Classification Of Capital And Revenue

After preparing trial balance, business prepares P/L A/C and the B/S to know the financial position as at the end of a period. There is a set rule that all the accounts appearing in the trial balance are transferred either to the P/L A/C or to the B/S. Which item will be transferred to the Trad. & P/L A/C and which to the B/S depends upon capital and revenue nature of the ledger a/c appearing in the trial balance. If we wrongly transfer an item of capital nature treating as of revenue nature or vice versa, then neither P/L A/C will reveal the correct profit or loss nor the B/S will reflect true financial position of the business.

Expenditure

Receipts

Reserves

Capital expenditure is the amount spent by the business on purchase of fixed assets that are used to earn income and are not intended for resale. Fixed assets purchased may be tangible or intangible.

CAPITAL EXPENDITURE = PURCHASE OF FIXED ASSET ( TANGIBLE + INTANGIBLE)

Capital exp. Yields benefit over a period extending beyond the accounting period.

i.

The expenditure which results in acquiring or bringing into existence an asset or advantage of enduring benefit. ii. Expenditure in connection with the purchase, receipt or erection of a fixed asset. All expenses, in addition to the purchase price, incurred for making the asset ready for use, are added to the cost of the asset and, thus, are capital expenditure. Ex- wages paid to workers for erecting machinery, overhaul of second-hand machinery purchased, . IT IS TO BE NOTED THAT EXPENSES INCURRED AFTER THE ASSETS HAS BEEN PUT TO USE ARE NOT CAPITAL EXPENDITURE. iii. Expenditure for the extension of or improvement in fixed asset. If because of any expenditure the profitearning capacity is increased , through lowering costs or increasing output, the expenditure will be capital expenditure.

TYPES OF CAP. EXP.

iv. Expenditure incurred to acquire the right to carry on business. The expenses necessary for either establishing the business, like preliminary expenses for floating a company, or obtaining license are capital expenditure only the initial expenditure is capital; renewal fee is revenue expenditure. v. Expenditure incurred to acquire a tangible asset. Even if the asset does not prove to be profitable, the expenditure on it is treated as capital expenditure. vi. Legal charges incurred. Legal expenses incurred in connection with acquiring or defending suits for protecting fixed assets, rights, etc, are also treated as capital expenditure. CAPITAL EXPENDITURE IS DEBITED TO A FIXED A/C WHICH APPEARS IN THE B/S.

Revenue expenditure is the amount spent on running of a business. In short expenditure, which is not capital exp is revenue exp. The benefit of revenue exp is exhausted in the accounting period in which it is incurred. The exof such expenses are: I. Expenses incurred for the day-to-day running of the business such as rent, salaries, wages, power, and fuel, etc. II. Expenses incurred for upkeep of fixed assets. III. Expenses incurred on purchase of stock of material and goods to the extent these are used up during the year; the remaining amount will be an asset. IV. Depreciation or the expired cost of fixed assets.

Basis

Capital Expenditure

Revenue Expenditure
It is incurred for the conduct of business. It is incurred for earning profits.

1. Purpose It is incurred for acquisition of fixed asset for use in business. 2. Capacity It increases the earning capacity of the business.

3. Period

Its benefit extend to more than one year. 4. Depiction Its shown in the balance sheet.

Its benefit extends to only one year. Its is part of trading or profit and loss account.

To know whether any expenditure is a capital expenditure or revenue expenditures, some bases are immaterial. One should not rely on them. An Amount Of Payment. Usually the amount of capital expenditure is more than revenue expenditure. But it does not mean that if amount of expense is small, it is certainly a revenue expenditure and if amount of expenditure is big it is certainly a capital expenditure. Payment Periodic or Lump-sum. Usually the payment of capital expenditure is made at a time in lump- sum. For ex- the purchase of land, while revenue expenditure are paid repeatedly on time to time , such as salary .

Here again , it should not be concluded that if payment is made repeatedly, it is a revenue expenditure only. It may also be possible that the payment of an asset purchased which is a capital expenditure, is made in fixed installments. Source Of Payment . Mostly the payment of capital expenditure made out of capital while revenue expenditure is paid out of revenue receipts. But it should not be considered as a general rule that expenses paid out of capital are capital expenditure and expenses paid out of revenue receipts are always revenue expenditure. Its Nature In The Hands Of Recipient . To decide that whether any expenditure is capital or revenue, it is useless to see that the payment for the recipient is an item of revenue or an item of expenditure. For ex- for a sewing machine manufacturer, amount received from sale of sewing machine is revenue receipt but for tailor who purchases this machine, it is a capital expenditure.

