EPFO EO/AO 2023 General Ability Test · Question 41 of 120

Correct — C, (c) Capital expenditure. The classification does not turn on the amount spent or on the word 'expenses' in the stem. It turns on the purpose clause the Commission wrote in: the engine was overhauled 'to get better fuel efficiency'. An expenditure is capital in nature when it does one of three things — acquires a fixed asset, adds to the earning capacity or working life of a fixed asset already owned, or permanently reduces the cost of running one. An overhaul undertaken so that the same motor car will thereafter burn less fuel is the third of these, and arguably the second as well: every kilometre driven after the overhaul costs the business less than it did before. The benefit is not consumed within the accounting year in which the money was paid, so charging the whole Rs. 25,000 against this year's profit would understate this year's profit and overstate the profits of every year that enjoys the cheaper running. The correct treatment follows from that. The Rs. 25,000 is debited to the Motor Car account rather than to a repairs account, becomes part of the asset's carrying amount in the Balance Sheet, and is written off through depreciation over the remaining useful life of the car. The accounting standards on fixed assets state the same test in their own words — a cost incurred after an asset is in use is added to its carrying amount only where it will yield benefits beyond the asset's originally assessed standard of performance, and 'better fuel efficiency' is precisely a performance beyond the original standard. The contrast the examiner is testing sits one line away. Had the stem read 'overhauling expenses of Rs. 25,000 to keep the engine in running order', nothing would have been added to the asset and the whole sum would have been revenue expenditure. Same car, same engine, same amount of money — different answer, because the purpose is different.

• (a)Deferred revenue expenditure — Deferred revenue expenditure is revenue in nature — it creates no asset at all — but its benefit spills over a few years, so it is written off in instalments instead of at once. The stock example is a heavy one-off advertising campaign launched for a new product. This spend is not of that kind: there is a tangible fixed asset in the books, the motor car, and the money has gone into improving it, so the debit has a real asset to attach itself to and there is nothing to defer. Note also that this category has narrowed sharply in modern practice, since the standards on intangible assets require most such costs to be written off as they are incurred.
• (b)Revenue receipt — A category error rather than a wrong judgement, and it is worth naming as such. A receipt is money coming INTO the business; this is money going OUT of it. Nothing in the stem describes an inflow. Accountancy runs a two-by-two grid — capital receipt, revenue receipt, capital expenditure, revenue expenditure — and a candidate who reads only the second word of each option can land in the receipts row by accident. Read the whole option before eliminating it.
• (d)Revenue expenditure — This is the trap, and it is a good one, because the great majority of what is spent on a motor car IS revenue expenditure — fuel, insurance, road tax, servicing, replacing worn tyres, ordinary repairs. All of those merely maintain the earning capacity the car already had. What separates this item from them is the stated object of getting better fuel efficiency, which raises the car's performance above what it was. The amount is no guide either way: Rs. 25,000 spent on routine servicing would still be revenue, and a far smaller sum spent on a genuine improvement would still be capital.

The capital-versus-revenue distinction is the first real judgement an accountant makes, and everything downstream depends on it. Revenue expenditure is consumed within the accounting period and is matched against the revenue of that period in the Profit and Loss Account. Capital expenditure buys a benefit that outlives the period, so it is parked in the Balance Sheet as an asset and released to the Profit and Loss Account gradually through depreciation. The working tests are: does the spend acquire a fixed asset, does it increase the earning capacity or extend the useful life of an existing asset, or does it permanently reduce operating cost? A yes to any of them makes the item capital. Purchase price, freight inward on a machine, installation charges, and repairs carried out on a second-hand asset BEFORE it is first put to use are all capital for the same reason — they are part of the cost of bringing the asset to working condition. Repainting, routine servicing and replacing a broken part with an identical one are revenue, because they only preserve what was already there.

An Accounts Officer applies this line every working day, which is why the accountancy block of the EO/AO paper opens with it. The examiner's method here is worth studying: the facts are made deliberately neutral — a repair-sounding word, a mid-sized amount, an ordinary asset — and the whole answer is hidden in a short purpose clause. The habit rewarded is reading the stem for WHY the money was spent rather than for WHAT it was called, because misclassification does not merely mislabel a line; it moves profit between years and moves value between the Balance Sheet and the Profit and Loss Account.

• Capital expenditure: benefit extends beyond the current accounting period; debited to an asset account and depreciated over its useful life.
• Revenue expenditure: benefit is consumed within the accounting period; charged in full to the Profit and Loss Account of that period.
• Three tests for capital treatment — acquisition of a fixed asset, increase in earning capacity or useful life, or permanent reduction in operating cost.
• An overhaul undertaken to obtain better fuel efficiency reduces future running cost, so it is capitalised to the asset.
• Routine servicing, fuel, insurance and ordinary repairs of the same vehicle remain revenue expenditure.
• Repairs to a second-hand asset incurred before it is first put to use are capital expenditure, being part of the cost of bringing it to working condition.
• Misclassifying capital expenditure as revenue understates current profit and understates assets; the reverse error overstates both.
• The size of the amount is not a test of classification, though a materiality convention lets a business expense trivial capital items outright.

• Classifying by the label on the spend ('expenses', 'repairs', 'overhauling') instead of by its purpose.
• Treating the amount as the test — a large repair bill is still revenue, and a small improvement is still capital.
• Forgetting that pre-use repairs on a second-hand asset are capital while identical repairs after it is in use are revenue.
• Mixing the receipts row into an expenditure question, which is exactly what one option here invites.

The EO/AO accountancy block reliably contains one classification item. It comes either as a one-line fact pattern like this, where a purpose clause decides the answer, or as a 'which of the following is NOT a capital expenditure' list mixing an improvement in among routine repairs. Rehearse the borderline cases rather than the definitions: legal fees on buying property, wages paid to workmen who install a machine, replacing a petrol engine with a diesel one, and a lump sum paid to acquire a running business.

No directly related past PYQ was found.

• practice — not a real PYQ

  Legal charges paid in connection with the purchase of a building are treated as :

  • (a)Revenue expenditure
  • (b)Deferred revenue expenditure
  • (c)Capital expenditure
  • (d)Capital receipt

  Answer(c) Capital expenditure

• practice — not a real PYQ

  Repairs carried out on a second-hand machine after its purchase but before it is put to use are :

  • (a)Revenue expenditure, being repairs
  • (b)Capital expenditure, being part of the cost of bringing the asset to working condition
  • (c)Deferred revenue expenditure written off over five years
  • (d)Charged to the Profit and Loss Appropriation Account

  Answer(b) Capital expenditure, being part of the cost of bringing the asset to working condition