Capital Expenditure Vs Revenue Expenditure

Companies incur costs to acquire resources that will be used in operations. Every cost creates either an immediate or a future economic benefit. Determining when the company will realize the benefit from a cost is paramount. When a cost creates an immediate benefit, such as fuel used in delivery vehicles, the company records the cost in the income statement as an expense. When a cost creates a future economic benefit, such as inventory to be resold or equipment to be later used for manufacturing, the company records the cost on the statement of financial position as an asset.

All costs are either held on the statement of financial position or are transferred to the income statement. When costs are recorded on the statement of financial position (referred to as capitalized), assets are reported and expenses are deferred to a later period. Once the company receives benefits from the assets, the related costs (in form of depreciation) are transferred from the statement of financial position to the income statement. At that point, assets are reduced and expenses are recorded in the current period. 

Corporate scandals involving WorldCom and Enron illustrate improper cost transfers designed to achieve higher profit levels. Neither of the companies transferred costs from the statement of financial position to the income statement as quickly as they should have. This had the effect of overstating assets on the statement of financial position and net income on the income statement. In subsequent litigation, the SEC and the Justice Department held that these companies intentionally overstated net income to boost stock prices. A number of senior executives from both Enron and WorldCom were sentenced to lengthy jail terms as a result of their criminal actions.

Asset costs should transfer to the income statement when the asset no longer has any future economic benefit (which is when it no longer meets the definition of an asset). For example, when stocks are purchased or manufactured, their cost is recorded on the statement of financial position as an asset called inventories. When inventories are sold, they no longer have an economic benefit to the company and their cost is transferred to the income statement in an expense called CoGS (cost of goods sold). CoGS represent the cost of inventories sold during that period. This expense is recognized in the same period as the revenue generated from the sale.