Tag: Expenditure

  • Introduction to Public Finance, Expenditure, Revenue, and Debt

    Introduction to Public Finance, Expenditure, Revenue, and Debt

    What does Public Finance Management mean? Introduction to Public Finance, Expenditure, Revenue, and Debt (In Hindi); Collection of sufficient resources from the economy in an appropriate manner along with allocating and use of these resources efficiently and effectively constitute good financial management. Resource generation, resource allocation, and expenditure management (resource utilization) are the essential components of a public financial management system – By Wikipedia.

    The Concept of Public Finance Management explains with its Expenditure, Revenue, and Debt.

    The following subdivisions form the subject matter of public finance.

    Step by step explains each one; Public expenditure, Public revenue, Public debt, Financial administration, and Federal finance.

    Public finance is the management of a country’s revenue, expenditures, and debt load through various government and quasi-government institutions. This guide provides an overview of how public finances manage; what the various components of it are, and how to easily understand what all the numbers mean. A country’s financial position can evaluate in much the same way as a business’ financial statements.

    Public Finance:

    The study of government’s role in the public finance economy is, it is the branch of economics; which evaluates the government expenditure of government revenue and government authorities, and one or the other adjustment to achieve desirable effects and avoid undesirable people.

    The federal government helps prevent market failure by supervising the allocation of resources, distribution of income, and stabilization of the economy. Regular funding for these programs mostly secures through taxation.

    Borrowing from banks, insurance companies, and other governments and earning dividends from their companies helps fund federal government, state and local governments also receive grants and assistance from the federal government, in addition to ports, airport services And user fees with other features; Penalty derived from breaking the law; Revenue from licenses and fees, such as for driving; And the sale of government securities and bond issues is also the source of public finance.

    Public Expenditure:

    Public expenditure refers to government expenditure ie government expenditure. This is done by the central, state, and local governments of any country. Of the two main branches of public finance, i.e. public revenue and public expenditure, we will first study public expenditure.

    Public expenditure can define in this way,

    “The expenditure incurred by public authorities like central, state and local governments to satisfy the collective social wants of the people is known as public expenditure.”

    But now, the cost of the government across the world has increased a lot. Therefore, modern economists have started analyzing the effects of public expenditure on production, distribution, and income levels, and employment in the economy.

    Classical economists did not analyze the effects of public expenditure in the nineteenth century, due to very limited governmental activities for public expenditure.

    During the 19th century, most governments followed laissez-faire economic policies, and their work was limited to protecting aggression and to maintain law and order. The size of the public expenditure was very small.

    Public Revenue:

    To maximize the social and economic welfare of the governments, there is a need to do various tasks in the field of political, social, and economic activities. To do these duties and tasks, the government needs a large number of resources. These resources call public revenues. Public revenue includes revenue from administrative activities such as taxes, fines, fees, gifts, and grants.

    According to Dalton, however, the word “Public Revenue / Income” has two senses – broad and narrow. In its broadest sense, it contains all the income or receipts that can secure a public authority at any time of time. In its narrow sense, however, it includes only the sources of public authority’s income, which is commonly known as “revenue resources”. To avoid ambiguity, thus, the former calls “public receipts” and later “public revenue”.

    As such, receipts from public lending (or public debt) and public property sales mainly exclude from public revenue. For example, the budget of the Government of India is classified as “Revenue” and “Capital”. In the “heads of revenue”, the heads of income under the capital budget calls “receipts”, thus, the word “receipts” includes. Public income sources that exclude from “revenue”.

    Revenue receipts and capital receipts are both. Revenue receipts derive from the taxes of various forms. Capital receipts include primary internal market borrowing and external debt. However, a large portion of the state’s revenue comes from internal sources. The main point of difference between the two is that where there is a gain or earning of people in the form of a source; then there is public property in the form of a source.

    Don’t Confuse they are differences and similarities; Public and Private Finance: Differences, Similarities, and Dissimilarities.

    Introduction to Public Finance Expenditure Revenue and Debt
    Introduction to Public Finance, Expenditure, Revenue, and Debt, #Pixabay.

    Public Debt:

    In simple terms, government / public debt (also known as public interest, government debt, national debt, and sovereign debt) is the outstanding debt by the government. Borrowing by public authorities is of recent origin. This practice of revenue collection was not prevalent before the eighteenth century.

    “Public debt” often uses interchangeably with sovereign debt terms. Public debt usually refers only to National debt. But in some countries, loans outstanding by states, provinces, and municipalities also include.

    In the Middle Ages, borrowing was a rare event. Whenever there is urgency, there is usually a war; the emperor relies on their deposits or borrows on their own debts. However, such lending was not recognized by society. It was considered a “dead-weight” loan.

    This promises to the government with them that the holders of these bonds will be paid interest at regular intervals, at the end of the term, at the lump sum rates at the regular intervals.

    Prof. According to Taylor,

     “Government debt arises out of borrowing by the Treasury, from banks, business organizations, and individuals. The debt is in the form of promises by the treasury to pay to the holders of these promises a principal sum and in most instances interest on that principle.”

    Prof. Adams points out that public debt is the source of advance revenue which is opposite with direct/derived revenue; and, therefore every question of public debt should be judged in the light of this fact.

  • How to Public expenditure is classified in 12 Criteria?

    How to Public expenditure is classified in 12 Criteria?

    What is meant by Public Expenditure? Of the two main branches of public finance, namely, public revenue and public expenditure, we shall first study the public expenditure. How to Public expenditure is classified into 12 Criteria? The classical economists did not analyze in-depth the effects of public expenditure, for public expenditure throughout the nineteenth century was very small owing to the very restricted Government activities.

    The best author gives Public expenditure is classified by the best 12 Criteria.

    The Governments followed laissez-faire, economic policies, and their functions were only confined to defend the country from foreign aggression and to maintain law and order within their territories. But now, the expen­diture of Government all the world over has greatly increased. Therefore, modern econo­mists have started analyzing the effects of public expenditure on production, distribution, and levels of income and employment in the economy.

    The following are the impor­tant classified or classification of public expenditure in the criteria made by different writers:

    Revenue Criteria:

    F.S. Nicholson classified public expenditure according to the amount of revenue the state realizes in return for the services which it per­forms through public expenditure.

    He gives the following four classes of public expenditure:

    • Firstly expenditure without any direct return of revenue, for example, poor relief and also the losses sustained in war.
    • Secondly, expenditure without any direct return of revenue, but indirectly beneficial to revenue. For example free education. Better educated persons are better taxpayers and less expensive citi­zen than paupers and criminals.
    • Thirdly, an expenditure with the partial direct return of revenue, for example, education for which fees are charged.
    • Fourthly expenditure with full return of revenue or even profit. For example investment in public undertakings, railways, posts, and telegraphs, etc.

    This classification is also subject to criticism. This classifica­tion is overlapping. The separation between the items is not clearly marked. This classification failed to bring out the essential differ­ences in kind between the several forms of expenditure.

