CAPITAL AND REVENUE

Capital and Revenue Receipts:

When the business receives money it is of two sorts. It my be a long-term receipt, a
contribution by the owner, either to start the business or to increase the funds available
to it. It might be a mortgage or an which brings money into the business for a long-
term, but in this case it is not the owner of the business but some other investor who is
supplying the money.
On the other hand, the receipt may be a short-term receipt, one which is truly a profit of
the business. It may be rent received, commission received or cash for sale of goods
made that day, or at some previous time.
Capital Receipt:
Receipts which are non-recurring (not received again and again) by nature and whose
benefit is enjoyed over a long period are called "Capital Receipts", e.g. money brought
into the business by the owner (capital invested), loan from bank, sale proceeds of fixed
assets etc. Capital receipt is shown on the liabilities side of the Balance Sheet.
Revenue Receipt:
Receipts which are recurring (received again and again) by nature and which are
available for meeting all day to day expenses (revenue expenditure) of a business
concern are known as "Revenue receipts", e.g. sale proceeds of goods, interest received,
commission received, rent received, dividend received etc.
 Distinction between Capital Receipt and Revenue Receipt:
Revenue Receipt Capital Receipt
1. It has short-term effect. The benefit is 1. It has long-term effect. The benefit is enjoyed
enjoyed within one accounting period. for many years in future.
2. It occurs repeatedly. It is recurring and 2. It does not occur again and again. It is
regular. nonrecurring and irregular.
3. It is shown in profit and loss account on the 3. It is shown in the Balance Sheet on the liability
credit side. side.

4. It does not produce capital receipt.
5. This does not increase or decrease the value
of asset or liability.
4. Capital receipt, when invested, produces revenue
receipt e.g. when capital is invested by the
owner, business gets revenue receipt (i.e. sale
proceeds of goods etc.).
5. The capital receipt decreases the value of asset
or increases the value of liability e.g. sale of a
fixed asset, loan from bank etc.

