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Final Account (Capital and Revenue)

Learning Objectives

• To understand the meaning of capital expenditure• To understand the meaning of revenue expenditure

Capital Expenditure

1. Capital expenditure is that expenditure the benefits of which are not fully consumedin a year but spread over several years.

2. It is the expenditure which results in the purchase or acquisition of asset or property.3. It is the expenditure incurred in connection with the purchase of asset.4. It is the expenditure incurred to bring an old asset into working condition.5. 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 workingexpenditure.

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

Revenue Expenditure

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

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

3. It is the expenditure which is incurred on purchase of goods meant for resale or topurchase 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 notmore than a year. All revenue expenditure are charged to trading and profit and lossaccount.

Deferred Revenue Expenditure

Deferred revenue expenditure is the expenditure which is originally revenue in nature butthe 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 iscarried forward to subsequent years as deferred revenue expenditure. It is shown as anasset in the balance sheet, e.g., heavy expenditure incurred on advertisements.

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Capital Receipts

Capital receipts are the receipts which are not received in the ordinary course ofbusiness. These are non-recurring receipts. Money obtained from the sale of fixed assetsor investments, issue of shares or debentures, loans taken are some of the examples ofcapital receipts. Capital receipts are shown as liability reduced from assets appearing inthe balance sheet.

Revenue Receipts

Revenue receipts are receipts obtained in the normal course of business. It is a receiptagainst 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 profitand loss account.

Capital Profit

Those profits which are not earned during the regular course of business and which arenot earned on account of the day-to-day trading activities of the business are capitalprofits. 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 inthe liabilities side of the balance sheet.

Capital Losses

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

Problem 1

1. An old machinery is purchased for Rs. 1,00,000 and Rs. 25,000 has been spent tobring it in working condition.Answer-- Both the above expenses are capital expenditures as Rs. 1,00,000 has beenspent to acquire the asset and Rs. 25,000 has been spent to make the machineryproductive. The machinery will now be used for many years and its cost is Rs.1,25,000.

2. A building is purchased for Rs. 10,00,000 and Rs. 1,00,000 has been spent asexpenses like brokerage, stamp duty, registration charges and on other legalexpenses.Answer-- Both the above expenditures are capital expenditures as Rs. 10,00,000 hasbeen spent for the purchase of asset and Rs. 1,00,000 for all the incidental expensesfor buying the asset. The cost of the building is now Rs. 11,00,000.

3. Repairs to building Answer-- It is revenue expenditure because it is incurred formaintaining the building. Both the reason for repairs and the amount are notimportant.

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4. Amount spent for the replacement of defective and worn out parts of an old plantAnswer-- It is revenue expenditure as it is incurred to keep the plant in normalworking condition. No new asset comes into existence.

5. Heavy expenditure incurred on advertisements.Answer-- Normally, advertisement is revenue expenditure. But, as heavy expenditureis incurred, it will be treated as deferred revenue expenditure. The benefits of it willbe received for many years. Proportionate amount will be written off every year bydebiting profit and loss account and the remaining amount will be shown in thebalance sheet on the asset side.

Problem 2

1. 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 installationcharges of Rs. 10,000 were incurred.Answer-- Rs. 5,00,000 spent on the purchase of asset and Rs. 35,000 spent on otherincidental expenses should be considered as capital expenditure until the machinerycomes in working condition. The cost of machinery will be Rs. 5,35,000.

2. New equipment for existing machinery were bought for Rs. 30,000 to increase theproduction by 25%Answer-- The above expenditure is capital expenditure as it increases the productioncapacity and thereby increases the earning capacity of the business. It is a non-recurring expense and should be added to the value of asset.

3. Taxes paid Answer-- It is revenue expenditure as it is a regular expense of thebusiness. It is a recurring expense. The benefit is only for one year.

4. Expenditure for repainting the factory shed Answer-- As repainting is a normalexpenditure made for maintenance of the factory, it is revenue expenditure. It is arecurring expense and no new asset comes into existence.

5. Traveling expenses of directors for a trip abroad for purchasing imported machineryAnswer-- As the traveling expenses is incidental expenditure to purchase machinery,it should be treated as capital expenditure and should be added to the cost ofmachinery. In this case, if directors purchase the machinery, it would be deferredrevenue expenditure and would be written off over a reasonable period of say 3 to 5years.

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Problem 3

1. A cinema theatre spent Rs. 10,000 for additional features Answer-- The aboveexpenditure is not increasing the earning capacity of business. Also, no new assetcomes into existence. Therefore, the above expense should be considered as revenueexpenditure.

2. Cost of goodwill purchased Answer-- It is capital expenditure. The amount spent willgive benefit for many years.

3. A petrol driven engine of a passenger bus replaced by a diesel engine Answer-- It iscapital expenditure as it is a non-recurring expense and will improve the efficiency ofthe bus. It will also increase the earning capacity of the bus as diesel will cost lessthan petrol. It decreases the working expenditure.

4. Customs duty paid on import of raw materials Answer-- It is revenue expenditure asraw materials are trading goods and all expenses related to the purchase of tradinggoods are revenue. It is a usual expense.

5. Purchase of uniforms, umbrellas and raincoats for staff and employees Answer-- It isa normal expenditure incurred on staff welfare and should be considered as revenueexpenditure.

