CH-19 CAPITAL AND REVENUE (EXPENSE & INCOME)

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Chapter 19 – Capital and Revenue (Expense & Income)

This chapter is fundamental to understanding financial accounting, as it helps in correctly classifying business transactions either capital items or revenue items.

  1. Introduction

The terms ‘Capital’ and ‘Revenue’ are core concepts in accounting.

Capital generally refers to the funds or assets invested in a business to generate future income.

Revenue refers to the income earned by a business from its normal operations.

  1. Capital Expenditure & Revenue Expenditure:

Capital Expenditure

Any expenditure incurred for acquiring or increasing the value of a fixed asset, or for enhancing the earning capacity of the business. The benefit of such expenditure extends beyond the current accounting period usually more than one year.

Characteristics:

  1. Purpose: To acquire or improve fixed assets (e.g., land, building, plant, machinery, furniture).
  2. Benefit Period: Benefits are received over a long period (multiple accounting periods).
  3. Impact on Earning Capacity: Increases the earning capacity or reduces operating costs.
  4. Nature of Asset: Results in the acquisition of an asset or enhances the value of an existing asset.
  5. Accounting Treatment: Debited to the respective Asset Account and shown on the Assets side of the Balance Sheet.

Examples:

  • Purchase of Land and Building, Plant and Machinery, Furniture, etc.
  • Expenses incurred on the purchase and installation of a new machine (e.g., wages for erection, cartage, freight, overhauling of a second-hand machine before use).

Revenue Expenditure

Any expenditure incurred for the purpose of maintaining the existing earning capacity of the business or for the day-to-day running of the business. The benefit of such expenditure is consumed or received within the current accounting period.

Characteristics:

  1. Purpose: To maintain fixed assets, meet day-to-day operating expenses, or for the normal course of business.
  2. Benefit Period: Benefits are received only within the current accounting period.
  3. Impact on Earning Capacity: Does not increase the earning capacity but helps in maintaining it.
  4. Nature of Asset: Does not result in the acquisition of an asset.
  5. Accounting Treatment: Debited to the Trading Account or Profit & Loss Account.

Examples:

  • Wages, Salaries, Rent, Electricity, Manufacturing expenses, Office expenses, Selling expenses.
  • Cost of goods purchased for resale or raw materials used in production.

Deferred Revenue Expenditure

Expenditure which is revenue in nature but provides benefits over several future accounting periods. It is typically a large amount, and it is considered appropriate to write it off over the period of its benefit rather than in the year it is incurred.

Characteristics:

  1. Nature: Essentially a revenue expenditure.
  2. Benefit Period: Benefits extend beyond the current accounting period.
  3. Amount: Usually a significant amount.
  4. Accounting Treatment: A portion is written off in the current year, and the unwritten-off portion is shown as an asset (fictitious asset) on the Balance Sheet.

Examples:

  • Heavy advertising expenditure incurred for launching a new product.
  • Research and development expenses for a new product.
  • Preliminary expenses (expenses incurred for the formation of a company).

Distinctions between Capital & Revenue Expenditure

Feature Capital Expenditure Revenue Expenditure
Benefit Period Long-term more than one year Short-term within one year
Purpose Acquire/improve fixed assets; enhance earning capacity Maintain existing earning capacity; day-to-day operations
Impact Increases assets or reduces liabilities Does not affect assets directly
Balance Sheet Shown on the Assets side Not shown on Balance Sheet (appears in P&L/Trading A/c)
Profit & Loss A/c Not debited to P&L/Trading A/c Debited to P&L/Trading A/c

 

Question:

Classify the following expenditures as Capital Expenditure or Revenue Expenditure:

  1. Wages paid for the erection of a new machine.
  2. Cost of whitewashing the factory building.
  3. Expenses incurred on replacing a worn-out engine of a motor car, which significantly extends its life.
  4. Freight and cartage paid on the purchase of new raw materials.
  5. Repairs to machinery due to normal wear and tear.
  6. Cost of materials used for constructing an extension to the existing factory building.
  7. Heavy expenditure incurred on advertising a new product launched recently.
  8. Installation expenses of a newly purchased air conditioner for the office.
  9. Legal fees paid for defending a suit concerning the company’s trademark.
  10. Premium paid for fire insurance.

