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There are 2 types of Transaction
1. Capital
2. Revenue
The concepts of capital and revenue are of fundamental importance to the correct determination of accounting profit for a period and recognition of business assets at the end of that period.
• Capital Transactions:
Transactions having long-term effect are known as capital transactions.
• Revenue Transactions:
Transactions having short-term effect are known as revenue transactions.
• Capital Expenditure
Capital expenditure can be defined as expenditure incurred on the purchase, alteration or improvement of fixed assets. For example, the purchase of a car to be use to deliver goods is capital expenditure. Included in capital expenditure are such costs as:
• Delivery of fixed assets;
• Installation of fixed assets;
• Improvement (but not repair) of fixed assets;
• Legal costs of buying property;
• Demolition costs;
• Architects fees;
• Revenue Expenditures
Revenue expenditure is expenditure incurred in the running / management of the business. For example, the cost of petrol or diesel for cars is revenue expenditure. Other revenue expenditure:
• Maintenance of Fixed Assets;
• Administration of the business;
• Selling and distribution expenses.
Capitalized Expenditure
Expenditure connected with the purchase of fixed asset are called capitalized expenditure e.g. wages paid for the installation of machinery.
The Treatments of Capital and Revenue Expenditures
Capital expenditures are shown in the Balance Sheet Assets Side while Revenue Expenditures are shown in the Trading and Profit And Loss Account debit side.
Revenue Receipts
Amount received against revenue income are called revenue receipt.
Capital Receipts
Amount received against capital income are called capital receipts.
Capital Profits
Capital profit which is earned on the sale of the fixed assets.
Revenue Profit
The profit which is earned during the ordinary course of business is called revenue profit.
Capital Loss
The loss suffered by a company on the sale of fixed assets.
Revenue Loss
The loss suffered by the business in the ordinary course of business is called revenue loss.
Rules for Determining Capital Expenditure
An expenditure can be recognised as capital if it is incurred for the following purposes :
• An expenditure incurred for the purpose of acquiring long term assets (useful life is at least more than one accounting period) for use in business to earn profits and not meant for resale, will be treated as a capital expenditure. For example, if a second hand motor car dealer buys a piece of furniture with a view to use it in business; it will be a capital expenditure. But if he buys second hand motor cars, for re-sale, then it will be a revenue expenditure because he deals in second hand motor cars.
• When an expenditure is incurred to improve the present condition of a machine or putting an old asset into working condition, it is recognised as a capital expenditure. The expenditure is capitalized and added to the cost of the asset. Likewise, any expenditure incurred to put an asset into working condition is also a capital expenditure.
• For example, if one buys a machine for ` 5,00,000 and pays ` 20,000 as transportation charges and ` 40,000 as installation charges, the total cost of the machine comes upto ` 5,60,000. Similarly, if a building is purchased for ` 1,00,000 and ` 5,000 is spent on registration and stamp duty, the capital expenditure on the building stands at ` 1,05,000.
• If an expenditure is incurred, to increase earning capacity of a business will be considered as of capital nature. For example, expenditure incurred for shifting ‘the ‘factory for easy supply of raw materials. Here, the cost of such shifting will be a capital expenditure.
• Preliminary expenses incurred before the commencement of business is considered capital expenditure. For example, legal charges paid for drafting the memorandum and articles of association of a company or brokerage paid to brokers, or commission paid to underwriters for raising capital.
• Thus, one useful way of recognising an expenditure as capital is to see that the business will own something which qualifies as an asset at the end of the accounting period.
Some examples of capital expenditure:
(i) Purchase of land, building, machinery or furniture
(ii) Cost of leasehold land and building
(iii) Cost of purchased goodwill
(iv) Preliminary expenditures
(v) Cost of additions or extensions to existing assets
(vi) Cost of overhauling second-hand machines
(vii) Expenditure on putting an asset into working condition and
(viii) Cost incurred for increasing the earning capacity of a business.
Rules for Determining Revenue Expenditure
Any expenditure which cannot be recognised as capital expenditure can be termed as revenue expenditure. A revenue expenditure temporarily influences only the profit earning capacity of the business. An expenditure is recognised as revenue when it is incurred for the following purposes :
Expenditure for day-to-day conduct of the business, the benefits of which last less than one year.
Examples are wages of workmen, interest on borrowed capital, rent, selling expenses, and so on.
Expenditure on consumable items, on goods and services for resale either in their original or improved form. Examples are purchases of raw materials, office stationery, and the like. At the end of the year, there may be some revenue items (stock, stationery, etc.) still in hand. These are generally passed over to the next year though they were acquired in the previous year.
Expenditures incurred for maintaining fixed assets in working order.
For example, repairs, renewals and depreciation.
Some examples of revenue expenditure
(i) Salaries and wages paid to the employees;
(ii) Rent and rates for the factory or office premises;
(iii) Depreciation on plant and machinery;
(iv) Consumable stores;
(v) Inventory of raw materials, work-in-progress and finished goods;
(vi) Insurance premium;
(vii) Taxes and legal expenses; and
(viii) Miscellaneous expenses.
Deferred Revenue Expenditures
Deferred revenue expenditures represent certain types of assets whose usefulness does not expire in the year of their occurrence but generally expires in the near future. These type of expenditures are carried forward and are written off in future accounting periods. Sometimes, we make some revenue expenditure but it eventually becomes a capital asset (generally of an intangible nature). If one undertake substantial repairs to the existing building, the deterioration of the premises may be avoided. We may engage our own employees to do that work and pay them at prevailing wage-rate, which is of a revenue nature. If this expenditure is treated as a revenue expenditure and the current year’s-profit is charged with these expenses, we are making the current year to absorb the entire expenses, though the benefit of which will be enjoyed for a number of accounting years. To overcome this difficulty, the entire expenditure is capitalised and is added to the asset account. Another example is an insurance policy. A business can pay insurance premium in advance, say, for a 3 year period. The right does not expire in the accounting period in which it is paid but will expire within a fairly short period of time (3 years). Only a portion of the total premium paid should be treated as a revenue expenditure (portion pertaining to the current period) and the balance should be carried forward as an asset to be written off in subsequent years.
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