    For ex­ample, defense and poor relief fall under the first category, however, they also confer an indirect benefit to revenue. By ensuring peace and tranquility defense ensures the smooth growth of productive activity and national income. This, in turn, will benefit public revenue consid­erably.

    Functional Criteria:

    Another classification of public expenditure is proposed by H.C. Adams. Functional classification is based on a classification of the various functions actually performed by public authorities.

    Adams classifies expenditure under three main functions of government:

    • Protective Functions: This includes expenditure on defense, police, judiciary, social disease, prisons, etc.
    • Commercial Functions: In this category include expenditure which helps the development of commerce and trade. Services sold to the citizens for a price (e.g., Post office, Railway, Insur­ance), subsidies and bounties granted, etc., are examples of com­mercial functions
    • Developmental Functions: In this category include expendi­ture that help to develop the resources of the country. Expendi­ture under this category includes expenditure on education, pro­vision of public recreation, public works, public health, etc.

    This division is not free from imperfections. There is no clear cut dividing line between institutions maintaining law and order and those that promote progress. Expenditure incurred for protection is also capable of promoting development Prof. Adams states that with the progress of society, the protective expenditure trend to decline. But this proposition is propositioned by historical facts.

    Benefit Criteria:

    Common classification of public expenditure adopted by the 19th-century writers is based on the principle of Benefits Conferred. Such as the division adopted by Cohn and Plehn.

    They divided public ex­penditure under the following four heads:

    • Firstly, expenditure which confers a common benefit on all citi­zens or taxpayers, for example, defense, universal education is given to the residents free of charge, etc.
    • Secondly, expenditure conferring a special benefit on some per­sons or in certain classes, for example; expenditure on poor relief.
    • Thirdly, that class of public expenditure which confers a special benefit on certain people and at the same time a common ben­efit on all the others, e.g., the administration of justice.
    • Fourthly, those items of expenditure which confer a special ben­efit only on some individuals; e.g., certain industries especially favored by the state (granting subsidy).

    An obvious objection to this classification is that all public ex­penditure is for the common and public interest. It is very difficult to distinguish between special benefits and common benefit con­ferred. The satisfaction of special benefit may lead to the generation of the conm­mon benefit. For example, expenditure on poor relief, which is specifically for the benefit of those immediately concerned, results in a common benefit such as prevention of crime, the satisfaction of the general sense of justice, etc.

    As Nicholson rightly observed “Public expen­diture which does not confer some common benefit or answer some public purpose ought not to exist in a modern state”, Hence Nicholson attempted to give a more scientific classification of expenditure.

    Productive and Unproductive Expenditure Criteria:

    Prof. Robinson classified public expenditure into productive and un­productive. Public expenditure is productive if it directly or indirectly helps to develop natural and human resources and help to increase national income.

    Whereas public expenditure is unproductive if it does not add to enhancing the productive capacity of the nation. Unproductive ex­penditure is one that is consumed in the process of rendering the service.

    Economic Criteria:

    In the social accounting sense, most of the countries have adopted economic classification. In this procedure, the expenditure and in­come of public bodies are classified into two heads.

    They are:

    • Revenue Account, and.
    • Capital Account.

    Revenue account includes an ordinary source of income and expenditure. Whereas capital ac­count includes the extraordinary source of income and expenditure. Revenue expenditure includes all current expenditures on administrators including defense and public commercial undertakings.

    Usually, expenditure does not result in the creation of assets treats as revenue expenditure. Whereas capital expenditure includes all capital transactions. These capital payments consist of capital expenditure on the acquisition of assets like land, buildings, machinery, equipment, etc.

    Investments in shares and loans and advances granted by the central government are part of this. This classification also knows as functional classification. This classi­fication provides a more detailed breakdown of revenue and capital expenditures of the government.

    Plan and Non-Plan Expenditure Criteria:

    Plan expenditure means the current development outlays as well as investment outlays. Whereas non-plan expenditure refers to the expenditure which the government is bound to incur and cannot do without it.

    It includes both development and non-development ex­penditure. A broad-based classification of public expenditure as detailed above. Each classification has its own defects and omissions.

    How­ever, the sphere of state activity is dynamically changing in recent years. The nature and form of activities undertaken by the state are varying in length and attitude. Hence a perfect and systematic clas­sification of public expenditure is very difficult to achieve.

    How to Public expenditure is classified in 12 Criteria
    How to Public expenditure is classified into 12 Criteria? #Pixabay.

    According to J.S. Mills:

    J.S. Mill based his division on the wants of the state, which in turn is determined by the functions of the state. He divides expenditure between obligatory or necessary and optional. This classification takes into account the nature of expenditure.

    Expenditure incurred on defense, justice, and maintenance of economic institutions are obligatory. Owing to past contracts and other legal commitments, coupled with the concept of sovereignty, the state is not free to de­cide whether to incur this type of expenditure or not.

    It is mandatory on the part of the government to incur obligatory expenditure. Whereas expenditure on social security measures is optional. The state can postpone or incur this type of expenditure depending upon the availability of resources. It is not compulsory in nature. It can if time warrants can postpone to a future date.

    According to Shirra’s:

    Prof. Findlay Shirras classified public expenditure into;

    • Primary expenditure, and.
    • Secondary expenditure.

    Primary expenditure includes all those expenditures which governments are obliged to undertake, it is mandatory on the part of the government to incur these expenditures. It includes expenditure on defense, maintenance of law and order, civil administration, payment of the debt, etc.

    These types of expenditures are essential for the existence of the state. All other expenditures, other than those under the category of primary expenditure are grouped into secondary expenditure. It includes ex­penditure on education, public health, poor relief, unemployment re­lief, and other expenses on social security measures.

    According to Roscher’s:

    Prof. Roscher classified public expenditure into three groups namely:

    • Necessary.
    • Useful, and.
    • Superfluous.

    Necessary expendi­ture is that which the state has to incur and which cannot post­pone to a future date. The best example is the expenditure on administra­tion.

    Useful expenditure is that which desires but can post­pone.

    Superfluous expenditure is that which the state may or may not occur. It otherwise calls ornamental expenditure.

    According to Dalton’s:

    Instead of following some strictly logical methods, Prof. Dalton gives a practical or empirical classification. According to Dalton, a broad distinction may draw between public expenditure designed on the one hand to preserve the social life of the community against violent attack whether external or internal and on the other, to im­prove the quality of the social life.

    In other words, the object of public expenditure may be either to keep social life secure and ordered or to make that secure and ordered life better worth living whether from an economic or non-economic point of view.

    Hence Prof. Dalton clas­sifies public expenditure into two categories – grants and purchase price. When the state incurs expenditure and does not get any commodity or service in return, the expenditure classifies as a grant.

    For example, expenditure on poor relief, payments of old-age social insurance, etc. are grants. When the state acquires or gets some commodity or service in return the expenditure is a purchase price.

