Question

Medha, an economics student, was studying about the expenditure on defence incurred by the government in the form of acquiring new platforms (jets, submarines etc.), and salaries and pensions of armed forces personnel.

She classified both the expenditures as capital expenditure.

Do you agree with Medha’s views ? Give valid explanation in support of your answer.

Hint:

Capital expenditure creates assets or reduces liabilities. New jets and submarines do this. Salaries and pensions do not, so they are revenue expenditure and Medha is not fully right.

Answer 1

Step 1: Recall the test for capital expenditure:
Capital expenditure is spending that creates an asset for the government or reduces its liabilities.
Revenue expenditure is spending that neither creates an asset nor reduces a liability. It is used for the day to day running of the government.

Step 2: Check the first item: new platforms:
Buying jets and submarines gives the government assets that last for many years.
So this spending is capital expenditure.

Step 3: Check the second item: salaries and pensions:
Salaries and pensions of the armed forces are paid for services in the current year and for past service.
They create no asset and do not reduce any liability of the government.
So this spending is revenue expenditure.

Step 4: Give the verdict on Medha:
Medha put both items under capital expenditure. Only the first one belongs there.

Final Answer:
No, I do not agree with Medha.
Acquiring jets and submarines is capital expenditure because it creates assets. Salaries and pensions are revenue expenditure because they neither create assets nor reduce liabilities.