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notes on capital and revenue

notes on capital and revenue

Discuss notes on capital and revenue within the Security management and portfolio management forums, part of the Upload / Download Banking and Insurance Projects and Notes category; hi i am sending a detailed notes on capital and revenue,i think it will help to those who are preparing ...

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notes on capital and revenue
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Loknath Banerjee
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notes on capital and revenue - July 1st, 2010

hi i am sending a detailed notes on capital and revenue,i think it will help to those who are preparing for accountancy.
CONCEPT OF CAPITAL AND REVENUE




 What is capital expenditure?

 What is revenue expenditure?

 What is deferred revenue expenditure?

 What do you mean by capital receipts?

 What do you mean by revenue receipts?

 What is capital profit?

 What is capital loss?

 Difference between Capital and Revenue Expenditure.


Capital Expenditure

 Capital expenditure is that expenditure the benefits of which are not fully consumed in a year but spread over several years.

 It is the expenditure which results in the purchase or acquisition of asset or property.

 It is the expenditure incurred in connection with the purchase of asset.

 It is the expenditure incurred to bring an old asset into working condition.

 It is the expenditure incurred for extending or improving an existing asset to increase its productivity or to increase the earning capacity of business or to decrease working expenditure.

It can be said that the capital expenditure benefits not only in the current accounting year but also many years in the future. The expenditure is generally non-recurring and the amount spent is normally large. However, it should be noted that not every big expenditure is capital expenditure. Capital expenditures are shown in balance sheet.

Revenue Expenditure

 Revenue expenditure is the expenditure which benefits in the current accounting year. It is not carried forward to the next year or years.

 It is the expenditure which is incurred in the normal course of business to run the business and to maintain the fixed assets of business.

 It is the expenditure which is incurred on purchase of goods meant for resale or to purchase materials which will be used to convert them into final product.

Therefore, revenue expenditure is a recurring expenditure made to maintain the business. The amount spent is generally small and the benefit is for a short period which is not more than a year. All revenue expenditure are charged to trading and profit and loss account.
(1)

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 profit and loss account of each year and 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.

Capital receipts
Capital receipts are the receipts which are not received in the ordinary course of business. These are non-recurring receipts. Money obtained from the sale of fixed assets or investments, issue of shares or debentures, loans taken are some of the 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 supply of goods or services. The money obtained from sales, interest, dividend, transfer fees etc. are examples of revenue receipts. Revenue receipts are credited to profit and loss account.

Capital Profit
Those profits which are not earned during the regular course of business and which are not earned on account of the day-to-day trading activities of the business are capital profits. For example, profit on sale of asset and premium received on issue of shares. These types of profits are normally not taken to profit and loss account but are shown in the liabilities side of the balance sheet.

Capital Losses
The losses which are not suffered during the regular course of business are called capital losses. For example, discount on issue of shares.

Difference between Capital and Revenue Expenditure

CAPITAL EXPENDITURE REVENUE EXPENDITURE
It is incurred for acquiring fixed assets in use and for increasing earning capacity of the business. It is incurred to run the business but does not increase the capacity of the business.
Benefits of such expenditure extend to years beyond which it is incurred. Usually the benefit is consumed in the period in which it is incurred
It is shown in the Balance Sheet. It is taken to the Trading / P&L A/c of the concern.


State with reasons whether the following items are capital, revenue or deferred revenue:
Problem 1

 An old machinery is purchased for Rs. 1, 00,000 and Rs. 25,000 has been spent to bring it in working condition.

 Both the above expenses are capital expenditures as Rs. 1, 00,000 has been spent to acquire the asset and Rs. 25,000 has been spent to make the machinery productive. The machinery will now be used for many years and its cost is Rs. 1, 25,000.

 A building is purchased for Rs. 10, 00,000 and Rs. 1, 00,000 has been spent as expenses like brokerage, stamp duty, registration charges and on other legal expenses.

 Both the above expenditures are capital expenditures as Rs. 10,00,000 has been spent for the purchase of asset and Rs. 1,00,000 for all the incidental expenses for buying the asset. The cost of the building is now Rs.11, 00,000
.