 

Solution:

  1. Wages paid for the erection of a new machine.

Classification: Capital Expenditure

Reason: These wages are directly related to bringing a new asset (machine) into usable condition. They increase the value of the machine and are incurred before the machine is put to use.

  1. Cost of whitewashing the factory building.

Classification: Revenue Expenditure

Reason: This is a routine maintenance expense incurred to keep the building in good condition. It does not enhance the earning capacity or significantly extend the life of the building beyond its normal maintenance.

  1. Expenses incurred on replacing a worn-out engine of a motor car, which significantly extends its life.

Classification: Capital Expenditure

Reason: While it’s a “repair,” the key phrase “significantly extends its life” indicates that it’s an improvement that enhances the asset’s utility and earning capacity over a longer period, going beyond mere routine maintenance.

  1. Freight and cartage paid on the purchase of new raw materials.

Classification: Revenue Expenditure

Reason: This is a direct expense related to acquiring goods for resale or production, which are part of the day-to-day operations. The benefit is consumed within the current accounting period as the raw materials are used or sold.

  1. Repairs to machinery due to normal wear and tear.

Classification: Revenue Expenditure

Reason: These are routine expenses incurred to maintain the machinery in working condition. They do not add to the value of the asset or extend its useful life beyond what was initially expected.

  1. Cost of materials used for constructing an extension to the existing factory building.

Classification: Capital Expenditure

Reason: An extension to a building increases the physical size and utility of a fixed asset. It enhances the earning capacity and provides benefits over a long period.

  1. Heavy expenditure incurred on advertising a new product launched recently.

Classification: Deferred Revenue Expenditure (or sometimes treated as Capital Expenditure in the initial phase, then amortised)

Reason: While advertising is generally revenue, “heavy expenditure” for a “new product” implies that the benefits are expected to accrue over several future years (e.g., building brand awareness, market penetration). Therefore, it’s typically treated as Deferred Revenue Expenditure, where a portion is written off each year.

  1. Installation expenses of a newly purchased air conditioner for the office.

Classification: Capital Expenditure

Reason: These expenses are necessary to make the new air conditioner (a fixed asset) ready for its intended use. They are added to the cost of the asset.

  1. Legal fees paid for defending a suit concerning the company’s trademark.

Classification: Revenue Expenditure

Reason: These are expenses incurred to protect an existing asset (trademark) or to maintain the legal standing of the business in its normal course of operations. They do not add new assets or significantly enhance the value of existing ones.

  1. Premium paid for fire insurance.

Classification: Revenue Expenditure

Reason: This is a recurring expense incurred annually to protect the business from risks. The benefit is for the current period (the insurance coverage period). 

  1. Capital Receipts and Revenue Receipts:

Capital Receipts

Receipts that are non-recurring in nature and generally relate to the capital structure of the business. They do not arise from the normal course of business operations.

Characteristics:

  1. Nature: Non-recurring.
  2. Source: Generally from the sale of fixed assets, issue of shares/debentures, or long-term loans.
  3. Impact on Capital/Liabilities: Either increases capital or creates a liability.
  4. Accounting Treatment: Shown on the Liabilities side of the Balance Sheet or credited to Capital Account.

Examples:

Amount received from the issue of shares and debentures.

Proceeds from the sale of a fixed asset (e.g., old machinery, building).

Revenue Receipts

Receipts that are recurring in nature and arise from the normal course of business operations.

Characteristics:

  1. Nature:
  2. Source: From the sale of goods/services, interest, dividends, rent received, etc.
  3. Impact on Revenue: Increases the revenue of the business.
  4. Accounting Treatment: Credited to the Trading Account or Profit & Loss Account.

Examples:

Proceeds from the sale of goods or services.

Interest received on investments.

Difference between Capital and Revenue Receipts

Feature Capital Receipt Revenue Receipt
Nature Non-recurring Recurring
Source Sale of fixed assets, loans, share issue Sale of goods/services, interest, rent
Impact Increases capital/liability Increases revenue
Balance Sheet Shown on the Liabilities side Not shown on Balance Sheet (appears in P&L/Trading A/c)
Profit & Loss A/c Not credited to P&L/Trading A/c Credited to P&L/Trading A/c

 

Questions on Capital and Revenue Receipts

Classify the following receipts as either Capital Receipt or Revenue Receipt, providing a brief reason for your classification.

