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Question
Why is it necessary to differentiate between capital and revenue items in accounting?
Solution
Accurate accounting requires the effective allocation of capital and revenue components. Allocating capital and revenue items might be challenging. Understanding capital and income distribution requires knowledge of the correct principles.
The following are the types of capital and revenue items in accounting:
- Capital Receipts: Capital Receipts refer to any new capital obtained through share issuance, loans, or asset sales. Capital receipts are shown on the balance sheet.
- Revenue Receipts: Revenue Receipts are the amounts received in the normal course of business. Income made from selling items, including discounts, commissions, interest, and transfer fees. Selling waste paper and packing containers generates cash. Revenue receipts are reflected in the Profit and Loss account.
- Capital Profit: Capital earnings are earned by selling fixed assets or raising capital for the firm. For instance, a business that purchased land for ₹ 2,00,000 may sell it for ₹ 2,50,000. The profit of ₹ 50,000 is capital in nature. For example, if a corporation offers shares with a face value of ₹ 100 for ₹ 110 each, the premium (₹ 10) is considered capital profit. Profits are allocated to either the Capital Account or the Capital Reserve Account. This sum is used to cover capital losses. Capital Reserve is recorded as a liability on the Balance Sheet.
- Revenue Profit: Earned in the regular course of business. Revenue earnings are recorded in the Profit and Loss Account. Examples include profits from sales, investments, discounts, and interest earned.
- Capital Losses: Capital losses happen when you sell fixed assets or raise share capital. A building purchased for ₹ 2,000,000 is sold for ₹ 1,50,000. ₹ 50,000 is a capital loss. Shares with a face value of ₹ 100 were issued at ₹ 95, representing a discount of ₹ 5. The discount represents a capital loss.
Capital loss is not reported in the Profit and Loss Account. They are displayed on the asset side of the Balance Sheet. Capital gains are offset by capital losses when they occur. Large capital losses are often spread over multiple years and assessed to the Profit and Loss Account annually. The balance amount is recorded as an asset on the balance sheet and will be written down in future years. If the loss is affordable, it is recorded in the same year's Profit and Loss Account. - Revenue Losses: Revenue losses occur in the usual course of business. For example, product sales may result in losses, which are reflected in the Profit and Loss Account.
RELATED QUESTIONS
Match the Column I and Column II:
| Column - I | Column - II | ||
| (a) | Capital Expenditure | i | Repairs costing ₹ 600 carried out on a boiler. |
| (b) | Revenue Expenditure | ii | Advertising expenses ₹ 25,000 incurred for launching a new product in the market. |
| (c) | Deferred Revenue Expenditure | iii | Interest received. |
| (d) | Revenue Receipts | iv | A sum of ₹ 15,000 spent on the overhauling of a second-hand delivery van. |
Give four examples of capital expenditure.
______ expenditure is an expenditure benefiting the future period.
Expenditure incurred to ______ the asset is capital expenditure.
State with reason whether the following is Capital or Revenue Expenditure:
Cost of overhauling a second-hand machine.
State whether the following is Capital, Revenue or Deferred Revenue Expenditure.
Cost of painting the new office building.
Classify the following into Capital and Revenue Expenditure.
Wages paid to workers for installation of machinery in the factory.
In the following case indicate the amount to be debited as Capital Expenditure and Revenue Expenditure:
A sum of ₹ 40,000 was spent on a machine consisting of ₹ 30,000 for increasing its production capacity, ₹ 1,000 for repairs and ₹ 9000 for replacement of worn-out parts.
Classify the following:
Amount paid to an engineer for installation of machinery.
Classify the following:
Renewal fee for a lease of land.