    Another example:

    The salaries of government employees, the price paid for purchasing a typewriter, etc., are the purchase price.

    To quote Dalton,

    “Payments by a public authority to any of its employees by way of salaries and wages or to contractors whom it employs, are pur­chase prices. On the other hand payments of old age, social insur­ance is granted.”

    Dalton says that some public expenditure may be partly a purchase price and partly a grant. This is so when the state pays a price higher than what a private buyer would pay. The differ­ence between the two is the element of grant at a purchase price.

    Dalton thinks that interest on public debts and pensions grant if looked at from the point of view of the present, as in the present the state secure no commodity or service by incurring this expenditure.

    However, if this expenditure looks at from a longer point of view then the state pays interest in return for the loans that secure in an earlier period. Similarly, pensions are a payment for service ren­dered in the past.

    Dalton also made a distinction between direct and indirect grants. Direct grants are those whose benefits accrue to the persons who secure the grants, for example, poor relief. On the other hand, indirect grants are those where part of the benefit accrues to a person other than the recipient of the grant, for example, subsidies. Part of the sub­sidy may pass on to the purchaser of the commodity in the form of lower prices.

    According to A.C. Pigou’s:

    Pigou has classified public expenditure into the transfer and non-transfer public expenditure. Pigou in the revised edition of his book on public finance emphasizes the distinction between Transfer Expen­diture which merely redistributes the money incomes of the mem­bers of the community and non-transfer expenditure which determines directly the uses to which part of the community’s productive resources shall be put.

    He says that expenditure of money by government authori­ties may conveniently separate under two heads, the expenditure that purchases current service of productive resources for the use of these authorities and expenditure which consist of payments made either gratuitously or in the purchase of existing property rights to pri­vate persons.

    The former group includes expenditure on navy-army, Civil service, educational service, judiciary, etc. The latter includes expenditure on the payment of interests on governmental debt, pen­sion, etc. In the first edition of his book, the former type of expenditure, he called, exhaustive, while in the second edition he called it real expenditure.

    In the third edition of he says,

    “It is perhaps better to call them simply non-transfer expenditures. The latter type must call transfer expenditures.”

    Non-transfer expenditure implies the actual using up of com­modities and services which would otherwise have been available for some other purpose. In the social accounting sense, non-transfer expenditure always gives rise to the creation of output and equivalent money income.

    For instance when the state pays salary to a sol­dier, then the soldier can utilize his service for no alternative pur­pose. In the absence of this expenditure, his service would have been available for some other purpose. Whereas transfer expenditure does not create any income or output.

    According to Pigou,

    “It implies only a transfer from the state to the recipients, of command over commodities and services.”

    For example, social expenditure on the old-age pension, poor relief, etc.

    According to Mehta’s:

    Prof J.K. Mehta made a two-way classification of public expendi­ture. He categorized public expenditure into;

    • Constant expendi­ture, and.
    • Variable expenditure.

    Mehta says,

    “Constant expenditure is that, the amount of which does not depend upon the extent of the use by the people, in whose interest it is incurred and upon the service that is financed by it.”

    The expenditure on defense is a clear example of constant expenditure. Variable expenditure is that which increases with every increase in the uses of public services by the people, whose benefit it incurs. Expenditure on postal service is an example of variable expenditure.

    Variable expenditure varies with the number of people using the service provided by the state. The essential feature of Mehta’s classification is that he uses the element of cost and not benefits as the basis of classification.

    He also recognized the fact that every item of public expenditure cannot place wholly under one or another class and hence a clear-cut distinction cannot draw between them.

  • Public Expenditure: Meaning, Definition, Classification, Types, and Principles

    Public Expenditure: Meaning, Definition, Classification, Types, and Principles

    What does Public Expenditure mean? Expenditure is the action of spending funds. Public expenditure refers to the expenses which the Govern­ment incurs for its maintenance as also for the economy as a whole. The Concept of Public Expenditure: Meaning, Definition, Classification, Types, and Principles.

    Here are explained the Concept of Public Expenditure with their point of Meaning, Definition, Classification, Types, and Principles.

    Public expenditure can define as, “The expenditure incurred by public authorities like central, state and local governments to satisfy the collective social wants of the people is known as public expenditure.” Earlier it was thought that “Every tax is an evil” and public expenditure is “unproductive”.

    Such ideas are no more nowadays. It means that the least amount of tax is to collect to meet “Three duties of the sovereign”. The three duties are the maintenance of internal law and order, defense from foreign attack and issue of currency.

    Nowadays, public authorities have to incur expenditure on the protection of citizens as well as of public welfare and the promotion of socio-economic development. However, after the great depression of 1930 and war and post-war years, increasing attention was paid to the study of public expenditure. So, they refer to the expenses of public authorities like the central, state and local governments.

    Meaning of Public Expenditure:

    To carry on their functions, governments must obtain the services of labor and other factor units and (except in a completely socialist economy) acquire goods produced by private business firms.

    Public expen­diture consists of expenditure by the central government, state governments, and local authorities (such as municipalities and public corporations), with the central government accounting for the major portion of such expenditure.

    Thus, the state is required to maintain good roads, bridges, defense activi­ties, canals, and harbors, to protect trade, to maintain the coinage and to provide social security, education, and religious instruction.

    As well as, Government expenditure:

    They refer to the expenditure incurred by the central government. There are different types of such expenditure. The usual distinction is between consumption expenditure and investment expenditure. Another distinction is between revenue expendi­ture and capital expenditure.

    The main items of government spending are the following:

    Social services such as education, health and welfare and social security; defence, that is the cost of maintaining the armed forces; environmental services, that is, spending on roads, transport services, law and order, housing and the art; national debt interest, that is, interest payments on money borrowed by the government. At present, this is about one-third of India’s national income.

    Since national income is a fixed number, spending in one direction can achieve only at the expense of spending elsewhere. Thus, if the govern­ment spends a larger part of the national income on defense, less will remain with the people for their consumption, thereby leading to a reduction in their standard of living.

    Similarly, too large an expenditure on the social services at the expense of defense expenditure may put a threat to national security – and social security is meaningless if it is at the expenses of national security. As a result, the actual amount spent in each direction represents a compromise between competing desires. So, there is always a need for careful planning of public expenditure.

    Definition of Public Expenditure:

    The theory of public expenditure has been more or less confining to that of generalities in terms of the effects of public expenditure on employment and price level. Even though public expenditure has increased rapidly during the last two centuries, in almost every state the area of them re­mains relatively unexplored.

    Further, the level of public expenditure depends on government programs, which are the outcome of po­litical decisions.

    Gerhard Colm points out,

    “The determination of gov­ernment programmes is a political procedure and as such is carried on in a milieu, usually called ‘Politics’ which includes vote gathering, pressure by lobbies, log rolling and competition among political ri­vals.”