Deferred Revenue Expenditure

It is that class of revenue expenditure which is incurred during an accounting period but, the benefit arising out of it extends beyond that accounting period. Such expenditure is unusually larger than the normal expenditure under the head. An ex of this is large exp on advertising on introducing a new product. The expenditure so incurred will be certainly give benefit in the periods beyond the accounting period in which the expenditure was incurred. It will be thus, proper to spread the expenditure over the years and not charge the entire amount to the P/L A/C for the year in which the expense is incurred.

Sometimes even a large loss, arising from an accident or other unforeseen circumstances, may be spread over three or four years instead of being charged wholly against the revenue of the year in which the loss is actually suffered. The loss of a building because of an earthquake may be treated in this manner. This type of loss is also treated like deferred revenue expenditure.

Deferred revenue expenditure is a fictitious asset. Although it appears on the asset side of B/S, it is not really an asset to the business.

CAPITAL AND REVENUE RECEIPT

CAPITAL RECEIPTS. Capital receipt are the amounts received in the form of additional capital introduced in the business, loans received and sale proceeds of the fixed assets. You may observe that when loan is received, it increases the business liability. Hence, it cannot be treated as revenue. Sal e of fixed asset reduces the fixed asset and amount received is not a revenue earned in the normal course of business. In fact, capital receipt do not affect the profit or loss of the business. They either increase the liabilities or reduce the asset. Hence, these are shown in the B/S only.

Revenue Receipt. These are the amounts in the normal and regular course of business mainly by sale of goods and services. An important feature of revenue receipt has been that the amount received does not need to be returned to any one. All such receipts are revenue and are treated as incomes. Hence, these are shown on the credit side of the P/L A/C.

RESERVES- Meaning & Importance.

MEANING
They are an appropriation of profits . They are created to strengthen the financial position and to meet unforeseen liabilities or losses. They are debited to P & L Appr. Account. They are invested, may be, outside the business. They are invested, may be , outside the business. Unutilized part can be distributed as dividend. It reduces divisible profits. They are created as a matter of prudence out

IMPORTANCE OF RESERVES in business to strengthen the Reserves are important

financial position of the concern. The creation of reserves will enable the concern to tide over a difficult financial period in future or to plough back profits which is a cost free source of internal financing. The purpose of reserves may be: I. Expansion II. Better financial position III. Redemption of liabilities IV. Meeting unforeseen contingencies V. Making dividends uniform from year to year ; and VI. Meeting legal requirement such as Investment Reserve required by the Income Tax law.

REVENUE RESERVES AND CAPITAL RESERVES

REVENUE RESERVES ARE CREATED OUT OF REVENUE PROFITS WHICH ARE AVAILABLE FOR DISTRIBUTION AS DIVIDENDS. EXAMPLE OF REVENUE RESERVES ARE: 1. GENERAL RESERVES 2. DIVIDEND EQUALISATION RESERVE 3. DEBENTURE REDEMPTION RESERVE 4. INVESTMENT FLUCTUATION RESERVE,

CAPITAL RESERVES ARE CREATED OUT OF CAPITAL PROFITS AND ARE NORMALLY NOT AVAILABLE FOR DISTRIBUTION AS CASH DIVIDENDS. EXAMPLES OF CAPITAL RESERVES ARE: 1. PROFIT PRIOR TO INCORPORATION 2. PREMIUM ON ISSUE OF SHARES OR DEBENTURES 3. PROFIT ON REDEMPTION OF DEBENTURES 4. PROFIT ON FORFEITURE OF SHARES 5. PROFIT ON SALE OF FIXED ASSETS 6. CAPITAL REDEMPTION RESERVES, AND 7. PROFIT ON REVALUATION OF FIXED ASSETS AND LIABLITIES.

THE DIFFERENCE.
BASIS REVENUE RESERVES CAPITAL RESERVES

1. SOURCE.

It is created out of business profits. It can be used for distribution of dividends without any precondition.

It is created out of capital profits. It can be used for distribution of dividends only if the co satisfies certain condition prescribed by the companies act.
It is created for meeting capital losses or to be used for purposes specified by Companies Act.

2. DIVIDEND

3. PURPOSE It is created for strengthening the financial position , and meeting contingencies or some specific purpose.