CONTENTS: 1. Revenue Item. 2. Capital Loss. 3. Revenue Losses. 4. Feature of Revenue Expenditures. 5.

What are basic rules for making difference between capital and revenue expenditure. 6. Deferred Revenue Expenditure. 7. Capital and Revenue Receipts. 8. Capital Expenditure and Revenue Expenditure. 9. Examples. 10. How can revenue expenditure turn into capital expenditure? 1. Revenue item: If any item of business which does not create any asset of business that type of items are called revenue items, suppose we pay rent but rent can not create any fixed asset so this is revenue item and it must show in profit and loss account, but if we have a special fund for building, this fund create long term asset up to that period this will show as fixed liabilities. This is not revenue item. There is also a major difference that is revenue items benefit is related to current year but capital items' benefits are related more than one year. E.g.: If advertisement's expense is Rs. 100 and its benefit is only related to current year then this is revenue item. But if we spend Rs. 9000000 lakh on advertisement and its estimated benefit is for 10 years then this will be the capital item. All revenue item will show in profit and loss account and all capital items will shown in balance sheet or financial statement 2. Capital loss: Capital loss may be defined as the loss relating to sale of any fixed asset or any other financial loss like premium given on repayment of debentures or bonds, or discount on issue of shares and debentures. Capital loss may explain with many other examples E.g.: Machines book value is Rs. 50000 and it is sold for on Rs. 40000 and Rs. 10000 is loss on sale of machinery, this is called capital loss. A company has 100 debentures of other company and each debenture is of Rs. 100 but these debentures are sold at Rs. 80 per debenture, so company is getting loss on sale of debenture of Rs. 2000. This is capital loss. In profit and loss account of company, we can not show any capital loss. In other words these losses can not be debited in Profit and loss account of company. These all losses will show in assets side of balance sheet of company. After this, it is written off by dividing number of fixed years and transferring to profit and loss account. If you know what is mean of written off , then , I can also explain it , written off means that part of any expenses or loss which is transferred from balance sheet to profit and loss account for closing the account of loss or expenses , specially capital losses.

3.

Revenue losses: Revenue losses include all losses which happen due to operating any business activity. It includes cash discount on sale, depreciation, loss due to falling of market prices. So, these losses will show in the debit side of profit and loss account of company. It is deemed that when we start the different activities of our business, many losses are happen, so it should be closed by transferring all these losses to profit and loss account. Feature of revenue expenditures: a. General operating expenses: Any expenses which are related to the general operation of business are revenue expenditures and will be debited in profit and loss account. b. Expenses related to short period: These types of expenses are related to short period, means benefit of these expenses is less than one year. c. Expenses for maintaining the stability of fixed assets: These expenses main feature is that these expenses is useful for maintaining the stability or efficiency of fixed assets, d. Recurring Nature: One of most important feature of these expenses that these expenses are recurring nature. In other words these expenses happen again and again in general business activities. For example, expenses for giving refreshment is revenue expenditure because almost daily, these type of expenses is paid by company e. Helpful for maintaining the profit of business: These type of expenditure is useful for maintaining the profit of business , but also above features should include in the expenses which I have mentioned in above points because capital expenditure will also helpful for maintaining the profit and you will then confused revenue and capital expenditures difference .

4.

5.

What are basic rules for making difference between capital and revenue expenditure: a. All expenses which are done for getting any fixed asset must be capital expenditure. For example, expenses of carriage and freight for getting fixed assets are also capital expenditure and will include in the total cost of fixed assets. b. All expenses which are done for increasing the size or improvement in fixed assets must be capital expenditure. c. All expenses which are done for getting share capital or long term loan must be capital expenditure. d. Look also nature of business, if business is relating to general goods sale -purchase transaction then above three rules will be applicable but, if nature of business shows dealing in above transaction, then above transaction becomes revenue expenditure. e. Legal judgments is also so important for taking decision , Like Income tax law 1961 has provided some rule regarding assessment of business and profession. These rules also give good guidance for making difference between revenue and capital expenditures.

6.

