Financial Accounting Lecture Series

(XII)

Capital and Revenue

Prof. M. C. Sharma

Department of Commerce
Shaheed Bhagat Singh Evening
College
(University of Delhi)
Delhi
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Quick Revision:
Trial Balance:
The statement prepared with the help of ledger balances, at any date
to find out whether debit total agrees with credit total is called Trial
Balance.
Objectives or Functions of Trial Balance
Preparing Trial Balance:
Balance Method
Total Method
Balance and Total Method

Preparing a Correct Trial Balance

Limitations of Trial Balance

Quick Revision:
Accounting Errors and Omissions
Types of Errors
On the Basis of Nature

On the basis of effect on

Trial Balance

Errors of Omission

Errors affecting trial balance

Errors of Commission

Errors not affecting trial

balance

Compensating Errors
Errors of Principles

Detection of Errors

Learning Objectives:
Understanding the concept of Capital
Understanding the concept of Revenue and

Income
Classification of Expenditures
Classification of Receipts

Nature of Transactions
Capital Nature of transactions:
Benefits are derived for long-term
Non-recurring
Not in ordinary course of business
Revenue Nature of transactions:
Benefits are derived for short-term (usually one
year)
Recurring
In ordinary course of business
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Concept of Capital
Capital may be referred as the amount (in terms

of money or assets having money value) which is

invested by the owner(s) in the business.
Capital is the amount of cash and other assets

owned by a business.
Capital

can also represent the accumulated

wealth of a business, represented by its assets
less liabilities.

Capital can also mean stock or ownership in a

company.
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Concept of
Income/Revenue
In accounting , the term income refers to business

income or accounting income.

Income is increases in economic benefits during the
accounting period in the form of inflows or
enhancements of assets or decreases of liabilities
that result in increases in equity, other than those
relating
to
contributions
from
equity
participants(IASB Framework).
Income is therefore an increase in the net assets of
the entity during an accounting period except for
such increases caused by the contributions from
owners.
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Business Income
Business

income
transactions.

is

based

on

actual

It is based on accounting period concept.

Business income is based on the recognition

and measurement of revenues.

Business

income requires identifying and

measuring costs (expenses) incurred to earn
revenue.

Business

concept.

income

is

bases

on

matching
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Gross Income Vs. Net

Income
Gross

income is total revenue of

business during an accounting period.

the

Net income (or Profit) for a given period is

derived by deducting expenses incurred to

earn revenues from gross income.

Classification of
Expenditures
Capital Expenditure
Revenue Expenditure
Deferred Revenue Expenditure

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Capital Expenditure
Capital expenditure benefits the business for

a long period and creates a tangible or

intangible assets for the business. It also helps
in generating revenue for the business.
Normally the amount involved in capital
expenditure is also substantial.

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Examples of Capital
Expenditure
Acquisition of a tangible fixed asset. All money

spent for acquiring a permanent asset are treated as

capital expenditure, as the assets are used for a long
time.
Extension of or improvement in fixed assets.

The expenditure incurred will be capital expenditure

if it has been incurred on the extension of a fixed
assets or for improvement in fixed asset as it leads
to increase in profit earning capacity.
Investment in shares, debentures and other

financial securities of other companies for a longterm.

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Examples of Capital
Expenditure
Acquisition of an intangible fixed asset. The expenses

which have been incurred to establish a business or to obtain

a license, copyright, patent right etc. will be capital
expenditure. The cost of purchasing goodwill is also
considered as capital expenditure. These are necessary to do
the business but renewal fees if any are treated as revenue
expenditure.
Development expenditure. Expenditure incurred to bring a

scheme into reality or to make it productive is called

development expenditure. Such expenditure is incurred in
plantation units, mines, housing projects etc. Such
expenditure should be treated as capital expenditure.
Expenses for the upkeep after the production starts, should be
treated as revenue expenditure.
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Accounting Treatment of Capital

Expenditure
Whenever

a
new
asset
is
purchased
or
constructed, the cost of it, being capital expenditure is
debited to the asset account.

Depreciation is charged on the capital assets as per

depreciation policy and methods adopted by the firm. For

the amount of depreciation, Depreciation Account is
debited as it is a loss to the firm and the Asset Account is
credited as the value of the asset is decreased.
While preparing financial statements, depreciation is

shown on the debit side of Profit & Loss Account and the
written down value of the asset is shown on the Assets
side of Balance Sheet.
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Second
Session
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Revenue Expenditure
Revenue expenditure may be defined as an

expenditure which benefits the company for a

short period. The benefits are normally
derived within a year. Such expenditure is
necessary to maintain the assets and to
generate the revenue income in ordinary
course of business.

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Examples of Revenue Expenditure

Recurring expenses. Day to day expenses of recurring

nature, incurred for running the business, such as wages,

salaries, rent, electricity charges, telephone charges, etc.
Cost of materials and goods. In case of materials and

goods purchased only that part of revenue expenditure

which has been consumed or sold during the year, is
considered revenue expenditure for the current year and the
balance is carried to the next year.
Operating expenses. Expenses incurred on operating the

machinery and business, running the vehicles, etc. are

revenue expenses. For example, cost of patrol and lubricant
for car and other vehicles of the firm; cost of diesel for
running a generator, etc.
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Examples of Revenue Expenditure

Maintenance

expenses.
Expenses
incurred
for
maintaining
fixed
assets
are
considered
revenue
expenditure. For example, repairs and maintenance on
building, plant and machinery, furniture, etc.

Depreciation. The decrease in the value of fixed asset due

to its wear and tear, passage of time and obsolescence is

also considered as revenue expenditure.

