Table of Contents
INTRODUCTION
Accounting aims to ascertain the financial performance of a firm. To do so the transactions have to be identified as capital or revenue in nature. This will determine whether they are placed in the Profit and Loss Account or the Balance Sheet. Let us study about capital and revenue expenditure and receipts.
EXPENDITURE
Expenditure means spending on something. This can be a payment in cash or can also be the exchange of some valuable item in exchange for goods or services. It is the process of causing a liability by a commodity. Receipts and invoices keep the records of expenditures. An expense is a word very similar to expenditure but expense shows the deduction in the value of the asset while expenditure simply denotes the obtaining of assets.
Determining Capital Nature and Revenue Nature
There are certain basic considerations when we are determining the nature of a financial transaction, i.e. capital nature or revenue nature. Some such considerations are as follows.
1. Nature of Business: The capital or revenue nature is dependent on the type of business a person does. It is different for different types of business. For instance, a business that provides car insurance to people comes under the revenue nature but the manufacturer buying the machinery for his factory is capital expenditure.
2. Recurring Nature of Expenditure: As stated earlier, revenue nature expenditures are recurring in nature, and capital nature expenditures are non-recurring in nature.
3. Purpose of Expenditure: The manufacturing process is an illustration of capital nature while renovation and repairing processes are expenses of a revenue nature.
Two types of expenditures are present based on time durations, That is:
- Capital expenditures
- Revenue expenditures
Capital Expenditure
Whenever a business spends money it receives some form of value representing goods or services, but the items which are purchased will be of benefit to the business for varying lengths of time. The fixed assets purchased by a firm are primarily intended for long-term use in the business, and will usually be retained by the business for some considerable time. Fixed assets consist of land, buildings, plant and machinery, furniture and fittings, office equipment, motor vehicles, and all other assets which are purchased for use in the business. The assets possessed by a firm will generally be used in the business over long periods, and will permanently increase the profit-making capacity of the business.
Capital expenditure, therefore, can be defined as: “Expenditure on the purchase of fixed assets, or expenditure to increase the value of an existing fixed asset. Capital expenditure will increase the assets possessed by a firm and will appear on the balance sheet”.
Revenue Expenditure
These are the costs incurred during the day-to-day running of a business. They include all such items as salaries, wages, telephone, lighting and heating, rent, interest rates, insurance, discounts allowed, carriage costs, and so on. These are costs for the services received, and the payments made for expenses incurred by the business, and form part of the expenditure involved in the daily routine operation of running a business; they will only be of benefit for a short period. The costs involved are ‘used up’, usually in less than a year, and they will only be temporary.
Difference between Capital Expenditure and Revenue Expenditure
Capital Expenditure | Revenue Expenditure | ||
| 1. | Its effect is long-term, i.e. it is not exhausted within the current accounting year. Its benefit will be received for several years in the future. | 1. | Its effect is temporary, i.e. the benefit is received within the accounting year. |
| 2. | An asset is acquired or the value of an existing asset is increased. | 2. | Neither an asset is acquired nor is the value of an asset increased. |
| 3. | Generally, it has a physical existence except for intangible assets. | 3. | It has no physical existence because it is incurred on items that are used by the business. |
| 4. | It does not occur again and again. It is nonrecurring and irregular. | 4. | It is recurring and regular and it occurs repeatedly. |
| 5. | This expenditure improves the position of the business. | 5. | This expenditure helps to maintain the business. |
| 6. | A portion of this expenditure (depreciation on assets) is shown in trading & P & L A/c and the balance is shown in the balance sheet on the asset side. | 6. | The whole amount of this expenditure is shown in trading P & L A/c or income statement. |
| 7. | It appears in the balance sheet until its benefit is fully exhausted. | 7. | It does not appear in the balance sheet. |
| 8. | It does not reduce the revenue of the concern. The purchase of fixed assets does not affect revenue. | 8. | It reduces the revenue (profit) of the business. |
Deferred Revenue Expenditure
Deferred revenue expenditure is the expenditure which is originally revenue in nature but the amount spent is so large that the benefit is received for not a year but for many years. A proportionate amount is charged to the profit and loss account of each year and the balance is carried forward to subsequent years as deferred revenue expenditure. It is shown as an asset in the balance sheet, e.g., heavy expenditure incurred on advertisements.
RECEIPT
Capital receipt and revenue receipt, both are very important components of accounting. It is important to correctly differentiate between the two. Classification of these transactions is reflected in the final statements of the company.
Capital receipts
Capital receipts are the receipts that are not received in the ordinary course of business. These are non-recurring receipts. Money obtained from the sale of fixed assets or investments, the issue of shares or debentures, and loans taken are some examples of capital receipts. Capital receipts are shown as liability reduced from assets appearing in the balance sheet.
Revenue Receipts
Revenue receipts are receipts obtained in the normal course of business. It is a receipt against the supply of goods or services. The money obtained from sales, interest, dividends, transfer fees, etc. are examples of revenue receipts. Revenue receipts are credited to the profit and loss account.
The distinction between Capital Receipt and Revenue Receipt
Capital Receipt | Revenue Receipt | ||
| 1. | It has long-term effects. The benefit is enjoyed for many years in the future. | 1. | It has short-term effects. The benefit is enjoyed within one accounting period. |
| 2. | It does not occur again and again. It is nonrecurring and irregular. | 2. | It occurs repeatedly. It is recurring and regular. |
| 3. | It is shown in the Balance Sheet on the liability side. | 3. | It is shown in the profit and loss account on the credit side.
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| 4. | Capital receipt, when invested, produces revenue receipt e.g. when capital is invested by the owner, the business gets revenue receipt (i.e. sale proceeds of goods etc.). | 4. | It does not produce a capital receipt. |
| 5. | The capital receipt decreases the value of an asset or increases the value of liability e.g. sale of a fixed asset, loan from a bank, etc. | 5. | This does not increase or decrease the value of assets or liability.
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| 6. | Sometimes expenses of a revenue nature are to be incurred for such receipt e.g. on obtaining a loan (a capital receipt) interest is paid until its repayment. | 6. | Sometimes, expenses of a capital nature are to be incurred for revenue receipt, e.g. purchase of shares of a company is capital expenditure but the dividend received on shares is a revenue receipt. |
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