What is Deferred Revenue Expenditure? As a matter of fact, deferred revenue expenditure is capital expenditure. Because, it has both quality of revenue and capital items, so it is deemed as deferred revenue expenditure. It involves a heavy expenditure of revenue nature and it is not prudent and desirable to write it off from the profit of one financial year and hence a pert is taken to profit and loss account and the balance is shown on the assets side of the balance sheet. The benefit from such expenditure may spreads over for 3 to 5 years.

I take one example to make you understand this concept with better way: Heavy advertisement expenses, because this is for promotion of sale so, it is revenue expenses but because amount is too large so it is also capital expenditure. Now, it will include in deferred revenue expenditure. If we fix the target of getting benefit for this advertisement is 10 years and advertising cost Rs. 500000. Now Rs. 500000 is divided by 10 years and we get Rs. 50000 and it will show as revenue expenses in profit and loss account and balance amount of Rs. 450000 will show in balance sheet. Every year one tenth part of Original and total advertising expenses will go to profit and loss account. This deferred revenue account will close in 10th year when there will not be any balance for showing as asset in balance sheet. Other Examples: preliminary expenses, underwriting commission, discount and brokerage on issue of shares or debentures, exceptional repairs, heavy advertisement cost, research and development expenses, special type of losses, etc. like,

7.

Capital and Revenue Receipts: When the business receives money it is again of two types. It may be a long-term receipt, a contribution by the owner, either to start the business or to increase the funds available to it. It might be a mortgage or an which brings money into the business for a long-term, but in this case it is not the owner of the business but some other investor who is supplying the money. On the other hand, the receipt may be a short-term receipt, one which is truly a profit of the business. It may be rent received, commission received or cash for sale of goods made that day, or at some previous time. Capital Receipt: Receipts which are non-recurring (not received again and again) by nature and whose benefit is enjoyed over a long period are called "Capital Receipts", e.g. money brought into the business by the owner (capital invested), loan from bank, sale proceeds of fixed assets etc. Capital receipt is shown on the liabilities side of the Balance Sheet. Revenue Receipt: Receipts which are recurring (received again and again) by nature and which are available for meeting all day to day expenses (revenue expenditure) of a business concern are known as "Revenue receipts", e.g. sale proceeds of goods, interest received, commission received, rent received, dividend received etc. Distinction between Capital Receipt and Revenue Receipt: S. No. Revenue Receipt Capital Receipt 1. It has short-term effect. The benefit is It has long-term effect. The benefit is enjoyed within one accounting period. enjoyed for many years in future. 2. It occurs repeatedly. It is recurring and It does not occur again and again. It is regular. nonrecurring and irregular. 3. It is shown in profit and loss account on It is shown in the Balance Sheet on the the credit side. liability side. 4. It does not produce capital receipt. Capital receipt, when invested, produces revenue receipt e.g. when capital is invested by the owner, business gets

5.

revenue receipt (i.e. sale proceeds of goods etc.). This does not increase or decrease the The capital receipt decreases the value of value of asset or liability. asset or increases the value of liability e.g. sale of a fixed asset, loan from bank etc. Sometimes, expenses of capital nature are to be incurred for revenue receipt, e.g. purchase of shares of a company is capital expenditure but dividend received on shares is a revenue receipt. Sometimes expenses of revenue nature are to be incurred for such receipt e.g. on obtaining loan (a capital receipt) interest is paid until its repayment.

6.

8.