    Classification of Public Expenditure:

    It is conventional in every textbook of public finance to classify public expenditures into various economic categories. Also, The classification of public expenditure refers to the systematic arrangement of differ­ent items of state expenditure, on some specified economic basis.

    Classification is always done on some logical and rational economic basis. Classification of public expenditure is important to understand the nature and effect of public expenditure. Through this classifica­tion, the state executive maintains effective control over them and prevented public funds leakages and wastages, di­versions and misappropriations.

    Classification of public expenditure is good for auditing and public funds can better safeguard against misappropriation. Classification of expenditure helps us to understand the relative importance of each head of expenditure at different times.

    According to Prof. Shirras, the test of public expenditures not the aggregate expenditure but it is the relative amounts which are as­signed to different heads from time to time. Hence classification of expenditure is important for a clear understanding of the nature and effects of them.

    Economists have proposed various methods of classifying pub­lic expenditures. However, the methods differ widely from one an­other. This is because; there is little agreement between authorities of public finance regarding the best way of arranging the various kinds of state outlays.

    Hence a completely satisfactory method is yet to emerge. Hence Mill, Roscher, Plehn, Nicholson, and Bastable have their methods. In this context, Shulz observes “Nineteenth-century fiscal writers devoted considerable space to the subject of the proper classification of government expenditure, but no two even agreed upon the same classification”.

    Extra Classifications:

    There are a variety of ways in which they can classify but broadly it is classifying under the following heads:

    According to the authority which spends the money viz;

    • Federal or Union or Central expenditure.
    • State or Provincial expenditure, and.
    • Local expenditure or expenditure of municipalities and other local bodies.

    According to the object of expenditure viz;

    • Development activities like providing subsidies, electric power, transport service, welfare activities, employment opportunities, and price stability, etc.
    • Non-developmental activities like money spent on administrative machinery, law and order, interest payment on public debt and defense, etc.

    According to the nature of expenditure via;

    • Revenue Expenditure, and.
    • Capital Expenditure.

    Revenue Expenditure is current expenditure e.g. administrative and maintenance expenditure. This expenditure is of a recurring type which Capital Expenditure is of capital nature and is incurred once for all. It is non-recurring expenditure e.g. expenditure for building multipurpose projects or a setting up big factories like steel plants, money spent on land, machinery, and equipment.

    Types of Public Expenditure:

    The main bases of Types of public expenditure are as follows:

    Capital And Revenue Expenditure:

    Capital Expenditure of the government refers to that expenditure that results in the creation of fixed assets. Also, They are in the form of investment. They add to the net productive assets of the economy. Capital Expenditure is also known as development expenditure as it increases the productive capacity of the economy. It is an investment expenditure and a non-recurring type of expenditure.

    For example; Expenditure, on agricultural and industrial development, irrigation dams, public -enterprises, etc, are all capital expenditures. Revenue expenditures are current or consumption expenditures incurred on civil administration, defense forces, public health and, education, maintenance of government machinery, etc.

    Development And Non–Developmental Expenditure/Productive And Non–Productive Expenditure:

    Expenditure on infrastructure development, public enterprises or development of agriculture increase productive capacity in the economy and bring income to the government. Thus they are classified as a productive expenditure. All expenditures that promote economic growth development are termed as development expenditure.

    Unproductive (known–development) expenditure refers to those expenditures which do not yield any income. Expenditure such as interest payments, expenditure on law and order, public administration, do not create any productive asset which brings income to the government such expenses are classified as unproductive expenditures.

    Transfer And Non-Transfer Expenditure:

    Transfer expenditure refers to those kinds of expenditures against there is no corresponding transfer of real resources i.e., goods or services. Such expenditure includes public expenditure on; National Old pension Scheme, Interest payments, subsidies, unemployment allowances, welfare benefits to weaker sections, etc. By incurring such expenditure, the government does not get anything in return, but it adds to the welfare of the people, especially to weaker sections of society. Such expenditure results in redistribution of money incomes within the society.

    The Non-transfer expenditure relates to that expenditure which results in the creation of income or output The Non-transfer expenditure includes development as well as Non-development expenditure that results in the creation of output directly or indirectly. Economic infrastructure (Power, Transport, Irrigation, etc.), Social infrastructure (Education, Health and Family Welfare), Internal law and order and defense, public administration, etc. By incurring such expenditure, the government creates a healthy environment for economic activities.

    Plan And Non-Plan Expenditure:

    The plan expenditure incurs on development activities outlined in the ongoing five-year plan. In 2009-10, the plan expenditure of the Central Government was 5.3% of GDP. Plan expenditure incurs on Transport, rural development, communication, agriculture, energy, social services, etc.

    The non-plan expenditure incurs on those activities, which are not included in the five-year plan. It includes development and Non-development expenditure. It includes; Defence, subsidies, interest payments, maintenance, etc.

    Other types of Public Expenditure:

    Mrs. Hicks classified the types of Public Expenditure based on duties of government. It is as follows:

    Defense Expenditure: It is expenditure on defense types of equipment, wages, and salaries of armed forces, navy, and air-force, etc. It incurs by the government to provide security to citizens of the country from external aggression.

    Civil Expenditure: Government/incurs this expenditure to maintain law and order and administration of justice.

    Development Expenditure: It is expenditure on the development of agriculture, industry, trade and commerce, transport and communication, etc.

    Public Expenditure Meaning Definition Classification Types and Principles
    Public Expenditure: Meaning, Definition, Classification, Types, and Principles, #Pixabay.

    Principles of Public Expenditure:

    As the public is an important part of fiscal policy, certain principles or canons are laid down to which public expenditure should conform.

    These principles of public expenditure or canons are as follows:

    The principle of Maximum Social Advantage:

    The government’s expenditure should so arrange as to secure the greatest possible net advantage, i.e., it should maximize the difference between the addition to welfare obtained by its expenditure and the social cost involved in obtaining the money. This principle has been calling by Dalton the Principle of Maximum Social Advantage.

    The principle of Economy:

    This principle says that the government should economies its expenditure and avoid wasteful and extravagant expenditure. The principle requires that the revenue collecting from the tax-payer should be judiciously spent. As too much they lead to inflation and adversely affects savings, the economy in government expenditure is cardinal.

    The principle of Sanction:

    According to this principle, expenditure should incur only if it has been sanction by a competent authority. It usually sees that unauthorizing spending leads to extravagance and overspending. But when a competent authority looks into the pros and cons and then gives its verdict to incur the expenditure it means that the expenditure incurred will provide genuine utility and serve its definite purpose.

    The principle of Elasticity:

    This principle states that it should be possible for public authorities to vary the expenditure according to need or circumstances. It means that they should be fairly elastic and flexible but not rigid. Rigidity proves to be a handicap in times of trouble alternation in the upward direction is not difficult but elasticity also needs in the downward direction.

  • What type of Deferred Revenue Expenditure is added to Accounting?

    What type of Deferred Revenue Expenditure is added to Accounting?

