With reference to the expenditure made by an organization or a company, which of the following statements is/are correct?

UPSC Prelims 2022 Question:

With reference to the expenditure made by an organization or a company, which of the following statements is/are correct?

1. Acquiring new technology is capital expenditure.
2. Debt financing is considered capital expenditure, while equity financing is considered revenue expenditure.

Select the correct answer using the code given below:

a) 1 only

b) 2 only

c) Both 1 and 2

d) Neither 1 nor 2

Correct Answer: Option a) 1 only

Explanation:

Learn more about Capital Expenditure in the given explanation below.

• Capital expenditures (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. CapEx is often used to undertake new projects or investments by a company. Types of capital expenditures can include purchases of property, equipment, land, computers, furniture, and software. So, statement 1 is correct.

Is Debt Financing a Capital Expenditure?

• No, debt financing is not considered a capital expenditure. Capital expenditures are investments in physical assets that have a long-term use and are expected to generate future economic benefits. Debt financing, on the other hand, is a liability that is used to finance the purchase of assets, but it does not create any new assets itself.
• For example, if a company borrows money to build a new factory, the cost of the factory would be considered a capital expenditure. However, the interest payments on the loan would not be considered a capital expenditure, because they do not create any new assets.
• In the case of debt financing for dental work, the cost of the dental work would be considered a personal expense, not a capital expenditure. This is because dental work is not expected to generate any future economic benefits for the individual.
• Debt financing occurs when a firm raises money for working capital or capital expenditures by selling debt instruments to individuals and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid. The other way to raise capital in debt markets is to issue shares of stock in a public offering; this is called equity financing. Both debt financing and equity financing are considered as capital expenditures. Revenue expenditures are the ongoing operating expenses, which are short-term expenses used to run the daily business operations. So, statement 2 is not correct.

Therefore, option (a) is the correct answer.

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