Difference between Capital Expenditure and Revenue Expenditure: Capital Expenditure: It consists of expenditure, the benefit of which is not fully consumed in the accounting period but spread over several periods. Any expenditure, which is undertaken for the purpose of increasing profit either by way of increasing earring capacity or by decreasing costs, is capital expenditure. Capital expenditure is one which (a) increase in quantity of fixed assets (b) increase in quality of fixed assets and (c) Replacement of fixed assets. An expenditure cannot be said to be a capital expenditure only because the amount is large the amount paid in lump-sum the receiver of amount is going to treat it for purchase of fixed asset Examples: plant and machinery, motor car, lease, trademark, patent, copy right, Goodwill, expansion or erection of machinery, expansion expenditure(increasing seating capacity in theatre), experiment expenses, development expenses in case of mines, etc. Revenue Expenditure: It constitutes the expenditure incurred for the payment of money for services of whatever type such rent, salaries, commission, repair, carriage etc. It is incurred for carrying on business and maintains assets in their existing conditions. It doesnt increase the profit earning capacity but merely maintains it at existing level. It is used in the sense of immediate or short term importance. Examples: cost of goods purchased, administrative expenses (rent, salary. etc.), manufacturing (oil, fuel, etc,) selling and distribution expenses (Commission, discount, advertising, etc.), Depreciation, interest on loan, loss on sale of assets, etc. S. No. 1. Revenue Expenditure Capital Expenditure Its effect is temporary, i.e. the benefit Its effect is long-term, i.e. it is not is received within the accounting exhausted within the current accounting year. year-its benefit is received for a number of years in future. Neither an asset is acquired nor the An asset is acquired or the value of an value of an asset is increased. existing asset is increased. It has no physical existence because Generally it has physical existence except

2. 3.

4. 5. 6.

it is incurred on items which are used by the business. It is recurring and regular and it occurs repeatedly. This expenditure helps to maintain the business. The whole amount of this expenditure is shown in trading P & L A/c or income statement. It does not appear in the balance sheet. It reduces revenue (profit) of the business. Decision regarding capital expenditure is taken by top management This expenditure is not deductible from income for Income tax purpose It increases the earning capacity of the business

intangible assets. It does not occur again and again. It is nonrecurring and irregular. This expenditure improves the position of the business. A portion of this expenditure (depreciation on assets) is shown in trading & P & L A/c and the balance is shown in the balance sheet on asset side. It appears in the balance sheet until its benefit is fully exhausted. It does not reduce the revenue of the concern. Purchase of fixed asset does not affect revenue. Decision regarding capital expenditure is taken by middle and lower level management This expenditure is not deductible from This expenditure is deductible from income for Income tax purpose It maintains the present capacity of the business

7. 8.

9.

10.

11.

9. Example: State with reasons whether the fallowing items of expenditure are capital or revenue: 1. 2. 3. 4. 5. 6. Wages paid on the purchase of goods. Carriage paid on goods purchased. Transportation paid on machinery purchased. Octroi duty paid on machinery. Octroi duty paid on goods. A second-hand car was purchased for Rs.7,000 and Rs.5,000 were spent for its repairs and overhauling. 7. Office building was whitewashed at a cost of Rs.3,000. 8. A new machinery was purchased for Rs.80,000 and a sum of Rs.1,000 was spent on its installation and erection. 9. Books were purchased for Rs.50,000 and Rs.1,000 were paid for carrying books to the library. 10. Land was purchased for Rs.1,00,000 and Rs.5,000 were paid for legal expenses. 11. Rs.50,000 were paid for customs duty and freight on machinery purchased fromJapan. 12. Old furniture was repaired at a cost of Rs.500. 13. An additional room was constructed at a cost of Rs.15,000. 14. Damages paid on account of the breach of contract to supply certain goods. 15. Cost of replacement of an old and worn out part of machinery. 16. Repairs to a motor car met with an accident. 17. Rs.10,000 paid for improving a machinery. 18. Cost of removing plant and machinery to a new site.

19. Cost of acquiring the goodwill of an old firm. 20. Cost of redecorating a cinema hall. 21. Cost of putting up a. gallery in a cinema hall. 22. Compensation paid to a director for loss of his office. 23. Premium paid on the redemption of debentures. 24. Costs of attending a mortgage. 25. Commission paid on issue of debentures. 26. Cost of air-conditioning the office of the director of a company. 27. Repairs and renewal of machinery. 28. Cost of acquiring patent rights and trade marks. 29. Compensation paid to workers for termination of their services. 30. Compensation paid to a person injured by company's car. 31. Expenditures incurred on alteration in windows ordered by municipal authorities. 32. Painting expenditures of a newly-constructed factory. 33. Expenditures incurred on renewal of patent. 34. Expenditures on replacement of a slate roof by a glass roof. 35. Rs.10,000 spent on dismantling, removing and reinstalling machinery and fixtures. 36. legal expenses incurred in an income tax appeal. Solution: Accounts Sr. No. Nature of Expenditure Revenue expenditure Reasons

Wages A/C is debited.

