CAPITAL AND REVENUE

EXPENDITURES AND
RECEIPTS

Importance of Distinguishing between Capital &

Revenue Items
TO DETERMINE WHICH ITEMS APPEAR IN
WHICH FINANCIAL STATEMENT.
Revenue items - profit and loss account
Capital items - balance sheet
DETERMINATION OF THE NET PROFIT
Requires Matching of revenue expenditure and revenue
income (As per Matching Concept)
PROFITS =
REVENUE RECEIPTS REVENUE EXPENSES

Capital and Revenue Receipts

Capital Receipts comprise of

Contributions of capital into the business by the proprietor,
partners or shareholders
any sums received from debenture holders,
any loans and
Sale proceeds of any fixed assets & long term
investments.
Revenue Receipts or income
are the outcome of firms activity in the accounting
period;
money received on sale of goods in trade or on rendering
of services.
Examples: Sales, commission and fees received, interest
/dividend on investments

Distinction Between Capital and Revenue Receipts

Capital Receipts

Revenue Receipts

Includes amounts realized by

sale of fixed assets or by
issue of share or debentures.
It is a receipt in substitution
of a source of income
Amount received for
surrender of certain rights
under an agreement is a
capital receipt, because a
capital asset is being given
up in the form of these rights

Includes amount realized

by sale of goods or
rendering services
It is a receipt in substitution
of an income.
Amount received as
compensation under an
agreement for the loss of
future receipts is a revenue
receipt

Classification of income
Capital income
Revenue income

Capital Profits / Capital Income

Capital profits are profits earned on account of sale
of fixed assets or in connection with share capital

Capital income is an income which does not relate to

operations of the business or which does not grow out
of or pertain to the running of the business proper.

Capital Profits / Capital Income

Examples:
Share premium,
sale of a fixed asset for a value more than that for
which it was purchased.eg. Capital gain of Rs 150,000
arises when building bought for Rs. 200,000 is sold
for Rs. 350,000.

Note: Only the profit realised over and above the cost of the fixed
asset should be taken as capital profit (transferred to capital reserve)
while the profit realised over and above book value of the asset till it
does not exceed the original cost of the asset should be taken as
revenue profit (credited to Profit and Loss Account)

Revenue Profits / Revenue income

Revenue profits are those earned in the ordinary
course of business
Revenue income is an income which arises out of and in

the course of regular operations of the business concern

Revenue profits appear in the Profit and Loss Account
Revenue profit and revenue income are synonymous.
Examples:

Profit made on sale of goods, income received from letting out of the
business property, dividends received on business investments, etc.

Expenditure
Expenditure refers to a payment or spending or a
promise to make future payment for benefits
received i.e. for assets or services.

Classification of Expenditure
Capital Expenditure
Revenue Expenditure
Deferred Revenue Expenditure

Capital Expenditure
Capital Expenditure is any expenditure which is

incurred for the purpose of long term advantage

Such expenditure is either incurred for

acquisition of a fixed asset (tangible or intangible) or

permanent improvement or addition or substitution

or extension to an asset to increase the earning

capacity of the business enterprise

Capital Expenditure
Definition:
Expenditure incurred in purchasing or
constructing property which is intended to assist
in the production of profit or in permanently
improving, enlarging or extending existing
property in order to increase its profit earning
capacity. The direct benefit of such an
expenditure will extend over several trading
periods and it replaces cash by permanent asset.
(Rowland, S.M. in Principles of Accounting)

Guidelines to determine that expenditure is

capital expenditure:
1. Increases Profits
If expenditure is for the purpose of increasing profit
either positively by increasing earning capacity or
negatively by decreasing working expenditure (day to
day expenses)

2. Produces an asset
If whether increasing the earning capacity or not, it
produces an asset comparatively permanent in nature.

