By Asok Nadhani
Capital and
Revenue Expenditure & Receipts
10.1 Nature of Capital
and Revenue Expenditure & Receipts
It is essential to make distinction between the
concept of capital and revenue. To calculate net profit, only revenue income
and expenditure are to be considered. To ascertain the financial position of
the business, capital expenditure and income or receipts are to be considered. For
example, cash introduced in business by proprietor is a Capital Receipt but cash received from a customer is a Revenue
Receipt.
Revenue means the aggregate exchange value
received for goods or providing services whereas Receipt means inflow of money into business.
10.2 Capital Expenditure
If the benefit of expenditure is not exhausted in one
accounting period, but it is spread over future accounting periods, the
expenditure is known as Capital
Expenditure. This type of expenditure increases earning capacity of
business (and not incurred to meet day-to-day expenditure). The benefit of its
usage is spread over a number of future accounting periods.
Following expenditure represent
of Capital Expenditure:
1.
Acquisition of asset: Expenditure incurred to acquire fixed assets
intended to be used in the business beyond the current financial year, and not
meant for resale (for instance, a plant bought during the current accounting
period, intended to be used over and over several years).
2.
Additions or Improvement of Asset: An additional item of plant or machinery
bought to improve the capacity, efficiency, life span or economy of operation (for
example, more spindles added in a ring frame in a spinning mill. Cost of such
spindles added is a capital expenditure).
3.
Expenditure of right or benefit of Asset: Expenditure incurred for acquiring benefit
or right of an enduring nature, (for example, goodwill, copyright, trademark,
patent, etc).
4.
Expenditure incurred to carry on Asset: Expenditure incurred in the course of
acquiring a fixed asset, and directly connected with it, (for example,
machinery construction and installation expenses, stamp duty and registration
charges in the acquisition of land, etc).
5.
Extension of Asset: Expenditure incurred to extend capacity of
business (for example, a new room is constructed to increase the capacity of
the business).
10.3 Revenue Expenditure
Revenue Expenditure affects profit of business for the
current period and it is deducted from revenue income to determine net income
of a business.
Following expenditure
represent of Revenue Expenditure:
1.
Day-to-day expenses: Day-to-day expenses in the conduct and
administration of business and gives benefit less than a year e.g. rent, taxes,
insurance, wages salaries, carriage etc.
2.
Expenditure of Current assets: Expenditure of current asset for conversion
into finished products, e.g. raw materials and stores.
3.
Expenditure incurred to maintain fixed asset:
To maintain fixed asset in
working order, e.g. repairs and renewal, depreciation, cost of spares, etc.
10.4 Deferred Revenue Expenditure
Sometimes, a heavy expenditure of revenue nature is incurred
which gives benefit beyond the current period. Such expenditure is classified
as Deferred Revenue Expenditure (e.g.
Preliminary expenses, brokerage on issue of shares and debentures, discount on
issue of shares or debentures, exceptional repairs, heavy advertisement,
expenses incurred for product promotion, underwriting commission, research and
development expenses etc). A portion of such expenses are treated as revenue in
current year and balance is carried forward and gradually written off in future
accounting period.
Sometimes losses of exceptional nature that involves a
huge sum are treated as Deferred Revenue Expenditure. For example, Damage of property
due to natural calamity, project work but not materialized.
Characteristics
(i)
Deferred
revenue expenditure is of revenue nature (i.e. for expenses incurred and not
for acquisition or any asset).
(ii)
The
benefit of deferred revenue expenditure is not exhausted in the year in which
it is incurred. Its benefit extends over a number of years.
(iii)
It is occasional
in nature, and normally heavy in amount.
(iv)
Only a
part of deferred revenue expenditure is charged against the profit and loss
account of the year in which it is incurred. Its unwritten portion is shown in
the Balance Sheet on the asset side as miscellaneous expenditure.
10.5 Revenue Expenditure
treated as Capital Expenditure
In some case, revenue expenses may be capitalized
(recognized as capital expenses) like:-
1.
Replacement of Fixed Assets: If an asset is replaced with similar type
of asset, the expenditure incurred is treated as Revenue Expenditure. For
example, a lathe machine in a factory becomes out of order and is replaced with
a similar type of machine, then it is revenue expenditure and will be an item
of Profit & Loss Account.
However, if the previous asset is replaced
with a superior quality, the expense incurred on it will be treated as partly
capital and partly revenue.
Example: An Inkjet Printer costing Rs.3,000 is
replaced with a LaserJet Printer costing Rs.12,000,
In this case, Rs.3,000 is revenue
expenditure and the excess value (12,000 – 3,000)= Rs.9,000 will be capital
expenditure.
2.
Legal Expenses: Legal expenses incurred in connection with purchase
of fixed assets (such as registration charges of land, building, motor car etc).
3.
Repairs: Second hand plant is purchased and immediate repairs
are made to bring it in working order. Such repair become capital expenditure
and is added to the plant as part of its cost.