1.

Wages paid on goods purchased and a revenue expenditure because goods purchased are meant for resale. It is recurring by nature as goods are purchased repeatedly in a business. The carriage paid on purchases is a revenue expenditure because goods purchased are meant for resale and whenever goods are purchased carriage is paid to bring the goods to the godown of the business. A machinery purchased is useless until it is brought to the business. As machinery is a fixed asset and transportation paid is an additional cost to the machinery, so it is a capital expenditure.

Carriage A/c is debited.

2.

Revenue expenditure.

Machinery A/c is debited instead of transportation A/c.

3.

Capital expenditure.

Machinery A/c is debited instead of octroi duty A/c

4.

Capital expenditure.

Octroi duty paid on machinery is also an additional cost to the machinery, If it is not paid, the machinery cannot be taken to the business, so it is a capital expenditure. Octroi duty paid on goods is a revenue expenditure because goods mean saleable goods. It is recurring and is paid repeatedly whenever goods are purchased. A second-hand car is a fixed asset as it "can be used for many years and its utility does not diminish in one year, so it is a capital expenditure. But it is useless if it is not made good to work, so the amount spent on its repair and overhauling is also a capital expenditure. Whitewashing of a building is necessary for its maintenance and because of this expenditure the profit earning capacity of the business has not increased, so it is a revenue expenditure. Machinery is a permanent asset of the business and can be used for many years but it will benefit to the business until it is installed and erected at a proper place. So amount spent on purchase of machinery, on its installation and erection is capital expenditure. Fixed asset "Books" has been acquired and can be used for many years. Cost of carrying books is regarded as a part of purchase price of the books, so it is a capital

Octroi duty A/c is debited.

5.

Revenue expenditure.

For both expenditures motor car A/C is debited

6.

Capital expenditure.

White washing A/c is debited.

7.

Revenue expenditure.

Machinery A/c debited for all expenditure.

8.

Capital expenditure.

For bath expenditures Books A/c is debited.

9.

Capital expenditure.

expenditure. Land A/c is debited. 10. Capital expenditure. Land purchased is a fixed asset. All expenses' connected with its acquisition are regarded as a part of its purchase price. Machinery is a fixed asset. All expenses connected with its import from Japan are regarded as a part of its purchase price, So it is capital expenditure. Value of furniture does not increase as a result of its repair -- it is simply kept in a proper working condition. This is an addition to a fixed asset and as a result of this expenditure the value of the building has increased, so it is a capital expenditure. In this case the goods have not been supplied by the business to the customer according to the contract between them. The customer claimed damages which the business paid. It is a usual thing that happens in ordinary course of trading, so it is a revenue expenditure. A worn out part of the machinery is simply the cost of repair and maintenance of fixed asset. The value and profit earning capacity of the machinery has not increased in any way, so it is a revenue expenditure. Cost of repair to a motor car does not increase the value of the car, it is simply

Machinery A/c is debited.

11.

Capital expenditure.

Repair A/c is debited.

12.

Revenue expenditure.

Building A/c is debited.

13.

Capital expenditure.

Damages A/c or general expenses is debited.

14.

Revenue expenditure.

Repair and maintenance A/c is debited.

15.

Revenue Expenditure.

Repair to car A/c is debited.

16.

Revenue Expenditure

incurred to put back the car into working condition, so it is a Revenue expenditure. Machinery A/c is debited. 17. Capital expenditure. Cost has been incurred to 'improve (h machinery. It increases the value and profit earning capacity of the machinery, so it is capital expenditure. Plant and machinery have been removed to a new site in order to increase their profit-earning capacity, so cost of removal is a capital expenditure. Goodwill is an intangible asset and it will benefit to the business for many years. So cost of acquiring goodwill (using the name of an old firm) is always a capital expenditure. Generally a cinema hall is decorated regular and re-decorating cost is a recurring expenditure Moreover, it will not add to the capacity of the hall, so it is a revenue expenditure. As a gallery has been put up in the cinema hall, it increases the capacity of the hall, which in turns enhances the profit-earning capacity of the business, therefore, the cost is treated as a capital expenditure. Compensation paid to the director of a company ,for the loss of his office is a revenue expenditure because the company will get the benefit of this expenditure only for one year. By issuing debentures, money is borrowed from the public for a long period of time and is used in the

Plant and , Machinery A/c is debited.