Problem 4

1. Legal expenditure incurred in connection with the issue of share capital. Answer--Any expenditure incurred at the time of formation of company is debited topreliminary expense account. Legal expenses are also debited to preliminaryexpenses. The preliminary expenses come under the head miscellaneous expenses onthe assets side of the balance sheet. It is an example of deferred revenue expenditureand is written off over a period of many years.

2. Cost of replacement of defective part of the machinery Answer-- When a machine ispurchased, the cost spent is debited to the machinery account. But, when any part ofthe machine is replaced on subsequent occasion, the expenses incurred are debited tomachinery repairs account. Such expenses are known as revenue expenditure. It isspent to maintain the asset.

3. Expenditure incurred to prepare a project report

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Answer-- Anytime when the project report is being prepared, certain expenses arerequired 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 projectmaterializes and expenses incurred are sizeable, they are treated as capitalexpenditure. And in case of a project which does not materialize, the projectexpenses are treated as revenue expenditure.

4. Expenditure incurred to train employees for better running of machinery Answer--Expenditure incurred to train employees for the better running of machinery willresult 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 intoacquisition of any tangible assets.

5. Expenditure incurred for repairing cinema screen Answer-- When the cinema screenis first constructed, the expenses incurred are capitalized. On a subsequent date, whenthe screen is repaired, expenditure incurred for repairs is treated as revenueexpenditure. The case would be different if the cinema screen is replaced by a widerscreen. In such a case, part of the expenses will be treated as revenue expenditure andthe balance amount will be treated as capital expenditure.

Problem 5

1. Damages paid for breach of contractAnswer-- It is revenue expense because such expenses are ordinary and normal expensesare incurred in the ordinary course of business.

2. Stock of Rs. 5,000 destroyed by fire and Rs. 3,500 received from insurance companyAnswer-- The recovery of Rs. 3,500 from insurance company is revenue receipt becauseit is on account of trading asset. The loss is revenue loss as stock is a trading asset andthis loss will be debited to profit and loss account.

3. Profit on sale of investmentAnswer-- If the investments are trading assets, the profit on sale will be treated asrevenue receipt and will be shown on the credit side of profit and loss account. Ifinvestments are not trading assets, the profit will be treated as capital gain.

4. Legal expenses incurred in income tax appealLegal expenses incurred in connection with income tax appeal are revenue expensesbecause they are normal business expenses incurred while doing business.

Problem 6

1. Compensation for loss of goodwillAnswer-- It is capital receipt as goodwill is an asset. Hence, any amount received on lossof an asset should be treated as capital receipt.

2. Dividend on investmentAnswer-- As it is a regular income, it is categorized as revenue receipt.

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3. Sale of old machineryAnswer-- The amount received on sale of old machinery should be considered as capitalreceipt as it is not a receipt that arises in the ordinary course of business.

4. Wages paid for the extension of buildingAnswer-- If wages are paid for the construction work resulting in the extension ofbuilding, they are treated as capital expenditure as they create fixed assets. Suchexpenses will be capitalized.

5. Import duty on raw materials purchasedAnswer-- It is revenue expenditure. Raw materials are trading assets. Import duty paid onmaterials purchased is an expenditure relating to the purchase of trading assets. It is anordinary business expenditure and hence revenue expenditure.

Summary

1. Capital expenditure is generally non-recurring and the amount spent is normallylarge.

2. Capital expenditure are shown in balance sheet.3. Revenue expenditure is a recurring expenditure made to maintain the business.4. All revenue expenditure are charged to trading and profit and loss account.5. The following are the examples of five revenue expenditure that can be treated as

capital expenditure in certain circumstances.

i) Carriage

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

ii) Repairs

Repairs to fixed assets to maintain them in a state of working efficiency isrevenue expenditure. However, when the amounts are spent by way of repairs toput second hand machinery in working order, such repairs should be capitalized.

iii) 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 orerection of plant, the wages paid should be capitalized and treated as a part of theplant or the cost of the asset concerned.

iv) 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 shouldbe added to the cost of property, i.e. they should be capitalized.

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v) Brokerage

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

Questions

1. What is capital expenditure?2. What is revenue expenditure?3. What is deferred revenue expenditure?4. What do you mean by capital receipts?5. What do you mean by revenue receipts?6. What is capital profit?7. What is capital loss?

8. State with reasons whether the following items are capital, revenue or deferredrevenue:

(a) Expenditure incurred in overhauling machinery(b) Amount brought by proprietor as capital(c) Building of cost Rs. 2,00,000 sold for Rs. 1,50,000(d) White washing of office building(e) Expenditure incurred for training employees(f) Received a gift from parents and introduced the amount in business(g) Insurance of godown(h) Renewal of license(i) Expenses incurred on research of a product not resulting in success (j)Bad debts recovered (k) Depreciation on assets(l) Shares purchased and brokerage paid on purchase(m) Loss on sale of plant (n) Preliminary expenses(o) Cost of dismantling, removing and reinstalling the old plant (p) Machinery ofvalue Rs. 10,000 sold for Rs. 10,500 (q) Charges paid to workers for erecting newmachinery (r) Rs. 2,00,000 received from issue of shares out of which Rs. 10,000 areissue expenses.

PROF. SARBESH MISHRAM.Com, M.Phil, PhD

Assistant Professor, FinanceNICMAR’s CISC, HYD – 84.