Analyse the importance for a business of distinguishing between revenue expenditure and capital expenditure.

Mark scheme

Marking points from the official mark scheme (May/June 2016). The mark or mark type is shown in brackets.

1. (a) Level 4: Good analysis of the importance of the distinction between revenue and capital expenditure (7-8 marks)
2. Level 3: Some analysis of the importance of the distinction between revenue and capital expenditure (5-6 marks)
3. Level 2: Some explanation/application of revenue and capital expenditure to a business (3-4 marks)
4. Level 1: Understanding of revenue and/or capital expenditure (1-2 marks)
5. Level 0: No creditable content (0 marks)
6. Answers could include:
7. These are two different kinds of business expenditure and have significantly different impacts on a business – revenue expenditure is a regular expenditure, gives benefit over the short term, maintains rather than enhances assets. Capital expenditure is long-term, irregular, and produces benefit (assets) over a number of accounting periods.
8. Different in terms of how they are financed – almost certainly financed in different ways – capital expenditure more likely to be financed with debt/loan financing.
9. Different in terms of how these types of expenditure are recorded in financial accounts.
10. Revenue expenditure is on assets and expenses that give short term benefit to the business (1 year) and recorded in full on the Income Statement. Capital expenditure will be recorded on the Income Statement as a yearly depreciation amount and on the Statement of Financial Position as asset valuation.
11. Please accept and reward other relevant points.
12. (b) Level 4: Effective evaluation of the benefits and drawbacks of funding expansion only through internal sources of finance (9-12 marks)
13. Level 3: Limited evaluation of the benefits and drawbacks of funding expansion only through internal sources of finance (7-8 marks)
14. Level 2: Analysis and some application of the use of internal sources of finance to fund expansion (3-6 marks)
15. Level 1: Understanding of internal sources of finance (1-2 marks)
16. Level 0: No creditable content (0 marks)
17. Answers could include:
18. Outline of types of internal funding sources, such as building up reserves through retained earnings, sale of unwanted assets.
19. Benefits such as:
20. No direct cost to the business
21. Readily available
22. Does not increase debt
23. No loss of control no share sale
24. Risk of high gearing reduced
25. Start projects quickly – no approval process externally
26. Drawbacks such as:
27. Using money from capital reserves or operating budgets leaves a business with less money to manage short-term expenses
28. There may well be a limit to the kinds of expansion that can be funded internally (depends on amount of reserves available)
29. Likely to fund only smaller projects where investment is modest, payback is quick and estimated returns significant.
30. The viability of an investment project may be given less robust scrutiny when internal financing is used.
31. There may be tax benefits of external funding that internal funding does not have (tax deductible interest/depreciation)
32. Strong answers will recognise the significance of only using internal sources and will explain how this approach might well limit or counter the advantage claimed.
33. Note: Do not reward selling shares as an internal source of finance – it is an external source of finance.
34. Please accept and reward other relevant points.