    What is Deferred Revenue Expenditure? Deferred Revenue Expenditure is an expenditure which is revenue in nature and incurred during an accounting period, but its benefits are to be derived in multiple future accounting periods. Such expenditure is then known as “Deferred Revenue Expenditure” and is Written off over a period of a few years and not wholly in the year in which it is incurred. So, the question is: What type of Deferred Revenue Expenditure is added to Accounting?

    The Concept of Accounting explains the type of Deferred Revenue Expenditure is added.

    It will be easier to understand the meaning of deferred revenue expenditure if you know the word deferred. Which means “Holding something back for a later time”. In some cases, the benefit of revenue expenditure may be available for a period of two or three or even more years. These expenses are unusually large in amount and, essentially, the benefits are not consumed within the same accounting period. Part of the amount which is charged to profit and loss account in the current accounting period is reduced from total expenditure and rest is shown in the balance sheet as an asset.

    For example,

    A new firm may advertise very heavily in the beginning to capture a position in the market. The benefit of this advertising campaign will last quite a few years. It will be better to write off the expenditure in three or four years and not only in the first year. When loss of a specially heavy and exceptional nature is sustained, it can also be treated as deferred revenue expenditure. If a building is destroyed by fire or earthquake, the loss may be written off in three or four years.

    The amount not yet written off appears in the balance sheet. But, it should be noted, loss resulting from transactions entered into. Such as a speculative purchase or sale of a large number of commodities. Cannot be treated as deferred revenue expenditure. Only loss arising from circumstances beyond one’s control can be so treated. Suppose, at the end of 2010-2011, a company owed $ 1, 00,000, expressed in rupees at Rs 48, 00,000. Suppose in 2011-2012 the rupee was devalued to Rs 49.50 per dollar raising the liability in terms of rupees to Rs 49, 50,000. This increase is a loss unless it relates to a specific asset; it can be treated as deferred revenue expenditure and spread over a few years.

    Then it is called deferred revenue expenditure. For example:

    • Preliminary expenses at the time of formation of new limited companies.
    • Heavy advertisement expenses.
    • Heavy Research and development expenses.
    • Commission on the issue of shares and debentures.
    • Major repair expenses.
    • Discount on issue of shares or debentures, and.
    • Expenses relating to shifting the business premises from one place to another place.

    Understand Another Example,

    Let’s suppose that a company is introducing a new product to the market and decides to spend a large amount on its advertising in the current accounting period. This marketing spend is supposed to draw benefits beyond the current accounting period. It is a better idea not to charge the entire amount in the current year’s P&L Account and amortize it over multiple periods.

    The image shows a company spending 150K on advertising. Which is unusually large as compared to the size of their business. The company decides to divide the expense over 3 yearly payments of 50K. Each as the benefits from the spend is expected to be derived for 3 years.

    What type of Deferred Revenue Expenditure is added to Accounting
    What type of Deferred Revenue Expenditure is added to Accounting? Image credit from #Pixabay.

  • Understand Capital and Revenue Expenditure in Accounting

    Understand Capital and Revenue Expenditure in Accounting

    What leads to an increase in capital in the course of business operations is income; what leads to a reduction in capital is expense or loss. But transactions also cover the acquisition of assets, like the purchase of an office building, raising a loan, payment of liabilities, etc.; all transactions are not expenses or incomes. To know the net profit earned or loss suffered, the expenses, losses, and incomes must be assembled in the Profit and Loss Account; the transactions concerning assets and liabilities will affect items in the Balance Sheet which portrays the financial position. So, what has discussed this article: Understand Capital and Revenue Expenditure in Accounting.

    The Concept of Capital and Revenue Expenditure, in the Accounting, explains why they exist in Financial Management.

    The following expenditures below are;

    Capital Expenditure:

    What is Capital Expenditure? Capital expenditures (CAPEX) refer to funds that are used by a company for the purchase, improvement, or maintenance of long-term assets to improve the efficiency or capacity of the company. Capital expenditure can be tangible, such as a copy machine, or it can be intangible, such as a patent. In many tax codes, both tangible and intangible capital expenditures are counted as assets because they have the potential to be sold if necessary.

    Revenue Expenditure:

    What is Revenue Expenditure? A revenue expenditure (REVEX) is a cost that is charged to expense as soon as the cost is incurred. By doing so, business is using the matching principle to link the expense incurred to revenues generated in the same reporting period. The amount incurred on maintaining the earning capacity of the business, The benefit of which is direct and would be in the same accounting year itself in which such expenditure has been incurred is termed as revenue expenditure.

    The Concept of Capital and Revenue Expenditure:

    Expenses, losses, and incomes are also known as revenue items since they together will show up the net profit or revenue earned. Other transactions are of capital nature. One must be clear in one’s mind regarding the nature of an item of expenditure. This is an important aspect of the matching principle and without it; financial statements cannot be properly prepared.

    Capital expenditure is that expenditure which results in the acquisition of an asset, tangible or intangible, which can be later sold and converted into cash or which results in an increase in the earning capacity of a business or which affords some other advantage to the firm.

    In a nutshell, if the benefits of expenditure are expected to accrue for a long time, the expenditure is capital expenditure. Obvious examples of capital expenditure are land, building, machinery, patents, etc. All these things stay with the business and can be used over and over again.

    Other examples are money paid for goodwill (the right to use the established name of an outgoing firm) since it will attract the old firm’s customers and, thus, result in higher sales and profits; money spent to reduce working expenses.

    For example, conve$ion of hand-driven machinery to power-driven machinery and expenditure enabling a firm to produce a large quantity of goods. Expenditure which does not result in an increase in capacity or in the reduction of day-to-day expenses is not the capital expenditure unless there is a tangible asset to show for it.

    It should be noted that all amounts spent up to the point an asset is ready for use should be treated as capital expenditure. Examples are fees paid to a lawyer for drawing up the purchase deed of land, overhaul expenses of second-hand machinery, etc. Interest on loans raised to acquire a fixed asset is particularly noteworthy.

    Such interest can be capitalized, i.e., added to the cost of the asset but only for the period before the asset is ready for use interest paid for the subsequent period cannot be capitalized. An item of expenditure whose benefit expires within the year or expenditure which merely seeks to maintain the business or keep assets in good working condition is revenue expenditure

    Examples are salaries and wages, fuel used to drive machinery, electricity used to light the factory or offices, etc. Such expenditure does not increase the efficiency of the firm, nor does it result in the acquisition of something permanent.

    The following items of expenditure seem to be revenue expenditure, but in actual practice, these are treated as capital expenditure since they lead to the business being established and run efficiently:

    • Expenses for the formation of a company—preliminary expenses.
    • Cost of issuing shares and debentures and raising loans, such as legal expenses underwriting commission, etc.
    • Interest on capital up to the point production is ready to commence, where the nature of the business is such that construction work must go on for a long period before production can start.
    • Expenses on acquisition and installation of assets, for example, legal fees to acquire property, or expenses incurred to renovate machinery bought secondhand or wages of workmen who install the machinery.

