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Concept of Capital and Revenue

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The main purposes of maintaining details and systematic record of business transactions are to ascertain the result of the business operation for an accounting year and to ascertain the financial position on a particular date. An income statement is prepared to ascertain the result, and a position statement called balance sheet for determining the financial position. The income statement and balance sheet together are called final accounts.
The wrong classification of items would lead to the wrong ascertainment of profit and also the financial position. It is, therefore, necessary to determine correctly whether an item is of a capital or of a revenue nature. This distinction is also important for taxation point of view because capital profits are taxed differently from revenue profits.

Basis for Classifying Capital and Revenue Items

Following are the basis to classify capital and revenue items:

  • Objectives
    An expenditure made for increasing earning capacity whereas revenue concept is concerned with maintaining current earning capacity.
  • Time period
    Capital items are concerned for long-term whereas revenue items are short-term in nature.
  • Nature
    Revenue items are recurring in nature and capital items are non-recurring.
  • Amount
    The amount of capital items and huge compared to revenue items.
  • Classification
    Capital items are classified as assets, liabilities and capital whereas revenue items are classified as income, expenses, profit, and loss.

Capital Expenditure and Revenue Expenditure

A business incurs expenditure on two types of items: (i) routine items like stationery, postage, repairs, salaries, etc., where the benefit is available for a short period, and (ii) fixed assets like machinery, building, furniture, etc., whose benefit is available over a number of years. In accounting terminology, the first category of expenditures is called revenue expense and the second one is called capital expenditure.


Capital Expenditure

When the benefit of expenditure is available over a number of years, it is considered as capital expenditure. The following expenditures are usually treated as capital expenditures.Any expenditure which results in the acquisition of fixed assets such as land, buildings, plant and machinery, furniture and fixtures, office equipment, copyright etc. These expenditures include not only the purchase price of the fixed waste but also various other expenses incurred in connection with their acquisition. So brokerage or commission paid in connection with the acquisition of assets, freight and cartage paid for the transportation of machinery, the expense incurred on its installation, legal fees and registration charges incurred in connection with the purchase of land and buildings are also treated as capital expenditure.

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Any expenditure incurred on a fixed asset which results the following:

  • It's expansion,
  • Increase in its life substantially and,
  • Increase in its revenue earning capacity which can be in the form of
  • Increased production capacity
  • Reduced cost of production
  • Increased sales of the firm.
  • Expenditure incurred, during the early years, on the development of mines and land for plantations till they become operational.
  • The cost of experiments which ultimately result in the acquisition of a patent. However, the cost of experiments which are not successful is treated as a deferred revenue expense and written off within two to three years.
  • Legal charges incurred in connection with acquiring or defending suits for protections fixed assets, rights, etc.

Revenue Expenditure

When the benefit of expenditures is likely to be available for less than one year, its is treated as the revenue expense. Thus, all expenses which are incurred during the regular course of business are regarded as revenue expenses. These may be as follows:

  • Expenses incurred in the day-to-day conduct of the business such as wages, salaries, rent, postage, stationery, insurance, electricity, etc.
  • Expenditure incurred for buying goods for resale or raw materials for manufacturing.
  • Expenditure incurred for maintaining the fixed assets such as repairs and renewals of the building, machinery etc.
  • Depreciation on fixed assets. This can also be termed as revenue loss.
  • Interest on loans borrowed for running the business. However, interest on loan paid during the initial period before production commences is treated as capital expenditure.
  • Legal charges incurred during the regular course of business such as legal expense incurred on collection from debtors legally charged incurred in defending a suit for damage etc.


Deferred Revenue Expenditure

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Sometimes, the benefit of certain expenditure is available for more than one year. It should be spread over a number of accounting years. Hence, it is capitalized and only a portion of the total amount spent is charged to the statement for the current year. The balance is shown as assets and will be written off during subsequent accounting years. Such expenditure is called deferred revenue expenditure because the charge to the income statement is deferred to future years. Some example of such expenditure are:

  • Expenditure incurred on the advertising campaign to introduce a new product in the market.
  • Expenditure incurred on the formation of a new company (preliminary expenses).
  • Brokerage charge, underwriting commission paid and other expenses incurred in connection with the issue of share and debentures.
  • The cost of shifting the plant and machinery to a new site which may involve dismantling, removing and re-erection of the plant and machinery.



  • When the benefit of expenditure is available over a number of years, it is considered as capital expenditure. 
  • When the benefit of expenditures is likely to be available foe less than one year, its is treated as revenue expense.
  • The main purposes of maintaining a details and systematic record of business transactions are to ascertain the result of the business operation for an accounting year and to ascertain the financial position on a particular date.
  • An income statement is prepared to ascertain the result, and a position statement called balance sheet for determining the financial position.  
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Very Short Questions

The following are the differences between capital expenditure and revenue expenditure:

Bases of difference

Capital Expenditure

Revenue Expenditure

Nature

Capital expenditure is non-recurring in nature.

Revenue expenditure is recurring in nature.

Purpose

It is incurred in acquiring permanent assets or improving their existing capacity.

It is incurred in managing day-to-day activities of the organization and maintaining its fixed assets.

Benefit

It gives benefit over a number of periods.

It gives benefit for more than a year.

Earning

It helps in increasing the earning capacity of the business.

It helps in maintaining earning capacity of the business.

Impact

Some of its important items are land, building, plant, machinery, furniture, vehicles, goodwill and preliminary expenses, which have the impact on financial soundness of the business.

Some of the important items are rent, salary, stationaery, legal expenses, interest, insurance, depreciation, repair and maintenance, advertising and carriage outward, which have the impact on the operating results of the business.

Treatment

It is shown on the asset side of the balance sheet.

It is shown on the debit side of the trading and profit and loss accounts.

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  • When the benefit of expenditure is available over a number of years, it is considered as ______. 

    revenue expenditure
    revenue gain
    capital gain
    capital expenditure
  • When the benefit of expenditures is likely to be available foe less than one year, its is treated as ______. 

    capital loss
    revenue loss
    revenue expense
    capital expense
  • Which one is the example of deferred expenditure?

    Expenses incurred in day-to-day conduct of the business such as wages, salaries, rent, postage, stationery, insurance, electricity, etc.
    Expenditure incurred for buying goods for resale or raw materials for manufacturing.
    Expenditure incurred on advertising campaign to introduce a new product in the market.
    Legal charges incurred in connection with acquiring or defending suits for protections fixed assets, rights, etc.
  • Which one is the example of revenue expenditure?

    Expenses incurred in day-to-day conduct of the business such as wages, salaries, rent, postage, stationery, insurance, electricity, etc.
    Cost of shifting the plant and machinery to a new site which may involve dismantling, removing and re-erection of the plant and machinery.
    Expenditure incurred on advertising campaign to introduce a new product in the market.
    Expenditure incurred, during the early years, on development of mines and land for plantations till they become operational.
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