Question

Distinguish between the accounting for capital expenditures and revenue expenditures. What is the key difference between the two? Go online and type in your favorite search engine, "capital expenditure policy." Why do you think there needs to be a policy about capital expenditures? Keep in mind, how each type impacts the financial statements. Please read below taken from Chapter nine:

Ethics: Don't Do It!  Capital Crime

One of the largest accounting frauds in history involved the improper accounting for maintenance expenditures. WorldCom, the second largest telecommunications company in the United States at the time, improperly treated maintenance expenditures on its telecommunications network as capital expenditures. As a result, the company had to restate its prior years' earnings downward by nearly $4 billion to correct this error. The company declared bankruptcy within months of disclosing the error, and the CEO was sentenced to 25 years in prison.

Answer 1

Fixed assets represent capital expenditures. These are expected to be productive assets for a long period of time (i.e. greater than one year). Expenditures on revenues are costs incurred that are related to specific revenue transactions or operating costs, such as the cost of goods sold or repairs and maintenance expense during the current year only. Thus, the differences between these two types of expenditures are as follows:

• Size - Capital expenditures involve much larger monetary amounts than revenue expenditures. This is generally because an expense is only classified as a capital expenditure when it exceeds a certain threshold value. Otherwise it is automatically designated as a revenue expenditure and accounted for in the current year only. There are certain exceptions to this rule and certain large expenditures may still be classified as a revenue expenditure as long they are directly associated with sale transactions or are current year costs only.
• Time - Capital expenditures are charged to expense on an annual basis via depreciation, and over the useful life of the asset. Revenue expenditures are charged to expense in the current period, or shortly thereafter if it relates to two years.
• Consumption. Revenue expenditure is consumed annually (i.e. within a very short period of time). Capital expenditure is consumed over the useful life of the fixed asset.

A capital expenditure policy is needed for the following reasons:

The policy would focus on capital equipment/ fixed assets and ensure that these are properly accounted for, tracked and safeguarded. The company would be able to place dollar limits over which an expenditure would be classified as a capital expenditure. The balance under that limit would all be a revenue expenditure. The company would be able to also document the useful life, method of depreciation etc. The company would also be able to document how they would check for obsolescence, impairment and the criteria for disposals. All of this would regulate how fixed assets are recorded.

Documentation of this policy would make it easier to prepare the financial statements as the significant accounting policies note would require a lot of this information. The actual note for calculation in the financial statements also needs to match with the capital policy and the significant accounting policies note. These are the important benefits.