Examples of Capital Expenditure

1. Purchase of permanent tangible asset

such as plant and machinery, office equipment, furniture

2. All sums spent up to the point an asset is ready for use

including expenditure on its purchase, receipt or erection

eg. cartage charges paid to bring the machinery to factory,

installation charges,
fees paid to lawyer for drawing land purchase deed,

overhauling expenses of second-hand machinery,

Examples of Capital Expenditure

3. Financing cost for a fixed asset

(i.e. interest paid on loans to purchase a fixed asset) for the

period up to the time the asset is put to use. Such interest is
added to the cost of fixed asset.

4. The amount spent on existing asset for the purpose of

its improvement or extension

which will raise the output or reduce the cost of production

5. Money paid for goodwill

6. Money spent to reduce working expenses
eg. Conversion of hand-driven machinery to power-driven
machinery.

Revenue Expenditure
These are expenses whose benefit expires within
the year of expenditure and which are incurred to
maintain the earning capacity of existing assets.
It is an expenditure on consumable items, on
services and on goods acquired for resale.

Revenue Expenditure
Revenue items generally include:
The cost of materials used in manufacturing goods
intended for resale.
Wages paid in connection with the production of goods
meant for sale.
Selling and distribution expenses.
All expenses incidental to the working of the business
such as depreciation, rent, salaries, interest, etc.
All expenses incurred for maintaining the efficiency of
fixed assets by means of repairs, replacement, renewals
and insurance.

Principles for determining the nature of

expenditure
1. Expenditure in the
acquisition of an income earning asset - capital
expenditure
in the process of earning of the profits - revenue
expenditure.

2. Expenditure made for the initiation or extension of a

business or for a substantial replacement of equipment deemed to be capital
3. Expenditure made not only once and for all but brings
into existence an asset or an long term advantage capital expenditure
4. Whether the expenditure incurred was part of the fixed
capital of the business or part of its circulating capital

Distinction between Capital and Revenue Expenditure

Capital Expenditure
Incurred in acquiring or
improving permanent assets not
meant for resale. May add to value
of an existing asset
Increases earning capacity
It is normally a non-recurring
outlay.
It produces benefit over several
years.
Thus a small part is charged to
income statement as depreciation
and the rest appears in the
balance sheet
Is an item of balance sheet

Revenue Expenditure
Is a routine expenditure incurred
in the normal course of business
and includes cost of sales and
maintenance of fixed assets.
Maintains the earning capacity
It is usually a recurring item
It is consumed within an
accounting year i.e. benefits
only one year.
Thus entire amount is charged to
income statement.Does not
appear in the balance sheet.
Shown in Trading and profit &
loss A/c

Revenue Expenditure becoming Capital Expenditure

Certain revenue expenditures are treated as capital expenditures since
they lead to the establishment of business and its efficient running in the
following circumstances:

1. Wages: wages on erection of plant & machinery or construction

2.

Raw material and stores used in construction of fixed asset

3. Transport charges: incurred for new plant & machinery

4.

Interest on capital: Interest on capital especially where the nature of

business requires construction work for a long period, before the
commencement of the production.

5.

Legal expenses: Legal expenses incurred to acquire the assets

6.

Repairs: Repairs on purchases of second-hand asset to put into

workable condition

Deferred Revenue Expenditure

Deferred revenue expenditures are expenditures which
are basically in the nature of revenue expenditure but
whose benefit covers a number of years i.e. their benefit
may extend over a number of years.
For Example: Heavy advertising expenditure incurred in
introducing a new line or developing a new market, Cost of
issuing shares and debentures, Cost of experiments, discount on
debentures, Preliminary expenses

Distinction between Capital Expenditure

and Deferred Revenue Expenditure
1. Nature of expenditure -deferred revenue expenditure is a
revenue in nature but it is incurred for > one accounting yr
2. Years of benefit: The deferred revenue expenditure
benefits lesser number of years in comparison to capital
expenditure.

Deferred revenue expenditure-for 3-5 years

Capital expenditure-for 10-15 years

3. Recovery:

Deferred revenue expenditure - once incurred cannot be

recovered back generally

Capital expenditure - capable of being reconverted into cash

though at a loss