 REPAIRS TO BUILDING

 It is revenue expenditure because it is incurred for maintaining the building. Both the reason for repairs and the amount are not important.

 AMOUNT SPENT FOR THE REPLACEMENT OF DEFECTIVE AND WORN OUT PARTS OF AN OLD PLANT

 It is revenue expenditure as it is incurred to keep the plant in normal working condition. No new asset comes into existence.

 HEAVY EXPENDITURE INCURRED ON ADVERTISEMENTS.

 Normally, advertisement is revenue expenditure. But, as heavy expenditure is incurred, it will be treated as deferred revenue expenditure. The benefits of it will be received for many years. Proportionate amount will be written off every year by debiting profit and loss account and the remaining amount will be shown in the balance sheet on the asset side.

Problem 2

 A machinery costing Rs. 5, 00,000 is imported on which freight and insurance of Rs. 7,000, custom duty of Rs. 13,000, clearing charges of Rs. 5,000 and installation charges of Rs. 10,000 were incurred.

 Rs. 5, 00,000 spent on the purchase of asset and Rs. 35,000 spent on other incidental expenses should be considered as capital expenditure until the machinery comes in working condition. The cost of machinery will be Rs. 5, 35,000.

 NEW EQUIPMENT FOR EXISTING MACHINERY WAS BOUGHT FOR RS. 30,000 TO INCREASE THE PRODUCTION BY 25%

 The above expenditure is capital expenditure as it increases the production capacity and thereby increases the earning capacity of the business. It is a non-recurring expense and should be added to the value of asset.

 TAXES PAID

 It is revenue expenditure as it is a regular expense of the business. It is a recurring expense. The benefit is only for one year.

 EXPENDITURE FOR REPAINTING THE FACTORY SHED

 As repainting is a normal expenditure made for maintenance of the factory, it is revenue expenditure. It is a recurring expense and no new asset comes into existence.

 TRAVELING EXPENSES OF DIRECTORS FOR A TRIP ABROAD FOR PURCHASING IMPORTED MACHINERY

 As the traveling expenses is incidental expenditure to purchase machinery; it should be treated as capital expenditure and should be added to the cost of machinery. In this case, if directors purchase the machinery, it would be deferred revenue expenditure and would be written off over a reasonable period of say 3 to 5 years.





Problem 3

 A CINEMA THEATRE SPENT RS. 10,000 FOR ADDITIONAL FEATURES

 The above expenditure is not increasing the earning capacity of business. Also, no new asset comes into existence. Therefore, the above expense should be considered as revenue expenditure.

 COST OF GOODWILL PURCHASED

 It is capital expenditure. The amount spent will give benefit for many years.

 A PETROL DRIVEN ENGINE OF A PASSENGER BUS REPLACED BY A DIESEL ENGINE

 It is capital expenditure as it is a non-recurring expense and will improve the efficiency of the bus. It will also increase the earning capacity of the bus as diesel will cost less than petrol. It decreases the working expenditure.

 CUSTOMS DUTY PAID ON IMPORT OF RAW MATERIALS

 It is revenue expenditure as raw materials are trading goods and all expenses related to the purchase of trading goods are revenue. It is a usual expense.

 PURCHASE OF UNIFORMS, UMBRELLAS AND RAINCOATS FOR STAFF AND EMPLOYEES

 It is a normal expenditure incurred on staff welfare and should be considered as revenue expenditure.

Problem 4

 LEGAL EXPENDITURE INCURRED IN CONNECTION WITH THE ISSUE OF SHARE CAPITAL.

 Any expenditure incurred at the time of formation of company is debited to preliminary expense account. Legal expenses are also debited to preliminary expenses. The preliminary expenses come under the head miscellaneous expenses on the assets side of the balance sheet. It is an example of deferred revenue expenditure and is written off over a period of many years.

 COST OF REPLACEMENT OF DEFECTIVE PART OF THE MACHINERY

 When a machine is purchased, the cost spent is debited to the machinery account. But, when any part of the machine is replaced on subsequent occasion, the expenses incurred are debited to machinery repairs account. Such expenses are known as revenue expenditure. It is spent to maintain the asset.

