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It is Very important to know and understanding the distinction between “capital” and “revenue”. It is important because after the trial balance is prepared. The final account can be prepared. The final account can be prepared in such a way that all the account is appearing in the trial balance are either transferred to the “P and L” account or “Balance Sheet”.
Generally, all the nominal accounts or revenue accounts are transferred to the P and L account, while all the real and is debited to office expenses and personal accounts (capital accounts) are to transfer to balance sheet. Here one point arises which cause a lot of importance- it is whenever an expenditure is incurred, it may be treated as an expense (and transferred to as an asset (transferred to balance sheet). The correct identification of revenue expenditure and capital expenditure is very necessary because wrong allocation of a revenue item to capital item (and vice versa) can create wrong financial statements. For example a computer is purchased for Rs.40 transferred to P and L account, instead of debiting it to an appropriate computer account and transferred computer account to the balance sheet as an asset (capital expenditure). It is clearly an error of principle, how a “capital expenditure” item is wrongly treated as “revenue expenditure”. It leads to incorrect P and L account and incorrect balance sheet.
It is an expenditure which provides benefits to the company for several future years (or several future accounting periods). Generally, capital expenditure refers to expenditure involving purchase of plant, machinery, assets, land, vehicles, patents, copy rights etc. whose benefits are received for more than one year by the firm. Expenditure may be identified as a capital expenditure →
1. Expenditure incurred for fixed assets land, building, plant, machinery, cost of installation of lights, fans, cost of erection of plant and machinery.
2. When expenditure, incurred in one year, gives benefit for a number of accounting years.
3. When expenditure is incurred to increase the earning capacity of a business.
4. All preliminary expenses incurred before the commencement of the business.
5. Expenditure for the extension of improvement in fixed assets. If due to such expenditure the profit earning capacity of firm increases, the expenditure should be capitalized.
6. Any expenditure which have the effect of increasing “fixed assets” of the company or which have the effect of increasing the capacity, efficiency, life span or economy of operation of an existing fixed assets.
1. Cost of land, building, plant and machinery.
2. Cost of manufacture, purchase of furniture etc.
3. Purchase of vehicle, cars, vans etc.
4. Cost of good will, trademark, copyrights etc.
5. Preliminary expenses.
Revenue expenditure is that expenditure which is not a capital expenditure. According to Kohler “it is an expenditure charged against operation; a term used to contrast with capital expenditure”. Revenue expenditure is incurred in the current period or in one period of account. The benefit of the revenue expenditure is utilized in that period itself. Revenue expenditure is incurred for the following purpose:
1. All establishment and other expenses incurred in the normal course of business. For instance, administration expenses of a business, expenses incurred in manufacturing and selling products.
2. Expenses incidental to the carrying of a business, the benefit of which is consumed within the accounting period. For instance, Rent, ,Wages ,Salaries ,Advertising, Taxes, Insurance etc.
3. Expenditure on goods purchased for resale. For instance, cost of goods purchased or cost of raw materials etc.
4. For maintaining fixed assets in working order. For instance, repairs, renewals and replacement of existing assets, depreciation, etc.
1. Expenditure on rent, wages, carriage, salaries, postage, insurance, advertising etc.
2. Interest on loan borrowed for running business.
3. Cost of goods bought for resale.
4. Cost of raw materials consumed in the course of manufacturing.
5. Expenses incurred for maintenance of various assets by way of repairs, renewals and replacement on building, plant, machinery, tools, fixtures, van, car etc. To keep them in the good condition.
6. Depreciation of fixed assets.
7. Taxes and legal expenses.
8. Loss arising from sale of fixed assets.
9. Maintenances of lights and fans.
10. All expenses incurred in the manufacturing and distribution of the products handled.
11. Wages paid for sale of goods.
12. Loss of goods by fire or other reasons.
13. Discounts and allowances.
State with reasons whether the following are capital or revenue expenditures:
1. A new machine is purchased for ₹ 60,000, ₹ 800 were spent on its carriage and ₹ 1,500 were paid as wages for its installation.
2. A sum of ₹ 10,000 was spent on painting the new factory.
3. ₹ 5,000 paid for the erection of a new machine.
4. ₹ 2,000 were spent on repairs before using a second hand generator purchased recently.
5. ₹ 1,500 were spent on the repair of a machinery.
6. ₹ 10,000 was paid as brokerage on issue of shares and other expenses of issue were ₹ 25,000.
Purchase of new machinery is a capital expenditure as it will result in increasing the earning capacity of the firm. Cost of installation will also be capitalized as it’s spent before machinery is put to use. Since, the factory is been painted for the first time it will be treated as a capital expenditure. Cost of erection of new machine will also be capitalized as it’s spent before machinery is put to use.
It is a capital expenditure as repairs are done before the generator is put to use. Repairs are done on regular basis that is why it will be treated as revenue expenditure. Expenses incurred on raising the capital will be treated as capital expenditure. Therefore, brokerage and other issue expenses are capital in nature.
State whether the following expenditure are Capital, Revenue or Deferred Revenue. Give reasons:
1. Furniture of the book value of ₹ 10,000 were sold off at ₹ 2,500 and new furniture of the value of ₹ 6,000 were acquired, cartage on purchase ₹ 50.
2. Property purchased for ₹ 20,00,000 and ₹ 1,50,000 paid for its registration and legal fee.
3. Replacement of old machine by a new one.
4. Damages paid by a transport company to its passengers injured in an accident.
5. Erection of shed for parking of vehicles at a cost of ₹ 10 Lac.
Loss on sale of furniture of ₹7,500 is revenue in nature and purchase + cartage ₹ 6,050 will be capitalized.
It is a capital expenditure as the legal fee is paid to acquire the asset.
It is a capital expenditure, as new machinery is purchased and it will result in increasing the earning capacity of the firm.
It is a capital expenditure, as damages paid on accident does not result in increasing the earning capacity of the firm
It is a capital expenditure, as new construction is done and it will result in increasing the earning capacity of the firm.
Classify the following into Capital, Revenue and Deferred Revenue expenditure, stating reasons in each case:
1. A sum of ₹ 32,000 has been spent on a machine as follows: (i) ₹ 20,000 for addition to double the output, (ii) ₹ 5,000 for repairs necessitated by negligence and (iii) ₹ 7,000 for replacement of worn-out parts.
2. Total expenditure on a cinema building during the year was ₹ 2,00,000 out of which 20% related to repairs and 80% represented improvements and additions.
3. Compensation paid to a retrenched employee for the loss of employment.
4. Second-hand furniture worth ₹ 40,000 was purchased and repairing of this furniture cost ₹ 15,000. The furniture was installed by own workmen-wages for this being ₹ 5,000.
5. A person was injured by the motor car of the company. ₹ 10,000 was paid to him by way of compensation.
6. Advertisement expenditure in special advertisement drive.
₹ 20,000 is capital expenditure as it will result in double output of the firm. Repairs and replacement of worn out parts is revenue in nature as it is done on regular basis.
Repairs of ₹ 40,000 is revenue in nature as it is done on regular basis and ₹ 1,60,000 is done on improvements which will give future benefits, therefore its capital expenditure. Compensation and remuneration to employees are done in normal course of business, therefore it.
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