    Diminution in the value of assets due to wear and tear or passage of time is the revenue loss. For instance, a piece of machinery is bought at the beginning of the year for $ 1, 00,000; at the end of the year, its value to the business may only be $ 90,000. The diminution—known as depreciation—is a revenue loss. Stocks of materials bought will be an asset unless consumed—to the extent, the materials are used up, they will be revenue expenditure, so also the cost of goods sold.

    However, the distinction is not always easy. In actual practice, there is a good deal of difference of opinion as to whether a particular item is capital or revenue expenditure. A cinema converts its ordinary screen into one for cinemascope. Is the expenditure-revenue or capital?

    One may say that since the eating capacity of the hall does not change, the expenditure is revenue expenditure. On the other hand, it may be argued that since cinemascope pictures attract large audiences, the hall will be full oftener. Therefore, the expenditure will result in higher earnings and should be classified as capital expenditure. There is truth on both sides.

    Understand Capital and Revenue Expenditure in Accounting
    Unde$tand Capital and Revenue Expenditure in Accounting, Image credit from #Pixabay.

  • Meaning, Definition, and Types of Revenue Expenditure

    Meaning, Definition, and Types of Revenue Expenditure

    What is Revenue Expenditure? A revenue expenditure (REVEX) is a cost that is charged to expense as soon as the cost is incurred. By doing so, business is using the matching principle to link the expense incurred to revenues generated in the same reporting period. The amount incurred on maintaining the earning capacity of the business, The benefit of which is direct and would be in the same accounting year itself in which such expenditure has been incurred is termed as revenue expenditure. So, what is the discussion? Meaning, Definition, and Types of Revenue Expenditure.

    The Concept of Revenue Expenditure of explanation in Meaning, Definition, and Types.

    Any expenditure incurred in connection with the operation and administration of daily activities of the business is called revenue expenditure. REVEX is incurred for maintaining earning capacity and working efficiency of the fixed assets. Revenue expenditure is incurred for acquiring merchandise for resale either in its original or improved form. Its benefit expires within a year. The most important point to remember here is that the benefit of revenue expenditure would exhaust in one year.

    Revenue expenditures are recurring in nature. REVEX should be matched with the revenue receipts of the business enterprise. The basic aim and object of incurring revenue expenditure are to run and maintain the earning capacity of the business enterprise. Note: REVEX is shown on the debit side of the trading and profit and loss accounts.

    Meaning and Definition of Revenue Expenditure:

    Revenue Expenditure is that expenditure which is not a capital expenditure.

    According to Kohler,

    “It is an expenditure charged against operation; a term used to contrast with capital expenditure”.

    Revenue expenditure is incurred in the current period or in one period of account. The benefit of the revenue expenditure is utilized in that period itself.

    All the expenditures which are incurred in the day to day conduct and administration of a business and the effect of which is completely exhausted within the current accounting year are known as “revenue expenditures”.

    These expenditures are recurring by nature i.e. which are incurred for meeting day to day requirements of a business and the effect of these expenditures is always short-lived i.e. the benefit thereof is enjoyed by the business within the current accounting year. These expenditures are also known as “expenses or expired costs.” e.g.

    Purchase of goods, salaries paid, postages, rent, travel expenses, stationery purchased, wages paid on goods purchased etc. This expenditure is incurred on items or services which are useful to the business but are used up in less than one year and, therefore, only temporarily increase the profit-making capacity of the business.

    Revenue expenditure also includes the expenditure incurred for the purchase of raw material and stores required for manufacturing saleable goods and the expenditure incurred to maintain the- fixed assets in proper working conditions i.e. repair of machinery, building, furniture etc.

    The Purpose of Revenue expenditure:

    Revenue expenditure is incurred for the following Purposes:

    • All establishment and other expenses incurred in the normal course of business. For instance, Administrative expenses of the business, expenses incurred in manufacturing and selling products.
    • Expenses incidental to the carrying of a business, the benefit of which is consumed within the accounting period. For instance, Rent, Wages, Salaries, Advertising, Taxes, Insurance etc.
    • Expenditure on goods purchased for resale. Example, the cost of goods purchased or the cost of raw materials etc.
    • For maintaining fixed assets in working order. For instance, repairs, renewals, and replace­ment of existing assets, depreciation etc.

    These revenue expenditure items appear in Trading and Profit and Loss Account.

    Items of Revenue Expenditure:

    • Expenditure on Rent, Wages, Carriage, Salaries, Postage, Insurance, Advertising etc.
    • Interest on loan borrowed for running the business.
    • Cost of goods bought for resale.
    • Cost of raw materials consumed in the course of manufacturing.
    • Expenses incurred for maintenance of various assets by way of repairs, renewals and re­placement on building, plant, machinery, tools, fixtures, van, car etc. to keep them in good condition.
    • Depreciation of fixed assets.
    • Taxes and legal expenses.
    • Loss arising from the sale of fixed assets.
    • Maintenance of lights and fans.
    • All expenses incurred in the manufacturing and distribution of the products handled.
    • Wages paid for the sale of goods.
    • Loss of goods by fire or other reasons.
    • Discounts and allowances.

    The Types of Revenue expenditure:

    There are two types of revenue expenditure:

    • Maintaining a revenue-generating asset: This includes repair and maintenance expenses, because they are incurred to support current operations, and do not extend the life of an asset or improve it.
    • Generating revenue: This is all day-to-day expenses needed to operate a business, such as sales salaries, rent, office supplies, and utilities.

    Other types of costs are not considered to be revenue expenditures, because they relate to the generation of future revenues. For example, the purchase of a fixed asset is categorized as an asset and charged to expense over multiple periods, to match the cost of the asset against multiple future periods of revenue generation.

    Revenue expenditure includes the following types of expenditures:
    • Items of expense incurred for producing finished goods such as the purchase of raw material and other direct expenses etc.
    • Establishment cost such as rent, light, repairs etc.
    • Administrative costs such as salaries of the staff, telephone expenses etc.
    • Selling and distribution expenses such as advertisement expenses, commission etc.
    • Financial expenses such as discount allowed, interest on loans etc.
    • Other miscellaneous expenses for maintaining the business enterprise such as repairs and renewals, insurance etc.

    Meaning Definition and Types of Revenue Expenditure
    Meaning, Definition, and Types of Revenue Expenditure. Image credit from #Pixabay.

  • Meaning, Definition, and Importance of Capital Expenditure

    Meaning, Definition, and Importance of Capital Expenditure

    What is Capital Expenditure? Capital expenditures (CAPEX) refer to funds that are used by a company for the purchase, improvement, or maintenance of long-term assets to improve the efficiency or capacity of the company. Capital expenditure can be tangible, such as a copy machine, or it can be intangible, such as a patent. In many tax codes, both tangible and intangible capital expenditures are counted as assets because they have the potential to be sold if necessary. So, what is the discussion? Meaning, Definition, and Importance of Capital Expenditure.

