 Hello and welcome to the session. This is Professor Farhad and this session we're going to look at revenue versus capital expenditure. This topic is pretty challenging in the real world and not a clear cut answer for it. For us today, we'll try to simplify matters. This topic is covered in an introductory accounting course, the CPA exam, the FAR section. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, tax and finance lectures. This is a list all the courses that I covered including many CPA questions. So please check out this list. If you like my recording, please like them, click on the like button, share them, put them in playlists, subscribe. If they benefit you, it means they might benefit other people. So share the wealth. Also connect with me on Instagram. On my website, you will have additional resources if you're looking to supplement your accounting education or if you're studying for your CPA exam and looking for that extra 7 to 10 points, I can help you with that. So let's go back and review what issues that we have to deal with when we buy plant asset. First, we have to determine the cost of the plant asset, compute the cost. Then we have to determine allocate the cost to the period benefited, and this is depreciation. We already talked about this topic, talked about this topic. In this session, we're going to look at topic three. And topic three is account for subsequent expenditure. What does that mean? What is what subsequent expenditure? It means after you buy the asset, when you spend money on the asset, how are you going to treat this expenditure? And the next topic would look at the topic of disposal. So in this session, we'll focus on number three. Let's assume you purchase this truck. This truck is obviously an asset, right? It's a delivery truck. It's an asset. You're using it for business. Let's assume, let's not assume you're going to have to fill it up with gas, change the oil, maintain it. All of these are considered subsequent expenditures. So here's what's going to happen. You spend money on this truck. And every time you spend money, really, every time you spend money, there are three things that you have to worry about. Either you are spending your money to pay off debt, like a payable or a liability of some sort. Or the other two options, you have to determine whether that expenditure is an expense or whether that expenditure is an asset. So you have to determine, is this an expense or is this an asset? So again, if you fill it out with gasoline, well, it's an expense because you're going to consume that gasoline fairly quickly. It's not going to provide any future benefit to you. If you change the oil, if you do a tune-up on that truck, it's basically the same concept. It's going to be expensed. Well, let's assume you added a lift. Let's look at this lift. And you spend $2,500. It doesn't matter what the amount is, but let's assume you spend money to add this lift to this truck. Guess what happened? Now, what you did is you increased the capacity of this vehicle, increased its capacity. Now it can produce more. It can be used to produce more unit, to deliver more goods and services. Why? Because now you could lift heavy stuff to that truck. Now, how do you treat such expenditure? Now it becomes an asset. So we need to learn the rules. When do we treat an expenditure as a revenue expenditure, which we treated as an expense? And if it's an expense, we have to understand it goes on the income statement. Therefore, it reduces your profit or it reduces your income. A capital expenditure, like the lift, it's treated as an asset. Eventually it goes to the income statement, but slowly through depreciation. So what is revenue expenditure? Well, once you hear the word revenue expenditure, kind of think about an expense. It does not materially increase the plant asset life or capability. For example, if you fill out your truck with gas, it doesn't increase your capacity. It's just you have to use it to maintain its current capacity. Otherwise, the truck will not drive. Record it as an expense in the current period. So those expenditure are recorded as an expense. They are reported on the income statements, which in turn reduces your net income. So revenue expenditure are reported on the income statement as expenses. Capital expenditure, on the other hand, provide longer than one period. So this lift that we added to the truck that we installed, it usually it's going to be with us for several years at least. It's recorded as an asset. So if we paid for the truck $30,000 and we added this lift, now we add the $2,500 to the truck asset and reported on the balance sheet. Now, would it go to the income statement? Yes, it goes through depreciation, the topic that we talked about in the prior session. So this is the difference between revenue and capital expenditure. Now, how do we know something is a revenue or a capital expenditure? Well, we have to break it down into two categories, either an ordinary repair or a betterment and extraordinary repair. Notice here, it's extraordinary, but still repair, but it's extraordinary. So if the expenditure, if we are spending money on something and it's considered ordinary repair, ordinary repair means it's maintaining the normal operating condition of the asset, does not increase its capacity or productivity, does not extend its life. If that's the case, like changing the oil, doing a tune up, replacing the battery on the car. So anything that doesn't, that needs those qualification, they are considered revenue expenditure, which is an expense. It's an expense. Any expenditure that's considered betterment and extraordinary repair, it's considered a capital expenditure, aka an asset expenditure. It's treated as an asset. How do we know something is an asset? It's a major overhaul or a partial replacement. Let's assume you replace the engine of that truck with a better, bigger and more powerful engine. Then yes, that's an extraordinary or a betterment for the truck. Therefore, it's treated as an asset. Or this new engine, it's going to extend the life beyond its original estimate. That's also a betterment. Therefore, it's treated as an asset. So the last thing we want to do is we want to look at an actual journal entry to see what things look like. So let's assume we spend 9,500 on ordinary maintenance in our manufacturing facility. Well, what do we do? We debit repair expense because we repair the facilities, the equipment, and we credit cash. So those repairs are ordinary. They're necessary to keep those equipment in a working condition. Let's assume we spent 1,800 to improve a machine. So we bought a new unit that's added to our current capacity, and we added that new unit to an existing unit, but it increases its life and capacity. Well, if we paid 1,800, we debit the machinery not an expense. So how do you determine whether it's considered repair or machinery? This is where the judgment comes into place. That's why in the real world, as when I started this session, I said it's not an easy answer. So in the real world, those are not easy answers, whether it's revenue or capital expenditure. Now, I can tell you a few things what companies do sometimes. Companies might have a cutoff policy. What is a cutoff policy? They might have a policy that says anything that's below $5,000, we always expense it. Just we don't have to worry about it. We always expense it. Now, anything above $5,000, we have to look into it, whether it's a capital or revenue expenditure. And I could assure you that in the real world, this topic is very challenging. Business owners, they question you about why did you treat this expenditure as an expense versus an asset or an asset versus an expense. So if a business wants to get a loan from the bank, they want you to treat their expenditure as assets. But if they want to show lower profit for taxes, they want to treat it as an expense. So it gets a little bit hairy. And I can talk from experience because when I was in practice, we had couple clients that always challenged us, not challenges or question us about expenditure such as whether it's a capital expenditure or a revenue expenditure. Conservatism says if you have any doubt, expense it. You have especially for GAP, if we're talking about financial accounting and reporting, any doubt, expense it. Because if you have to choose between an asset and an expense, be conservative and expense it. Now, for tax purposes, it's a different story. You have to follow the IRS rules. This is basically revenue versus expenditure. In the next session, we would look at the last topic in cap plant asset. And that's when we dispose of the asset. So after we use the asset, what do we have to do with it? We dispose it. As always, I would like to remind you to like this recording, share it, put it in playlist. Please visit my website if you're looking for additional resources, especially to pass your CPA exam and stay safe during these days where the coronavirus is out there. Good luck and study hard.