Profit and Loss Account and Balance Sheet are prepared on the above basis .If an item of capital nature is transferred to Trading Account or Profit and Loss Account , i.e., treating it as of revenue nature or vice versa , then neither Profit and Loss Account will show correct profit or loss nor the Balance Sheet will show true and fair financial position of the business . It is , therefore , necessary to understand and classify correctly wheather an item appearing in the Trail Balance is of revenue nature or of capital nature . Thereafter , the item should be transferred to the final accounts accordingly.
There are certain rules governing the classification of expenditure and receipts as revenue and capital . Let us discuss these rules or basis .
Capital Expenditure
Capital Expenditure gives benefit of enduring nature , i.e., the benefit extends to period or periods beyond the accounting period , Capital expenditure increases the earnings capacity or reduces the operating expenses of a business .
Capital Expenditure is the amount incurred by an enterprise normally on purchase of fixed assets . Fixed assets are used in the business to earn income and are not intended for resale . Fixed assets purchase may be tangible or intangible .
Following types of expenditures are usually accounted as capital Expenditure:
1. Expenditure incurred for acquisition of fixed assets such as land , building , machinery , furniture , motor vehicle , etc .
2. Expenditure incurred for purchase , receipt or installation of a fixed assets : All expenses in addition to the purchase price incurred for getting the assets ready for use are capital expenditure and thus , are added to the cost of the examples of such expenses are wages paid to workers for installing the machinery , cost of the plateform on which the machinery will be fixed , overhaul of second - hand machinery purchased , etc . It is to be noted that expenses incurred after the assets have been put to use , are not Capital Expenditure.
3.Expenditure for extension of or improvements in fixed assets : Expenditure incurred or existing assets because of which the profit - earning capacity increase , thought lowering costs or increasing output , the expenditure is a Capital Expenditure .
4. Expenditure incurred to acquire the right to carry on business : Expenses necessary for either establishing the business , like preliminary expenses for floating a company or obtaining licence are capital expenditure . Similarly , cost of a patent , i.e., the right to produce certain goods in a certain manner , is capital expenditure - only the initial expenditure is capital ; renewal fee is revenue expenditure .
5. Expenditure incurred for purchase of intangible assets such as goodwill , patents right and trademark , copyright , etc.,
6. Legal Expenses : Legal expenses incurred in connection with acquiring or defending suits for protecting fixed assets , rights , etc ., are also capital expenditure .
Treatment of Capital Expenditure : Capital Expenditure is debited to fixed assets accounts and is shown in the Balance Sheet .
Revenue Expenditure
Revenue Expenditure is the amount incurred on running a business , i.e., benefit of such expenses are consumed or exhausted with the accounting period . In short , an expenditure which is not capital expenditure is revenue expenditure . The benefit of revenue expenditure is exhausted within the accounting period in which it is incurred .
Examples of such expenses are :
1. Expenses incurred in day - to - day running of the business such as rent , salaries , wages , power , fuel , etc .
2. Expenses incurred for repairs and maintenance of fixed assets .
3.Expenses incurred on purchase of stock of material and goods to the extent that these are used up during the year ; the remaining amount will be an asset .
4. Depreciation or the expired cost of fixed assets .
Revenue expenditure is accounted as an expense and is matched against revenue of the period to determine profit or loss of that period . It also includes that part of capital expenditure which expires or consumed within an accounting year ( Depreciation ).
Following expenses appear to be revenue Expenses but they are capital expense :
1. Expenses incurred on the repair and whitewashing for the first time on the purchase of an old building , since these expenses are necessary to make the building useable.
2. Wages paid to workers to produce a tool to be used in the factory itself or to fix a machine .
3. Expenses incurred in connection with the purchase of land or building such as fees paid to lawyer or registration expenses .
4 . Interest on loan Raised to acquire an asset up to the point of time it is ready for use .
Treatment of Revenue Expenditure : Revenue Expenditure is shown on the debit side of Trading or Profit and Loss .
Capital Receipts and Revenue Receipts
Distinction between capital receipts and revenue receipts is also necessary as is in the case of expenditure .
Capital Receipts :
Capital Receipts 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. Thus , it is not treated as revenue receipts . Sale of any assets reduces fixed assets , thus , the amount received is not revenue rearmed in the course of business . In fact , capital reduce assets . Hence , these are shown in the Balance Sheet .
Revenue Receipts :
These are the amounts received in the normal course of the business , mainly from sale of goods and services . An important feature of revenue receipts is that such receipts are incomes. Hence these are shown on credit side of the profit and loss Account .
Distinction Between Capital Receipts and Revenue Receipts.
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