  1. Amount received from the sale of old newspapers and scrap materials.
  2. Loan taken from State Bank of India for business expansion.
  3. Proceeds from the sale of a machine that was used in the factory.
  4. Rent received from a portion of the building that is sublet.
  5. Subscription money received from members by a non-profit organization.
  6. Interest received on fixed deposits with a bank.
  7. Capital brought in by the proprietor to start a new business.
  8. Sale proceeds of goods sold to customers on credit.
  9. Donation received for the construction of a new classroom by a school.
  10. Commission received for acting as an agent.
  11. Grant received from the government for meeting daily administrative expenses.
  12. Amount realized from the issue of shares to the public.
  13. Recovery of Bad Debts (where the bad debts were previously written off).
  14. Legacy received by a club (as per the will of a deceased person).
  15. Fees collected from students by a coaching institute.

Solutions:

  1. Amount received from the sale of old newspapers and scrap materials.

Classification: Revenue Receipt

Reason: This is a recurring receipt from the incidental sale of waste products that arise in the normal course of business operations. It helps offset minor expenses.

  1. Loan taken from State Bank of India for business expansion.

Classification: Capital Receipt

Reason: A loan creates a long-term liability for the business. It’s a source of capital (funds) and is not generated from the primary operating activities.

  1. Proceeds from the sale of a machine that was used in the factory.

Classification: Capital Receipt

Reason: This receipt is from the sale of a fixed asset. Fixed assets are not held for resale in the ordinary course of business, making their sale proceeds a capital nature.

  1. Rent received from a portion of the building that is sublet.

Classification: Revenue Receipt

Reason: If the business regularly sublets part of its property or has this as a recurring income stream, it’s considered part of its normal operations (even if secondary) and thus a revenue receipt.

  1. Subscription money received from members by a non-profit organization.

Classification: Revenue Receipt

Reason: For non-profit organisations, subscriptions are a regular and recurring source of income to meet their day-to-day operational expenses.

  1. Interest received on fixed deposits with a bank.

Classification: Revenue Receipt

Reason: This is income earned regularly from investments, which is part of the financial activities of a business and recurs over time.

  1. Capital brought in by the proprietor to start a new business.

Classification: Capital Receipt

Reason: This is the initial or additional investment made by the owner into the business. It forms part of the owner’s equity and is not generated from operational activities.

  1. Sale proceeds of goods sold to customers on credit.

Classification: Revenue Receipt

Reason: This is the primary source of income for most businesses, arising directly from their core operation of selling goods or services. It’s recurring in nature.

  1. Donation received for the construction of a new classroom by a school.

Classification: Capital Receipt

Reason: This is a specific donation tied to the creation of a fixed asset (a new classroom). Its benefit is long-term, and it’s not for day-to-day operational expenses.

  1. Commission received for acting as an agent.

Classification: Revenue Receipt

Reason: If acting as an agent and earning commission is part of the regular business activity, then it’s a recurring income from services rendered.

  1. Grant received from the government for meeting daily administrative expenses.

Classification: Revenue Receipt

Reason: This grant is for routine, recurring operational expenses and directly supports the day-to-day functioning of the entity.

  1. Amount realised from the issue of shares to the public.

Classification: Capital Receipt

Reason: This directly increases the capital base of the company. It’s a non-recurring event used to raise long-term funds for the business.

  1. Recovery of Bad Debts (where the bad debts were previously written off).

Classification: Revenue Receipt

Reason: When bad debts are written off, they reduce the profit. Their subsequent recovery reverses that impact and is considered a gain related to past revenue transactions.

  1. Legacy received by a club (as per the will of a deceased person).

Classification: Capital Receipt

Reason: A legacy is typically a one-time, significant receipt, usually not part of the club’s regular activities, and often intended to create an endowment or fund for long-term use.

  1. Fees collected from students by a coaching institute.

Classification: Revenue Receipt

Reason: This is the core income for a coaching institute, arising directly from its primary service of providing education. It’s regular and recurring.

C.Capital Loss and Revenue Loss

Capital Loss

A capital loss is a loss incurred when a capital asset (or fixed asset) is sold for a price lower than its original cost (or its written down value/book value, if depreciation has been charged). It is a non-recurring loss and does not arise from the normal day-to-day operations of the business.