6. Sometimes, expenses of capital nature are to 6. Sometimes expenses of revenue nature are to be
be incurred for revenue receipt, e.g. incurred for such receipt e.g. on obtaining loan
purchase of shares of a company is capital (a capital receipt) interest is paid until its
expenditure but dividend received on shares repayment.
is a revenue receipt.
Capital Expenditures:
Definition and Explanation:
An expenditure which results in the acquisition of permanent asset which is intended to be
permanently used in the business for the purpose of earning revenue, is known as capital
expenditure. These expenditures are 'non-recurring' by nature. Assets acquired by incurring these
expenditures are utilized by the business for a long time and thereby they earn revenue. For
example, money spent on the purchase of building, machinery, furniture etc. Take the case of
machinery-machinery is permanently used for, producing goods and profit is earned by selling
those goods. This is not an expenditure for one accounting period, machinery has long life and its
benefit will be enjoyed over a long period of time. By long period of time we mean a period
exceeding one accounting period.
Moreover, any expenditure which is incurred for the purpose of increasing profit earning capacity
or reducing cost of production is a capital expenditure. Sometimes the expenditure even not
resulting in the increase of profit earning capacity but acquires an asset comparatively permanent
in nature will also be a capital expenditure.
It should be remembered that when an asset is purchased, all amounts spent up to the point till the
asset is ready for use should be treated as capital expenditure. Examples are: (a): A machinery
was purchased for Rs.50,000 from Karachi. We paid carriage Rs.1,000, octroi duty Rs.500 to
bring the machinery from Karachi to Lahore. Then we paid wages Rs.1,000 for its installation in
the factory. For all these expenditures, we should debit machinery account instead of debiting
carriage A/c, octroi A/c and wages A/c. (b): Fees paid to a lawyer for drawing up the purchase
deed of land, (c): Overhaul expenses of second-hand machinery etc. (d): Interest paid on loans
raised to acquire a fixed asset etc.
Examples:
Purchase of furniture, motor vehicles, electric motors, office equipment, loose
tools and other tangible assets.
Cost of acquiring intangible assets like goodwill, patents, copy rights, trade
marks, patterns and designs etc.
Addition or extension of assets.
Money spent on installation and erection of plant and machinery and other
fixed assets.
Wages paid for the construction of building.
Structural improvements or alterations in fixed assets resulting in an increase in
their useful life or profit earning capacity.
Cost of issue of shares and debentures (certain expenditures are incurred by the
companies when share and debentures are issued).
Legal expenses on raising loans for the purchase of fixed assets.
Interest on loan and capital during the construction period.
Expenditures incurred for the development of mines and plantations etc.
Money spent to bring a second-hand asset into working condition.
Cost of replacing factory building from an old place to a new arid better site.
Premium given for a lease.
Revenue Expenditure:
Definition and Explanation:
All the expenditures which are incurred in the day to day conduct and
administration of a business and the effect-of which is completely exhausted within
the current accounting year are known as "revenue expenditures". These
expenditures are recurring by nature i.e. which are incurred for meeting day today
requirements of a business and the effect of these expenditures is always short-lived
i.e. the benefit thereof is enjoyed by the business within the current accounting year.
These expenditures are also known as "expenses or expired costs." e.g. Purchase of
goods, salaries paid, postages, rent, traveling expenses, stationery purchased, wages
paid on goods purchased etc.
This expenditure is incurred on items or services which are useful to the business
but are used up in less than one year and, therefore, only temporarily increase the
profit-making capacity of the business.
Revenue expenditure also includes the expenditure incurred for the purchase of raw
material and stores required for manufacturing saleable goods and the expenditure
incurred to maintain the- fixed assets in proper working conditions i.e. repair of
machinery, building, furniture etc.
Examples:
Following are the examples of revenue expenditure.
Wages paid to factory workers.
Oil to lubricate machines.
Power required to run machine or motor.
Expenditure incurred in the ordinary conduct and administration of business, i.e.
rent, , carriage on saleable goods, salaries, wages manufacturing expenses,
commission, legal expenses, insurance, advertisement, free samples, postage,
printing charges etc.
Repair and maintenance expenses incurred on fixed assets.
Cost of saleable goods.
Depreciation of fixed assets used in the business.
Interest on borrowed money.
Freight, cartage, octroi duty, transportation, insurance paid on saleable goods.
Petrol consumed in motor vehicles.
Service charges to motor vehicles.
Bad debts.
 Difference between Capital Expenditure and Revenue Expenditure:
Revenue Expenditure Capital Expenditure
1. Its effect is temporary, i.e. the benefit is 1. Its effect is long-term, i.e. it is not exhausted
received within the accounting year. within the current accounting year-its benefit is
received for a number of years in future.
2. Neither an asset is acquired nor the value of an 2. An asset is acquired or the value of an existing
asset is increased. asset is increased.
3. It has no physical existence because it is 3. Generally it has physical existence except
incurred on items which are used by the intangible assets.
business.
4. It is recurring and regular and it occurs 4. It does not occur again and again. It is
repeatedly. nonrecurring and irregular.
5. This expenditure helps to maintain the business. 5. This expenditure improves the position of the
business.
6. The whole amount of this expenditure is shown 6. A portion of this expenditure (depreciation on
in trading P & L A/c or income statement. assets) is shown in trading & P & L A/c and the
balance is shown in the balance sheet on asset
side.
7. It does not appear in the balance sheet. 7. It appears in the balance sheet until its benefit is
fully exhausted.
8. It reduces revenue (profit) of the business. 8. It does not reduce the revenue of the concern.
Purchase of fixed asset does not affect revenue.
Deferred Revenue Expenditure:- In some cases, the benefit of a revenue
expenditure may be available for period of two or three or even more years.
Such expenditure is then known as "Deferred Revenue Expenditure" and
is written off over a period of a few years and not wholly in the year in
which it is incurred. For example, a new firm may advertise very heavily in
the beginning to capture a position in the market. The benefit of this
advertising campaign will last quite a few years. It will be better to write
off the expenditure in three or four years and not in the first year.
When loss of a specially heavy and exceptional nature is sustained, it can
also treated as deferred revenue expenditure, But it should be noted, loss
resulting from transactions entered into, such as speculative purchase or
sale of a large quantity of a commodity, cannot be treated as a deferred
revenue expenditure. Only loss arising from circumstances beyond one's
control can be so treated.
 Examples
• Preliminary expenses
• Brokerage or commission on underwriting of
shares or debentures
• Cost of issue of share or debentures
• Heavy cost of advertisement
• Cost of change in location of business etc
 Research and Development Expenses
definition of the terms "Research" and
"development" as follows
• Research is original and planned investigation
undertaken with the hope of gaining new
scientific or technical knowledge and
understanding;
• Development is the translation of research
findings or other knowledge into a plan or design
for the production of new or substantially
improved materials, devices, products, processes,
systems or services prior to the commencement
of commercial production.
 Areas of R&D
• The following are some of the areas towards which
R&D effort is directed
– Improvements in existing products
– Design and development of new products
– Development of new processes
– Adaptation of imported technology to suit Indian
conditions
– Import substitution of material/ components
– Conservation of energy
– Market research for existing and new products
 Research and development costs include:
• Salaries and wages and other related costs (cost to the company) of
personnel in research and development
• Cost of material and services consumed in R&D activity
• Depreciation of building, equipment and facilities, to the extent they are
used for R&D
• Overhead costs related to research and development activities,
apportioned/allocated based on Cost Accounting Standard - 3
• Payment to outside bodies (Research laboratories / universities etc.) for
R&D projects related to the enterprise
• Other costs related to R&D such as amortization of patents and licenses
• Expenditure incurred for obtaining patents for new products /
processes.
• Costs incurred to maintain production or to promote sales of existing
products are excluded from the costs of research and development
Accounting Treatment of Research and
Development Costs
• In appropriate circumstances, it is treated as a direct
charges to jobs or product involved. This method is
usually employed where such cost can be identified to
product or special jobs, such as, government contracts,
methods of manufacture, R & D on behalf of
customers.
• It is treated as an item of general overhead and
apportioned & absorbed accordingly. This method is
used where research cost is very low and is incurred for
the whole line of products. Research on existing
product is treated as factory overhead and market
research as selling overhead.
• It is treated as deferred revenue overhead
expenses and written off in 3-4 years. This
method is suitable where research expenses
are incurred, though the benefit have not yet
been obtained.
• The expenses are written off to P&L A/C in the
period in which they are incurred. This
method is particularly suitable where research
work does not result in tangible benefits.
 Preproduction expenses
These costs are incurred prior to the
commencement of formal production, e.g., in
making a trial run. These costs are incurred
when a new factory is established, or a new
project is taken up, or a new product line is
introduced, but there is no established or
formal production to which these cost are
charged.