Types of Budget Expenditure
TYPES OF BUDGET EXPENDITURE (CAPITAL AND REVENUE)
Capital expenditures are the ones that create some liability/asset for the government. These include loans to public enterprises, loans to States, Union Territories and foreign governments and acquisition of valuables.
They are long-term investments of huge amount of money for acquiring long-term assets like manufacturing equipment. Such assets acquired provide income-generating value over a period of years. Hence, the cost of such assets is recovered through year-by-year depreciation over the productive life of the asset. In essence, the expenditure which is done for initiating current, as well as the future economic benefit, is actually capital expenditure.
Examples of capital expenditures
Following are the most important items of capital expenditure:-
- Purchase of factory and building.
- Purchase of machine, furniture, motor vehicle, office equipment etc.
- Cost of goodwill, trademarks, patents, copy right, patterns and designs.
- Expenditure on installation of plant and machinery and other office equipment.
- Additions or extension of existing fixed assets.
- Structural improvement or alterations as to fixed assets which increase their life or earning capacity. For example: Conversion of handloom to powerloom.
- Preliminary expenses of a limited company.
- Cost of issue of shares and debentures.
- Legal expenses on loans and mortgage.
- Interest on capital during construction period.
- Development expenses in case of mines and plantations.
They are short-term expenses meant for running the day-to-day business of the government. An item of expenditure whose benefit expires within the year is revenue expenditure.
Revenue expenditure includes interest payments, subsidies, wages to government employees, pensions, social services and so on. Any expenditure that does not lead to formation of any asset or liability for the government will fall under this category.
The expenditure incurred for the following purposes will be treated as revenue expenditure.
- Expenditure incurred for the purpose of floating assets i.e., asset for resale purpose such as cost of merchandise, raw-material and stores required for manufacturing process.
- All establishment and other day-to-day expenses incurred in the conduct and administration of the business such as salaries, rent, taxes, postage, stationery, bank charges, insurance, advertisement charges etc.
- Expenditure incurred to maintain the fixed assets in proper working condition such as repair, replacement and renewals of building, furniture, machinery etc.
Examples of Revenue expenditures
Following are the important Items of revenue expenditure:
- All expenses incurred in the ordinary conduct of business, such as rent, salaries, wages, manufacturing expenses, carriage, commission, legal charges, insurance and advertisement, free samples, salaries, postage expenses etc.
- Expenses incurred by way of repairs, renewals and replacement for the purpose of maintaining the existing fixed assets of the business in working order.
- Cost of merchandise bought for resale.
- Cost of raw-material and stores purchased for manufacturing process.
- Wages paid for manufacture of products for sale.
- Depreciation of assets used in business.
- Interest on loan borrowed for business.
- Freight and cartage paid on merchandise purchased.
- Cost of oil to lubricate machinery.
- Service to vehicle.
- Any kind of expenditure incurred in defending law suit regarding sale or purchase of merchandise.
Key Differences between Capital and Revenue Expenditure
- Timing: Capital expenditures are long-term investments for acquiring assets. However, revenue expenditures are short-term routine expenditures.
- Consumption: A capital expenditure thing is consumed over a long period of time spanning the productive life of the fixed asset. On the contrary, Revenue expenditure things are consumed over a short period of time.
- Size: Capital expenditures involve larger monetary amounts than revenue expenditures.
- Capital expenditure is non-recurring but revenue expenditure is recurring.
- The benefit of capital expenditure extends over a substantial number of years. On the contrary, the benefit of revenue expenditure is limited to current year only.
- Capital expenditure is shown in the balance sheet, in asset side, and in the income statement (depreciation), but revenue expenditure is shown only in the income statement.
- Capital Expenditure is capitalized as opposed to Revenue Expenditure, which is not capitalized.
- The capital expenditure seeks to improve earning capacity. However, the revenue expenditure seeks to maintain earning capacity.
- The capital expenditure is not matched with capital receipts. However, the revenue expenditure is matched with revenue receipts.
Capitalized or deferred revenue expenditure
It refers to heavy expenditure of revenue nature. Actually, its benefit is available for a period of two or three or even more years. This expenditure is not written off from the profits of the year in which this expenditure is incurred.
It is desirable to spread this expenditure equally over the number of years over which its anticipated benefit is likely to follow.
Examples of deferred revenue expenditure
- Exceptional repairs of a non-recurring nature by way of overhauling of the plant and machinery;
- Advertising payment made under contact extending over a period more than one year or heavy amount expended on advertisement in one year in order to popularize a new product.
Some Recent Developments
The difference between capital expenditure and revenue expenditure must always be kept in the right perspective for prudential financial management. This becomes doubly important because of some new developments in recent years. Actually the government has ended the distinction of Plan and Non-Plan expenditure from April 1, 2017. A new classification of capital and revenue expenditures has been introduced in the General Budget 2017-18. Such a new classification is expected to formulate “a clear and effective link between the government’s earnings, spending and outcomes”.
There is a proposal in the Union budget 2018-19 that the government will stop setting targets on revenue deficit reduction from next year through an amendment in the Fiscal Responsibility and Budget Management (FRBM) framework. Experts opine that it will incentivise government’s expenditure more towards consumption wherein the expenditure pattern will move away from more productive capital expenditure.
The government has also accepted the key recommendation of the N.K. Singh committee on fiscal discipline to bring down debt-to-GDP ratio to 40% by 2024-25. The government is also going to use fiscal deficit target as the key operational parameter. The revenue deficit broadly measures the extent of borrowings used for revenue expenditure. However, fiscal deficit measures the overall borrowing to finance both revenue account deficit as well as capital account deficit.
For quite some time, the central government has also been reporting a narrower version of revenue deficit called “effective revenue deficit”, which measures the revenue deficit minus grants to states for creation of capital assets. Government has proposed to abandon tracking both these targets.
The Economic Affairs Secretary S.C. Garg says, “There is no great qualitative difference in government’s capital and revenue expenditure. A lot of capital expenditure is done outside the budget by public sector units. The distinction is more artificial than real”. As per the medium term fiscal policy statement, the finance ministry is of the view that “in a country with numerous development deficits, an undue focus on revenue deficits may be detrimental to equitable development. Human capital and its development by focusing on schools and hospitals and also maintenance of assets, which are in nature of revenue expenditure, are as important to improve productivity as buildings and roads”.
The N.K. Singh Committee says that revenue deficit should be brought down gradually. It recommended reduction of revenue deficit by 25 basis points every year to bring it down to 0.8% by 2023-24 without eliminating it completely. The committee says, “The logic of this is that borrowing for expenditures that are to be incurred year after year is neither desirable nor sustainable; these should be tax-financed. This is the basis of the commonly known as the golden rule of fiscal policy”.
The philosophy behind the FRBM Act was to force government from switching from consumption to capital expenditure as the latter has a higher multiplier effect on GDP growth. Experts say, “If the government is doing away with revenue deficit targeting and going ahead only with fiscal deficit targeting, it will have serious implication not only on GDP growth but also on achieving public debt target”.
There are experts who believe that since physical infrastructure is deficient in India, it would be prudent and useful first to fix that deficiency before doing away with targeting revenue deficit. Social infrastructure like health and education should be financed through increase in tax-GDP ratio. In this way, fiscal deficit can be used to finance physical capital formation while keeping revenue deficit in balance.