    The Concept of Capital Expenditure explanation of Meaning, Definition, and Importance of Capital Expenditure.

    Also known as CAPEX or capital expenses, capital expenditures include the purchase of items such as new equipment, machinery, land, plant, buildings or warehouses, furniture and fixtures, business vehicles, software and intangible assets such as a patent or license. Long-term assets are a company’s land, buildings, machinery, vehicles, furniture, computers, office equipment, software as well as patents, trademarks, and licenses. Companies report CAPEX on the cash flow statement and are amortized over the life of the related asset because, usually, the asset’s useful life is longer than the taxable year and, therefore, CAPEX cannot be reported as an expense.

    Meaning and Definition of Capital Expenditure:

    An expenditure which results in the acquisition of the permanent asset which is intended to be permanently used in the business for the purpose of earning revenue is known as capital expenditure. These expenditures are ‘non-recurring’ by nature. Assets acquired by incurring these expenditures are utilized by the business for a long time and thereby they earn revenue.

    For example, money spent on the purchase of building, machinery, furniture etc. Take the case of machinery-machinery is permanently used for, producing goods and profit is earned by selling those goods. This is not an expenditure for one accounting period, machinery has a long life and its benefit will be enjoyed over a long period of time. By a long period of time, we mean a period exceeding one accounting period. Moreover, any expenditure which is incurred for the purpose of increasing profit earning capacity or reducing the cost of production is a capital expenditure.

    Sometimes the expenditure even not resulting in an increase of profit earning capacity but acquires an asset comparatively permanent in nature will also be a capital expenditure. It should be remembered that when an asset is purchased, all amounts spent up to the point until the asset is ready for use should be treated as capital expenditure.

    Examples are, A) A machinery was purchased for $50,000 from Karachi. We paid carriage $1,000, octroi duty $500 to bring the machinery from Karachi to Lahore. Then we paid wages $1,000 for its installation in the factory. For all these expenditures, we should debit machinery account instead of debiting carriage A/c, octroi A/c and wages A/c. B) Fees paid to a lawyer for drawing up the purchase deed of land, C) Overhaul expenses of second-hand machinery etc. D) Interest paid on loans raised to acquire a fixed asset etc.

    Rules and Items for Determining Capital Expenditure.

    Capital Expenditure is that expenditure which results in the acquisition of the permanent asset or fixed asset which is used continuously in the business for the purpose of earning revenue any amount spent on the asset which will result in increasing the production or reducing the cost of production may also be treated as Capital Expenditure.

    The following Rules for Determining Capital Expenditure are:
    • Expenditure incurred for acquiring Land, Building, Machinery, Investments, Patents or Furniture etc. are permanent or fixed assets. The fixed asset is used in the business for earning the profit and not for resale, is called a Capital Expenditure. For instance, when we purchase furniture it is a capital expenditure and at the same time to the Furniture Shop, who is engaged in buying and selling of furniture, it is not capital expenditure.
    • Expenditure incurred for putting an old asset in working condition or for putting a new asset to use is capital expenditure. For instance, an old machine is purchased for Rs. 10,000 and Rs 2,000 is spent for its repairs and installation and the total expenditures are capital expenditure.
    • Which increases the earning capacity in any way of a fixed asset can be called capital expenditure. For instance, the amount spent on cinema theatre for air conditioning.
    • Spent on raising the capital required for earning the profit is called capital expenditure. For instance, underwriting commission, brokerage etc.
    • On an existing asset which results in the improvement or extension of the business by increasing the earning capacity of the asset or by reducing the cost of production is also called capital expenditure. For instance, installations of machine or additions to buildings or plant etc. are capital expenditure.
    • When the benefit of expenditure is not fully consumed in one period but spread over several periods, is called capita, expenditure. For instance, expenditure met for massive advertisements.
    The following Items of Capital Expenditure are:
    • Land, Building, Plant, and Machinery.
    • Leasehold Land and Building.
    • Manufacture or purchase of furniture and fixtures.
    • Office Cars, Vans, Lorries or Vehicles.
    • Installation of lights, fans etc.
    • The erection of Plant and Machinery.
    • Trade Mark, Patents, Copyrights, Patterns, and Designs.
    • Preliminary Expenses.
    • Goodwill.
    • Addition to an extension of existing fixed assets.
    • Development in case of Mines and Plantations.
    • The invention.
    • Increasing capacity of the fixed asset, and.
    • Administration in industrial enterprises incurred during the period of construction.

    Importance of Capital Expenditure:

    Decisions how much to invest in capital expenditures can often be extremely vital decisions made by an organization.

    They are important because of the following reasons:

    Long-term Effects: 

    The effect of capital expenditure decisions usually extends into the future. The range of current production or manufacturing activities is mainly as a result of past capital expenditures. 

    Similarly, the current decisions on capital expenditure will have a major influence on the future activities of the company. Capital investment decisions usually have a huge impact on the basic character of the organization. 

    The long-term strategic goals, as well as the budgeting process of a company, need to be in place before authorization of capital expenditures.

    Irreversibility: 

    Capital expenditures can hardly be undone without the company incurring losses. Since most forms of capital equipment are customized to meet specific company requirements and needs, the market for capital equipment that has been used is generally very poor.

    Once the capital equipment is purchased, there is little room to reverse the decision since the cost can often not be recouped. For this reason, wrong capital investment decisions are often irreversible, and poor ones lead to substantial losses being incurred. Once acquired, they need to be employed for use.

    High Initial Costs: 

    Capital expenditures are characteristically very expensive, especially for companies in industries such as production, manufacturing, telecom, utilities, and oil exploration.

    The Capital investments in physical assets like buildings, equipment, or property offer the potential of providing benefits in the long run but will need a huge monetary outlay initially, much greater than even operating outlays. Capital costs often tend to rise with advanced technology.

    Depreciation: 

    Capital expenditures lead to an increase in the asset accounts of an organization. However, once capital assets start being put in service, their depreciation begins, and they continue to decrease in value throughout their useful lives.

    “A capital expenditure (CAPEX) is an expense that a company makes towards. The purchase of new equipment or the improvement of its long-term assets, namely property, plant, and equipment”. Capital expenditures normally have a substantial effect on the short-term and long-term financial standing of an organization.

    Therefore, making wise capital expenditure decisions is of critical importance to the financial health of a company. Many companies usually try to maintain the levels of their historical capital expenditure to show investors. That the managers of the company are investing effectively in the business. The expenditure amounts for an accounting period are usually stated in the cash flow statement.

    Meaning Definition and Importance of Capital Expenditure
    Meaning, Definition, and Importance of Capital Expenditure. Image credit from #Pixabay.