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Accounting Treatment of Revenue

Expenditure
At the end of the year accounts of revenue expenditures

are closed by transferring to the debit side of Trading and

Profit & Loss Account.
Cost of goods sold consisting of purchase price of goods,

direct expenses and manufacturing expenses are debited

to Trading Account.
Office

and

distribution

administrative
expenses,

expenses,

financial

selling

expenses

and
and

depreciation are debited to Profit & Loss Account.

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Difference b/w
Capital Expenditure and Revenue
Expenditure
Basis of
Capital Expenditure
Difference
1. Objective It is incurred for the
purchases of tangible
and intangible fixed
assets.
2. Period of Benefits are derived for
benefit
long term.

Revenue Expenditure
It is incurred for the conduct of
business.

The
benefits
of
revenue
expenditure
are
derived
immediately or within one
year.
3. Earning
Capital
expenditure It does not increase the
capacity
increases the earning earning capacity.
capacity
of
the
business.
4.
Capital expenditure is Revenue expenditure is shown
Accounting
shown as an asset in on the debit side of Trading
the Balance Sheet.
and Profit & Loss A/c.
5.
Depreciation is charged No depreciation is charged on
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Depreciation on capital expenditure. revenue expenditure.

Revenue Expenditures to be
treated as
Capital Expenditure
Wages. When wages paid are for construction or

erection of building or for installation of a plant or

machinery are treated as capital expenditure. Wages
paid to produce tools are also capital expenditure.
Transportation Cost. Freight and carriage paid on

acquisition of a fixed asset, these are treated as

capital expenditure.
Raw materials, goods and stores. Cost of raw

material, goods and stores used for manufacturing a

fixed asset is treated as capital expenditure.
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Revenue Expenditures to be
treated as
Capital Expenditure
Repairs. Repairs charges incurred first time on a second

hand asset purchase is treated as capital expenditure.

Legal expenditure. To acquire the title of some fixed

assets legal charges, like registration and stamp duty are

paid. These are treated as capital expenditure.
Interest on loan. When Interest is paid on loan (raised

to acquire fixed assets) for the period before starting

commercial production is treated as capital expenditure.

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Example:
Do you consider the following to be capital or
revenue expenditure? Give reason.
1) The cost of removal of stock from old work shop to new work

shop Rs. 3,000.

2) Legal expenses incurred for purchase of a building.
3) Paid white-washing charges Rs.1,000.
4) Purchased a motorcycle for marketing manager.
5) Rs. 10,000 was paid as compensation to a discharged
employee.
Solution
6) Revenue expenditure.
7) Capital expenditure.
8) Revenue expenditure.
9) Capital expenditure.
10)Revenue expenditure.
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Deferred Revenue
Expenditure
According to guidance notes on terms used in

financial statement issued by the Institute

of Chartered Accountants of India,
Deferred revenue expenditure are those
expenditure for which payment has been
made or a liability has been incurred but
which is carried forward on the presumption
that it will be of benefit over a subsequent
period or periods.

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Accounting Treatment Of
Deferred revenue expenditure
Deferred revenue expenditure is written off

over the period of benefit or a reasonable

period.
The amount written off in a year is debited to

Profit & Loss Account and credited to the

deferred revenue expenditure account.
The unwritten off part of deferred revenue

expenditure is shown on the assets side of the

balance
sheet
under
the
heading
Miscellaneous expenditure.
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Distinction between Deferred

Revenue Expenditure and Revenue
Expenditure
Basis of
Deferred Revenue
Revenue Expenditure
Expenditure
difference
1. Benefit
It benefits the business Benefits
of
revenue
for more than one year.
expenditure are derived
in the year of incurrence.
2.
It is written off over the It is fully written in the
Accounting period
of
benefit. year in which it is
Unwritten off part is incurred.
shown in the balance
sheet.

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State in the following cases whether the

expenditure is a capital expenditure or
revenue expenditure or deferred revenue
expenditure.

1) Wages paid to workers for converting raw

material into finished goods.

2) Custom duty paid on imported machinery.
3) Office rent paid in advance for three years.
4) Heavy expenditure incurred on advertising a

new product.
5) Expenditure on development of a product.
6) Amount spent to overhaul a motor truck

purchased on second hand .

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Solution
1) Revenue expenditure. The expenditure has been

incurred in the normal course of business.

2) Capital expenditure. It is incurred on acquisition

of asset and necessarily adds to the value of

imported machinery.
3) Deferred revenue expenditure. Here, 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 year). Only a portion of the total office rent
paid, relating to the current period should be
treated as revenue expenditure and the balance
should be carried forward as an asset.
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Solution
4) Deferred

revenue expenditure. The

benefit of this expenditure will be available
for a number of years. The proportionate
amount will be written off every year.

5) Revenue

expenditure. The expenditure

incurred has been in the normal course of
business.

6) Capital

expenditure. The expenditure

incurred will improve the present condition
of the motor truck.
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Capital and Revenue Receipts

Capital

receipts are the amounts received,

normally of non - recurring nature, not obtained in
the ordinary course of business and not available
for payment as profits to the owners.
Thus, capital receipts are the amounts received as
additional capital from owner(s), loan received
and sale proceeds of fixed assets.
Capital receipts either increase the liabilities or
reduce the assets of the firm.
Capital receipts do not affect the profit or loss of
the firm.
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Capital and Revenue Receipts

Revenue receipts are normally of recurring

nature, obtained in the ordinary course of

business mainly through sale of goods and
services.
Amount received does not need to be
returned to anyone.
Revenue receipts are treated as income and
shown on the credit side of Profit and Loss
Account.
Revenue receipts, net of revenue expenses
and expired portion of capital and deferred
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