Examples:

  • Selling an old machine for less than its book value.
  • Selling a piece of land at a price lower than its purchase price.
  • Loss incurred on the sale of investments (e.g., shares or debentures) held for a long term.

Revenue Loss

A revenue loss refers to a loss incurred in the normal course of business operations during an accounting period when total revenue is less than total revenue expenses. It is a recurring loss that reflects the operational inefficiency or an unfavourable operating environment of the business. It can also refer to losses arising from regular trading activities.

Examples:

  • Selling goods for less than their cost of purchase or production (loss on sale of goods).
  • Loss due to theft of stock (goods meant for resale).
  • Loss due to fire or flood destroying inventory (goods).

Questions on Capital Loss and Revenue Loss

Classify the following scenarios as resulting in a Capital Loss or a Revenue Loss, and briefly explain your reasoning.

  1. A furniture dealer sells a dining table from his showroom stock for ₹10,000, which he had purchased for ₹12,000.
  2. A manufacturing company sells an old, unused machine for ₹50,000. Its book value (original cost less depreciation) was ₹75,000.
  3. Goods worth ₹25,000 held for resale are destroyed by fire.
  4. A company’s total operating expenses for the year amount to ₹5,00,000, while its total operating revenue is ₹4,50,000.
  5. A business invests in shares of another company as a long-term investment. It sells these shares for ₹80,000, which were originally purchased for ₹1,00,000.
  6. During the year, a retail shop experiences theft of goods from its shelves amounting to ₹5,000.
  7. A software company sells its office building for ₹1,50,00,000. The book value of the building was ₹1,80,00,000.
  8. Debts amounting to ₹15,000 from a customer (who purchased goods on credit) become irrecoverable and are written off.

Solutions:

  1. A furniture dealer sells a dining table from his showroom stock for ₹10,000, which he had purchased for ₹12,000.

Classification: Revenue Loss

Reason: The dining table is part of the dealer’s regular trading stock (goods meant for resale). Selling goods below their cost is a loss incurred in the normal course of business operations.

  1. A manufacturing company sells an old, unused machine for ₹50,000. Its book value (original cost less depreciation) was ₹75,000.

Classification: Capital Loss

Reason: The machine is a fixed asset, not an item held for regular resale. The loss arises from the disposal of a non-current asset, making it a capital loss.

  1. Goods worth ₹25,000 held for resale are destroyed by fire.

Classification: Revenue Loss

Reason: These are goods (inventory) meant for sale in the ordinary course of business. Loss due to fire, theft, or any other casualty affecting inventory is considered a loss arising from operating activities.

  1. A company’s total operating expenses for the year amount to ₹5,00,000, while its total operating revenue is ₹4,50,000.

Classification: Revenue Loss (specifically, a Net Operating Loss or Net Loss)

Reason: When the total expenses incurred in running the day-to-day operations exceed the total revenue earned from those operations, it results in an overall revenue loss for the period.

  1. A business invests in shares of another company as a long-term investment. It sells these shares for ₹80,000, which were originally purchased for ₹1,00,000.

Classification: Capital Loss

Reason: The shares are held as a long-term investment, which is a capital asset. The loss arises from the sale of this non-operating asset.

  1. During the year, a retail shop experiences theft of goods from its shelves amounting to ₹5,000.

Classification: Revenue Loss

Reason: These are goods (inventory) that were meant for sale. Loss due to theft of stock is an operational loss, impacting the revenue-generating cycle.

  1. A software company sells its office building for ₹1,50,00,000. The book value of the building was ₹1,80,00,000.

Classification: Capital Loss

Reason: The office building is a fixed asset. The loss incurred on its sale (selling price less than book value) is not part of the company’s core software development or sales activities.

  1. Debts amounting to ₹15,000 from a customer (who purchased goods on credit) become irrecoverable and are written off.

Classification: Revenue Loss

Reason: Bad debts arise directly from credit sales, which are a core revenue-generating activity. They represent a failure to collect revenue that was expected, hence it’s an operational loss.

D.Capital Profit and Revenue Profit:

Capital Profit

A capital profit is a profit that arises from transactions that are not part of the normal, day-to-day operating activities of the business. These profits are typically non-recurring and are generated from the sale or revaluation of capital assets (fixed assets or long-term investments).

