increase the future earning capacity of the government or business and develop its capital stock.
• Characteristics:
  • Long-Term Benefits: CapEx leads to the creation of assets that provide utility over several years.
  • Non-Recurring: Typically involves a large, infrequent outlay of funds.
  • Capitalization: Recorded as an asset on the balance sheet; its value is depreciated or amortized over its useful life.
• Examples:
  • Construction of roads, bridges, and schools.
  • Purchase of machinery, equipment, or land.
  • Investments in public sector undertakings (PSUs).
• Impact on Government Finance:
  • Leads to asset creation and economic growth.
  • Helps in infrastructure development and public welfare.
  • Initial increase in government debt if financed by borrowing, but potential future revenue can offset this.

2. Revenue Expenditure (RevEx)

• Definition: Short-term expenses that are necessary for the daily operations and maintenance of government services. These do not create assets nor provide benefits beyond the current fiscal year.
• Purpose: To meet the current administrative and operational expenses, maintain existing assets, and provide public services.
• Characteristics:
  • Short-Term Benefits: Expenditure benefits are realized within the fiscal year.
  • Recurring Nature: Often involves routine payments like salaries, subsidies, pensions, and maintenance costs.
  • Expense Recognition: Directly recorded in the income statement, reducing the surplus or increasing the deficit.
• Examples:
  • Salaries of government employees.
  • Interest payments on government loans.
  • Subsidies (like food and fuel subsidies) and pensions.
  • Maintenance of government buildings and infrastructure.
• Impact on Government Finance:
  • Does not lead to asset creation but is crucial for providing essential public services.
  • Excessive revenue expenditure can lead to higher fiscal deficits if not managed efficiently.