 EXPENDITURE INCURRED TO PREPARE A PROJECT REPORT

 Anytime when the project report is being prepared, certain expenses are required to be incurred such as market survey expenses. When expenses are incurred, it is not certain as to whether the project would materialize or not. If the project materializes and expenses incurred are sizeable, they are treated as capital expenditure. And in case of a project which does not materialize, the project expenses are treated as revenue expenditure.

 EXPENDITURE INCURRED TO TRAIN EMPLOYEES FOR BETTER RUNNING OF MACHINERY

 Expenditure incurred to train employees for the better running of machinery will result into greater efficiency and hence will increase the profit of the business. However, such expenses are treated as revenue expenditure as they do not result into acquisition of any tangible assets.






 Expenditure incurred for repairing cinema screen

 When the cinema screen is first constructed, the expenses incurred are capitalized. On a subsequent date, when the screen is repaired, expenditure incurred for repairs is treated as revenue expenditure. The case would be different if the cinema screen is replaced by a wider screen. In such a case, part of the expenses will be treated as revenue expenditure and the balance amount will be treated as capital expenditure.


Problem 5
 DAMAGES PAID FOR BREACH OF CONTRACT

 It is revenue expense because such expenses are ordinary and normal expenses are incurred in the ordinary course of business.

 STOCK OF RS. 5,000 DESTROYED BY FIRE AND RS. 3,500 RECEIVED FROM INSURANCE COMPANY

 The recovery of Rs. 3,500 from insurance company is revenue receipt because it is on account of trading asset. The loss is revenue loss as stock is a trading asset and this loss will be debited to profit and loss account.

 PROFIT ON SALE OF INVESTMENT

 If the investments are trading assets, the profit on sale will be treated as revenue receipt and will be shown on the credit side of profit and loss account. If investments are not trading assets, the profit will be treated as capital gain.

 LEGAL EXPENSES INCURRED IN INCOME TAX APPEAL

 Legal expenses incurred in connection with income tax appeal are revenue expenses because they are normal business expenses incurred while doing business.

Problem6

 COMPENSATION FOR LOSS OF GOODWILL

 It is capital receipt as goodwill is an asset. Hence, any amount received on loss of an asset should be treated as capital receipt.

 DIVIDEND ON INVESTMENT

 As it is a regular income, it is categorized as revenue receipt.

 SALE OF OLD MACHINERY

 The amount received on sale of old machinery should be considered as capital receipt as it is not a receipt that arises in the ordinary course of business.







 WAGES PAID FOR THE EXTENSION OF BUILDING

 If wages are paid for the construction work resulting in the extension of building; they are treated as capital expenditure as they create fixed assets. Such expenses will be capitalized.


 IMPORT DUTY ON RAW MATERIALS PURCHASED

 It is revenue expenditure. Raw materials are trading assets. Import duty paid on materials purchased is an expenditure relating to the purchase of trading assets. It is an ordinary business expenditure and hence revenue expenditure.

Examples of five Revenue expenditures that can be treated as Capital expenditure in certain circumstances.

 Carriage

Carriage inward on goods purchased is revenue expense. But carriage inward paid on the purchase of plant, furniture etc. should be capitalized and treated as part of the cost of the assets.

 Repairs

A repair to fixed assets to maintain them in a state of working efficiency is revenue expenditure. However, when the amounts are spent by way of repairs to put second hand machinery in working order, such repairs should be capitalized.

 Wages

Wages paid to workers engaged in the production of goods is revenue expense. But where workers are engaged in extension of buildings, manufacture of tools or erection of plant, the wages paid should be capitalized and treated as a part of the plant or the cost of the asset concerned.

 Legal Charges

Legal charges paid in the normal course of business are revenue expenses. However, legal charges paid in connection with the purchase of properties should be added to the cost of property, i.e. they should be capitalized.

 Brokerage

Brokerage paid on purchase of properties, fixed assets or investments should be capitalized.
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