  • Meaning, Nature, and Importance of Capital Expenditure Decisions

    Meaning, Nature, and Importance of Capital Expenditure Decisions

    It is the planning, evaluation, and selection of capital expenditure proposals, the benefits of which are expected to accrue over more than one accounting year. Capital expenditure decisions are just the opposite of operating expenditure decisions. Decisions involving the acquisition of machinery, vehicles, buildings, or land are examples of such decisions. So, what is discusses are: Meaning, Nature, and Importance of Capital Expenditure Decisions.

    The Concept of Capital Expenditure Decisions is explaining in Meaning, Definition, Nature, Objectives, Difficulty, and Importance.

    What is Capital Expenditure? A capital expenditure is the use of funds by a company to acquire physical assets to improve its value or increase its long-term productivity. Also known as capital expenses, capital expenditures include purchases such as buildings or warehouses, new equipment such as machinery or computers, and business vehicles. Many companies strive to maintain their historical capital expenditure levels in order to show investors that managers are investing adequately in the business.

    Much of the discussion has focused on decisions relating to near-term operations and activities. But, managers must also ponder occasional big-ticket expenditures that will impact many years to come. The decision on long-term investments is quite pivotal due to many reasons. It is a part of the duties of an entity’s key management to affect most accurate the decision with respect to the long-term investments. The question of decisions is: What is the concept of financial decisions?

    Such capital expenditure decisions relate to the construction of new facilities, large outlays for vehicles and machinery, embarking upon new product research and development, and similar items where the upfront cost is huge and the payback period will span years to come. A number of business factors combine to make business investment perhaps the most important financial management decision.

    Meaning of Capital Expenditure Decisions:

    The capital expenditure decision is the process of making decisions regarding investments in fixed assets which are not meant for sale such as land, building, plant & machinery, etc. Thus it refers to long-term planning for proposed capital expenditures and includes raising of long-term funds and their utilization. The key function of the finance manager is the selection of the most profitable project for invest­ment. This task is very crucial because any action taken by the manager in this area affects the working and profitability of the firm for many years to come.

    Definition of Capital Expenditure Decisions:

    Former is generally termed as ‘current’ expenditure and is ex­pected to result in benefits in a short period of less than a year. The latter is termed as ‘capital’ expenditure, and is expected to result in benefits in the future period of one or more years and is also known as capital budgeting decisions. Capital Expenditure Decisions Managers in all organizations periodically face major decisions that involve cash flows over several years. Decisions involving the acquisition of machinery, vehicles, buildings, or land are examples of such decisions.

    Although the tendency is to focus on the financial dimensions, such decisions are made even more complex because they usually involve a number of nonfinancial components as well. Thus, the final decision may involve consideration of architectural, engineering, marketing, regulatory, and numerous other variables.

    These types of decisions involve considerable risk because they usually involve large amounts of money and extended durations of time. In addition, capital expenditure decisions (also called capital budgeting) are usually accompanied by a number of alternatives from which to choose. Sometimes, an option that is best in the long term may be the least desirable in the near term and vice versa.

    Nature of Capital Expenditure Decisions:

    Capital expenditure decisions involve the acquisition of assets that have a long life span and which provide benefits spread over a long period of time.

    The nature of capital expenditure decisions can be explained in brief as under:

    • Irreversible Decision: Capital expenditure decisions once approved represent long-term invest­ments that cannot be reversed or withdrawn at any time. Withdrawal or reversal of such decisions may lead to considerable financial losses to the firm.
    • Maximization of Shareholder’s Wealth: It helps protect the interest of the shareholders as well as of the firm because it avoids over-investment and under-investment in fixed assets.
    • Substantial Investments: Capital expenditure decisions involve large amounts of funds. Such decisions have its effect over a long span of time.
    • Estimation of Future Cash Inflows: Preparation of capital expenditure budget involves forecast­ing of cash inflows over several years for evaluating the profitability of projects.

    Objectives of Capital Expenditure Decisions:

    Financing decisions are one of the most crucial and critical decisions of a firm as they have a significant impact on the profitability of the firm.

    There is the number of objectives of capital expenditure decisions, some of which are:

    • Cost Reduction: The existence of a firm depends on profitability, which in turn depends on the production of goods or services at a reasonable price. This is possible if over/under-investment in fixed assets is avoided.
    • Providing Contemporary Goods: Consumer tastes change every day. To satisfy the new demands from customers, either proper utilization of existing facility or installation of the latest machinery is necessary—which is not possible without proper capital expenditure decision.
    • Increasing Output: An output may be increased by utilizing the existing facility or through expansion by installing new plant and machinery.

    The Importance of Capital Expenditure Decisions:

    Here are understand about the importance of Capital expenditure and also know their Difficulty.

    The following importance is:
    • Effects in the Long Run: the consequences of capital expenditure decisions extend into the feature. The scope of current manufacture activities of a company governed largely by capital expenditures in the past. Likewise, current capital expenditure decisions provide the framework for future activities. Capital investment decisions have an enormous bearing on the basic character of a company.
    • Irreversibility: The market for used capital equipment, in general, is ill-organized. Further, for some types of capital equipment, custom-made to meet the specific requirement, the market virtually be non-existent. Once such equipment is acquired, reversal of decision may mean scrapping the capital equipment. Thus, a wrong capital investment decision cannot be reversed without incurring a substantial loss.
    • Substantial outlays: Capital expenditures usually involve substantial outlays. An integrated steel plant, for example, involves an outlay of several thousand million. Capital costs tend to increase with advanced technology.
    The following difficulty is:
    • Measurement problems: Identifying and measuring the costs and benefits of a capital expenditure proposal tends to be difficult. This is more so when a capital expenditure has a bearing o some other activities of the company like cutting into sales of some existing product or has some intangible consequences like improving the morale of workers.
    • Uncertainty: A capital expenditure decision involves costs and benefits that extend far into the future. It is impossible to predict exactly what will happen in the future. Hence, there is usually a great deal of uncertainty characterizing the costs and benefits of a capital expenditure decision.
    • Temporal Spread: The costs and benefits associated with a capital expenditure decision are spread out over a long period of time, usually 10-20 years for industrial projects and 20-50 years for infrastructural projects. Such a temporal spread creates some problems in estimating discount rates and establishing equivalence.

    Capital Expenditure Decisions Managers in all organizations periodically face major decisions that involve cash flows over several years. Decisions involving the acquisition of machinery, vehicles, buildings, or land are examples of such decisions. Other examples include decisions involving significant changes in a production process or adding a major new line of products or services to the organization’s activities.

    Decisions involving cash inflows and outflows beyond the current year are called capital-budgeting decisions. Managers encounter two types of capital-budgeting decisions. Acceptance-or-Rejection Decisions In acceptance-or-rejection decisions, managers must decide whether they should undertake a particular capital investment project. In such a decision, the required funds are available or readily obtainable, and management must decide whether the project is worthwhile.

    Meaning Nature and Importance of Capital Expenditure Decisions
    Meaning, Nature, and Importance of Capital Expenditure Decisions. Image credit from #Pixabay.