18.

Capital expenditure.

Goodwill A/c is debited.

19.

Capital expenditure.

Re-decoration 'A/c or Maintenance A/c is debited.

20.

Revenue expenditure.

Cinema hall A/c or Building ' debited.

21.

Capital expenditure.

Expense A/c is debited.

22.

Revenue expenditure.

23.

Capital expenditure.

purchase of fixed assets or on the expansion of the business, therefore, premium paid is a capital expenditure. 24. Capital expenditure. Mortgage means a deed showing that the money has been borrowed (loan raised) by mortgaging assets as collateral security. The assets will remain mortgaged with the lender until the loan has been repaid. So the assets have been utilized for raising loan and the costs attending the mortgage is, therefore, a capital expenditure. Debentures are considered as borrowed capital and are used for the acquisition of fixed assets such as machinery etc., therefore, commission paid on issue of debentures is a capital expenditure. By making the office of the director, air-conditioned, the efficiency of the director will increase and it will last for many years, so cost of airconditioning is a capital expenditure. Annual repair and renewal of machinery is necessary to keep it in a proper working c

25.

Capital expenditure.

26.

Capital expenditure.

Repair A/c is debited.

27.

Revenue expenditure.

11. How can revenue expenditure turn into capital expenditure? Ans: Some expenditures although of revenue nature basically, are directly connected with fixed assets and spent directly on the acquisition of fixed assets. Such expenditures are added to the cost of assets and are called "Capitalized Expenditures". For example, we buy a second-hand plant for $50,000. This is undoubtedly a capital expenditure. A further sum of $5,000 is spent on its repair and overhauling in order to bring the plant into proper working order. Expenditure on account of repair and overhauling, although revenue by nature, will be treated as Capital Expenditure in this case and will be debited to plant account not to Repairs A/c. Thus, a revenue expenditure which

increases the utility or productive capacity of an asset, is treated as capitalized expenditure. Below are a few examples of such expenditure: (a) Expenditure on installing an asset. i.e. installation charges. (b) Expenditure on repair to property, if the production capacity or utility of the property is increased. It may, however, be noted that sometimes a new asset may require some repair after its purchase but before it is installed and put into operation. Cost of such repair, although it may not increase the production capacity of the asset, will be treated as a capitalized expenditure. (c) Expenditure incidental to purchase of fixed assets, e.g. freight, clearing charges, customs duty, carriage, octroi duty, import duty on assets purchased. (d) Expenditure on removal of old property. (e) Cost of repair to second-hand assets: Repair is a revenue expenditure. But the cost of repair after buying a second-hand asset to bring them into proper working condition is treated as Capitalized Expenditure. (f) Wages: It is a revenue expenditure but if paid for installation of a machine or plant, then it is treated as a capitalized expenditure. (g) Legal Charges: Legal charges i.e. lawyer's fee, court fee in connection with the purchase of asset of permanent nature are regarded as capital expenditure. (h) Interest: Interest paid is generally a revenue expenditure. But in some industries like iron & steel, cement industry etc., a concern has to wait for a long period before it starts operation. Interest for such period on capital and loan is treated as capital expenditure.