4.
Wages: Paid to workers to erect and install new machinery or
any other fixed asset is capital expenditure and should be treated as the part
of cost of the asset.
5.
Transport Expenses: Incurred for transporting any fixed asset
is added to the cost of acquisition of the fixed asset.
6.
Interest on capital: During construction work, it may be added to
the cost of plants or buildings, in some specific cases.
7.
Raw Material and stores: Consumed for making of a fixed asset, is
treated as a part of the cost of the asset.
8.
Advertisement Expenses: The cost of special advertising undertaken
introducing a new line of goods may be treated as capital expenditure, if such
benefit will accrue in future periods also.
9.
Development Expenses: Initial phase development expenses (e.g. development
of land and tea plants, projects of long gestation period etc.) may be treated
as ‘Capital Expenses’.
10.6 Distinction between Capital and Revenue Expenditure
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Capital
Expenditure
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Revenue
Expenditure
|
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The benefit of expenditure is not exhausted in one
accounting period, but extends over future accounting periods.
|
It normally influences profit earning capacity of
business for one financial year.
|
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All items of capital expenditure, which are not
written off, are shown in the B/S as assets.
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All revenue items, the benefit of which has
exhausted during the year, are transferred to Trading, P & L A/c and so
not carried forward to Balance Sheet.
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It involves acquisition of fixed asset meant for use
and not to resale.
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It does not involve in acquisition of any fixed
asset.
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It involves improving the earning capacity of fixed
asset
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It involves maintenance of the earning capacity of business
assets.
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These expenses may be incurred before or after
commencement of business.
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These expenses are always incurred after
commencement of business.
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Capital expenditures are not matched with Capital
receipts.
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Revenue expenditures are matched with revenue
receipts.
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They are of non-recurring nature.
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They are normally of recurring nature.
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10.7 Distinction between Capital and Deferred Revenue Expenditure
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Capital
Expenditure
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Deferred
Revenue Expenditure
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It results in permanent
and long-term benefit in the form of an asset
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Deferred Revenue Expenditure is primarily of a
revenue nature and does not result in acquisition of any asset.
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If the business does not continue, some value may be
realized from out of Capital Expenditure,
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if the business discontinues, no value will be
realized out of deferred expenses.
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Mostly Capital Expenditure relates to acquisition of
tangible asset and is shown under fixed asset in the Balance Sheet.
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Deferred Revenue Expenditure does not result in tangible
expenses and is shown on the asset side of the Balance Sheet under
Miscellaneous Expenditure.
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Capital Expenditure is depreciated over the assets
working life..
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Deferred Revenue
Expenditure is written off.
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10.8 Distinction between Revenue and Deferred Revenue Expenditure
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Revenue
Expenditure
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Deferred
Revenue Expenditure
|
|
The benefit of such expenditure expires during the
year.
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Benefit of such
expenditure is available over a number of future years.
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10.9 Capital Receipts
It refers to amount received from the activities other
than normal business activities (e.g. Issue of shares and debentures, sale of
fixed assets, capital invested by proprietor). Such receipt is of non-recurring
nature. They do not affect profit and are shown as a liability or as a
reduction from the asset.
10.10 Revenue Receipt
It refers to amount received in the course of normal
business activities for e.g. Sales, interest, dividend, etc. Such receipts are
of recurring nature and for general purpose. They are shown on the credit side
of Profit & Loss A/c.
10.11 Distinction between Capital and Revenue Receipts
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Capital
Receipts
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Revenue
Receipts
|
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Capital Receipts can not be distributed as profit.
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Revenue receipts may be distributed as profit after
deducting revenue expenses.
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They are of non-recurring nature.
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They are of recurring nature.
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Capital Receipts
create Capital Reserve.
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Revenue Receipts
create Revenue Reserve.
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It can not be used to create Reserve Fund.
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It can be used to create Reserve Fund after
deducting revenue expenses.
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10.12 Distinction between Capital and Revenue Profits
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Capital
Profits
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Revenue
Profits
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Capital profit
arises out of some casual or non-recurring transaction.
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Revenue profits
arise out of ordinary and normal business operations and are of recurring nature.
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Capital profits are transferred to Capital Reserve and
are shown in Balance Sheet (e.g. Profit on sale of fixed assets, premium on
issue of debentures), and are not available for distribution as dividend.
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Revenue profits are available for
distribution as dividend.
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Example: 1 From the list of the
following, find out the nature of the expenses.
a. A machine was
acquired for Rs.10,000.
b. Carriage of
Rs.1,000 spent on the machinery purchased and installed.
c. A labour will
operate the machine and he will be paid Rs.1,000 p.m. as wages.
d. 100 acre of land
has been acquired @ Rs. 1,200 rent p.m.
e. Rs.800 paid to a
mechanic for servicing a motor car of the company including Rs.30 for
purchasing of Mobil.
f. Rs.15,000 has been
spent on for construction in factory premises.
g. Heavy
advertisement cost of Rs.25,000 was incurred to launch a new product.