Examples:

  • Profit on the sale of an old delivery van for more than its book value.
  • Profit on the sale of a piece of land or building no longer needed by the business.

Revenue Profit

A revenue profit is the profit generated from the normal, day-to-day operating activities of the business. These profits are recurring in nature and represent the core earning capacity of the business.

Examples:

  • Profit earned from selling stationery by a stationery shop.
  • Commission received from clients for services rendered.

Questions on Capital Profit and Revenue Profit

Classify the following scenarios as resulting in a Capital Profit or a Revenue Profit, and briefly explain your reasoning.

  1. A shoe manufacturing company sells shoes for ₹5,00,000 that cost them ₹3,00,000 to produce.
  2. A company sells an old, fully depreciated delivery van for ₹20,000. Its book value was ₹
  3. A retailer receives a discount of ₹5,000 from a supplier for making a bulk purchase of goods.
  4. A business owns a plot of land not used for its main operations. It sells this land for ₹20,00,000, which was originally purchased for ₹15,00,000.
  5. A company issues new shares to the public at a premium of ₹10 per share.
  6. An advertising agency receives a commission of ₹15,000 for creating an ad campaign for a client.
  7. A club receives a donation of ₹5,00,000 specifically for the construction of a new sports complex.
  8. A general store earns ₹50,000 from daily sales of groceries.
  9. Interest received on a fixed deposit from the bank amounting to ₹8,000.
  10. A publishing house sells its old printing press for ₹1,20,000. Its book value was ₹90,000.

Solutions:

  1. A shoe manufacturing company sells shoes for ₹5,00,000 that cost them ₹3,00,000 to produce.

Classification: Revenue Profit (specifically, Gross Profit)

Reason: Selling shoes is the core business activity of a shoe manufacturing company. The profit arises from its normal operations.

  1. A company sells an old, fully depreciated delivery van for ₹20,000. Its book value was ₹

Classification: Capital Profit

Reason: The delivery van is a fixed asset. The profit arises from the sale of a non-current asset, which is not part of the company’s regular trading activities.

  1. A retailer receives a discount of ₹5,000 from a supplier for making a bulk purchase of goods.

Classification: Revenue Profit (or reduction in cost, leading to higher revenue profit)

Reason: This discount directly reduces the cost of goods purchased for resale, thereby increasing the gross profit on sales, which is a revenue item. It relates to the normal buying and selling operations.

  1. A business owns a plot of land not used for its main operations. It sells this land for ₹20,00,000, which was originally purchased for ₹15,00,000.

Classification: Capital Profit

Reason: The land is a fixed asset. The profit arises from the sale of a non-operating asset, which is a non-recurring event for most businesses.

  1. A company issues new shares to the public at a premium of ₹10 per share.

Classification: Capital Profit (or Capital Gain, transferred to Share Premium Account/Capital Reserve)

Reason: Share premium is a profit arising from the capital structure of the company (issue of shares). It’s not generated from day-to-day operations and is typically transferred to a Capital Reserve.

  1. An advertising agency receives a commission of ₹15,000 for creating an ad campaign for a client.

Classification: Revenue Profit

Reason: Earning commission for providing services is the primary revenue-generating activity for an advertising agency.

  1. A club receives a donation of ₹5,00,000 specifically for the construction of a new sports complex.

Classification: Capital Profit (or Capital Receipt)

Reason: This donation is specifically tied to the creation of a fixed asset. It’s a one-time receipt for a long-term purpose, not for covering daily expenses.

  1. A general store earns ₹50,000 from daily sales of groceries.

Classification: Revenue Profit

Reason: Selling groceries is the core business activity of a general store. This profit is earned from its regular, day-to-day operations.

  1. Interest received on a fixed deposit from the bank amounting to ₹8,000.

Classification: Revenue Profit

Reason: Interest income is a recurring income generated from the temporary surplus funds of the business, considered part of its normal financial activities.

  1. A publishing house sells its old printing press for ₹1,20,000. Its book value was ₹90,000.

Classification: Capital Profit

Reason: The printing press is a fixed asset. The profit arises from the sale of this non-current asset, which is not the main business of a publishing house.

 

 

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