Objective Type questions 1. Capital expenditure is any expenditure benefiting ..period (a) current (b) future (c) past (d) more than one accounting period 2. The cost of housing plot purchased for sale is a. expenditure (a) Capital (b) revenue (c) deferred revenue (d) miscellaneous 3. Amount spent on asset to make it useable conditions is debited to (a) Profit and loss Account (b) Income and expenditure account (c) Assets account (d) Receipts and payment account

4. A heavy expenditure incurred in introducing a new product into the market is (a) Capital expenditure (b) revenue expenditure (c) deferred revenue (d) miscellaneous 5. Rs.200000 spent as traveling expenses by the directors to go to abroad for purchase of capital asset is (a) Capital expenditure (b) revenue expenditure (c) deferred revenue expenditure (d) miscellaneous 6. Rs.20000 spent on the repairs of machine is (a) Capital expenditure (b) revenue expenditure (c) deferred revenue expenditure (d) miscellaneous 7. Rs.25000 spent on overhauling the second hand machinery (a) Capital expenditure (b) revenue expenditure (c) deferred revenue expenditure (d) miscellaneous 8. White washing expenses is a (a) Capital expenditure (b) revenue expenditure (c) deferred revenue expenditure (d) miscellaneous 9. TVS limited received a subsidy of Rs 1 crore from the central government is a (a) Revenue receipt (b) Revenue expenditure (c) Capital expenditure (d) Capital receipt 10. A debt recorded as bad in the earlier year recovered during the year is a (a) Revenue receipt (b) Revenue expenditure (c) Capital expenditure (d) Capital receipt 11. Failure to make distinction between capital and revenue items will result in (a) under trading (b) overtrading (c) Receipts and payment A/c being false and misleading (d) Final accounts being false and misleading 12. Wages paid for installation of machinery included in the wages will affect

(a) (b) (c) (d)

wages account wages and machinery Profit and loss account Machinery account

13. If an old machinery whose book value is Rs.4000 and is sold at Rs.4200 (a) Rs.4200 treated as capital receipt (b) Rs. 4200 treated as revenue receipt (c) Rs.4000 treated as capital balance ignore (d) Rs.4000 treated as capital & 200 treated as revenue receipt 14. Consider the following - cost of extension of building Rs.250000/- cost of improvement of electrical wiring system Rs.19000, cost of repair to building Rs.25000 and whitewashing charges Rs.5000/- what is the amount of revenue expenditure? (a) Rs.30000/(b) Rs.299000/(c) Rs. 44000/(d) Rs.49000/15. Donation received by a non-trading concern is normally (a) Revenue receipt (b) Revenue expenditure (c) Capital expenditure (d) Capital receipt Problems on accounting equations Assets = Capital + liabilities Owners equity or capital = Assets liabilities Gross profit = Sales cost of goods sold Cost of goods sold = Opening stock + Net purchases+ Direct expenses Closing Stock Net profit = Gross profit indirect expenses 16. Goods purchased Rs.100000/- Sales Rs.90000/- Margin 20% on sales. Closing stock is (a) Rs.10000/(b) Rs.25000/(c) Rs. 28000/(d) Rs.30000/17. Soman starts business with a capital of Rs.45000. He purchases goods on credit worth Rs.5000. How these transactions can be expressed in an Accounting Equation (a) 5000=50000- 45000 (b) 50000 = 50000 (c) 50000 = 45000+5000 (d) 45000 = 50000- 5000 18. The capital at the beginning is Rs.50000. Goods withdrawn during the year is Rs.16000 and additional capital introduced during the year is Rs.20000. The capital at the end of the year Rs.52000. The net effect of the transactions is

(a) (b) (c) (d)

loss Rs.2000/profit Rs.2000/profit Rs. 30000/loss Rs.4000/-

19. In a balance sheet, if total assets amount to Rs.80000/- while the liabilities to outsiders amount to Rs.29000/- and profit during the year Rs.11000/-. What the amount of capital? (a) Rs.40000/(b) Rs.51000/(c) Rs. 80000/(d) Rs.72000/20. Ascertain the cost of goods sold from the following: Opening stock 8500, purchase 30700, direct expenses 4800 indirect expenses5200 closing stock 9000 (a) 3500 (b) 35000 (c) 29800 (d) 30000 ANSWSERS 1] d 2] b 3] c 4] c 5] a 6] b 7] a 8] b 9] d 10] a 11] d 12] b 13] d 14] a 15] d 16] b 17] c 18] a 19] a 20] b