Solution:
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Reason
|
Rs.
|
Type of the Expenditure
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a. Acquisition of machine means for use of
machine in business and not for resale. It will increase earning capacity of
business
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10,000
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Capital Expenditure
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b. Carriage of
Rs.1,000 spent on the machinery purchased and installed are to added to cost
of acquisition. So it is to be treated as Capital Expenditure in the same way
as in above question a).
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1,000
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Capital Expenditure
|
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c. Wages paid for regular
operation of the machine is
of recurring nature as it is one of the regular activities of business.
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1,000p.m
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Revenue Expenditure
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d. Rent paid for land
is of recurring nature, for
the purpose of Business.
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1,200p.m
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Revenue Expenditure
|
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e. Servicing a
motor car of the company including purchasing of Mobil is relates to
maintenance of Motor car in its existing condition.
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800
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Revenue Expenditure
|
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f. Construction in
factory premises will extend
capacity of business and will also provide future benefit.
|
15,000
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Capital Expenditure
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g.
A
heavy advertisement expenditure of revenue nature incurred to launch a new
product will reap benefit over a number of years. So it will be carried
forward and are written off in future accounting period.
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25,000
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Deferred Revenue
Expenditure
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Example: 2 From the list of the
following, find out the nature of the expenses.
a. A second hand machine
was purchased on 24th
December, 2008 and Rs. 500 on repairing and Rs.350 as freight were spent
at the time of its acquisition.
b. Expenses incurred
to obtain license for the machine, Rs.5,000.
c. A project was
taken and spent Rs.2,00,000 on it but it was not materialized.
d. A legal fee including
registration charges paid for acquiring a motor car of Rs.580.
Solution:
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Reason
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Rs.
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Type of the Expenditure
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a. Repairing and
freight charges relate to acquisition of a second
hand machine to bring it in working condition will be treated as Cost of
Acquisition, which will provide future benefit. (500+350)
|
850
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Capital Expenditure
|
|
b. License fee
relates to acquisition of machine and will be treated as a part of
acquisition cost as explained above in a).
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5,000
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Capital Expenditure
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c. As the project was
taken but has not been materialized. This is a exceptional type of loss
involving a large sum amount. Though it will not provide any future benefit, as the
amount is heavy it will be treated as Deferred Revenue Expenditure
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2,00,000
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Deferred Revenue
Expenditure
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d. Legal expenses (including registration
charges) is incurred in connection with purchase of motor car is a part of
its cost as it is incurred to get ownership right. Hence it will be treated
as Capital Expenditure.
|
580
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Capital Expenditure
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Example: 3 From the list of the
following find out the nature of the income.
a. Cost of Motor
Vehicle Rs.1,50,000 stood in the books at Rs.50,000 sold for Rs.60,000.
b. From issuing share
of Rs.2,00,000, Rs.60,000 received by way of premium.
c. Loan taken from
bank of Rs.50,000.
Solution:
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Reason
|
Rs.
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Type of the Income/Receipt
|
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a. Profit on sale
of Motor vehicle (fixed assets) is not a regular activity of business. Hence,
the profit (60,000 – 50,000)= Rs.10,000 is a Capital Profit..
|
10,000
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Capital Profit
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b.
Premium
on issue of share
|
1,40,000
60,000
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Capital Receipt
Capital Profit
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c. Loan taken is a
liability and it is repayable.
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50,000
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Capital Receipt.
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[Newly added
examples]
Example: 4 From the list of the
following find out the nature of the income.
a. Amount spent for
replacement of worn out part of machine Rs.60,000.
b. Amount spent for
construction of temporary huts to provide accommodation of labours on the side
of construction of shopping mall and were demolished when the shopping mall was
ready ,Rs. 1,00,000.
c. Amount of Rs.5,000
were realized against their debts.
d. Amount invested by
proprietor in business as capital Rs.50.000.
e. Paid for painting
the factory shed Rs.1,200.
Solution:
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Reason
|
Rs.
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Type of the Income /Expenditure
|
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a. Amount spent for
replacement of worn out part of machine is a part of maintenance cost.
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60,000
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Revenue
Expenditure
|
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b. Cost of the
temporary huts for providing accommodation to labours was necessary to
construct the shopping mall. As it is a part of construction cost, the
expenditure will be treated as Capital Expenditure.
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1,00,000
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Capital Expenditure
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c. Amount realized
from debtors is realization of amount against credit sales. Therefore, it is
a revenue receipt.
|
5,000
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Revenue Receipt.
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d. It is a
liability of business to its proprietor.
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50,000
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Capital Receipt.
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e. Painting of factory
shed is type of maintenance cost.
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1,200
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Revenue
Expenditure
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