Classification of Transaction into revenue and capital

Capital Expenditure

Capital expenditure is the expenditure incurred to acquire fixed assets, capital leases, office equipment, computer equipment, software development, purchase of tangible and intangible assets, and such kind of any value addition in business with the purpose to enhance the income. However, to decide nature of the capital expenditure, we need to pay attention on:

• The expenditure, which benefit cannot be consumed or utilized in the same accounting period, should be treated as capital expenditure.
• Expenditure incurred to acquire Fixed Assets for the company.
• Expenditure incurred to acquire fixed assets, erection and installation charges, transportation of assets charges, and travelling expenses directly relates to the purchase fixed assets, are covered under capital expenditure.
• Capital addition to any fixed assets, which increases the life or efficiency of those assets for example, an addition to building.

Revenue Expenditure

Revenue expenditure is the expenditure incurred on the fixed assets for the ‘maintenance’ instead of increasing the earning capacity of the assets. Examples of some of the important revenue expenditures are as follows:

• Wages/Salary
• Freight inward & outward
• Administrative Expenditure
• Selling and distribution Expenditure
• Assets purchased for resale purpose
• Repairs and renewal expenditure which are necessary to keep Fixed Assets in good running and efficient conditions

Revenue Expenditure Treated as Capital Expenditure

Following are the list of important revenue expenditures, but under certain circumstances, they are treated as a capital expenditure:

• Raw Material and Consumables: If those are used in making any fixed assets.
• Cartage and Freight: If those are incurred to bring Fixed Assets.
• Repairs & Renewals: If incurred to enhance life of the assets or efficiency of the assets.
• Preliminary Expenditures: Expenditure incurred during the formation of a business should be treated as capital expenditure.
• Interest on Capital: If paid for the construction work before the commencement of production or business.
• Development Expenditure: In some businesses, long period of development and heavy amount of investment are required before starting the production especially in a Tea or Rubber plantation. Usually, these expenditures should be treated as the capital expenditure.
• Wages: If paid to build up assets or for the erection and installation of Plant and Machinery.

A transaction refers to the exchange of an asset and discharge of liabilities for consideration in terms of money. However, these transactions are of two types, viz. Capital transactions and Revenue transactions.

the accounting profit for a period the concept of capital and revenue is of utmost importance. The bifurcation of the transactions between capital and revenue is also necessary for the recognition of business assets at the end of the accounting or financial year.

Important Terms

1. Capital Transactions

Capital transactions are transactions that have a long-term effect on the business. It means that the effect of these transactions extends to a period of more than one year.

2. Revenue Transactions

Revenue transactions are transactions that have a short-term effect on the business. Usually, the effect of these transactions is only for a period of one year.

3. Capital Expenditure

Capital expenditure is the expenditure that a business incurs on the purchase, alteration or the improvement of fixed assets. For example, the purchase of furniture for office use is a capital expenditure. The following costs are included in the capital expenditure:

1. Delivery charges of fixed assets
2. Installation expenses of fixed assets
3. Alteration or improvement expenses of fixed assets
4. Legal costs of purchasing a fixed asset
5. Demolition costs of fixed assets
6. Architects fee

   4. Revenue Expenditure

The expenditure incurred in the running or the management of the business is known as the revenue expenditure. For example, the cost of the repairs of machinery is a revenue expenditure.

We need to show the Capital expenditure on the Assets side of the Balance Sheet while we show the Revenue expenditure on the debit side of the Trading and Profit and Loss Account.

5. Revenue Receipts

The revenue receipt is the amount received by a business against the revenue incomes.

6. Capital Receipts

It is the amount which is received against the capital income by a business.

7. Capital Profits

Capital profit refers to the profit that is earned on the sale of fixed assets.

8. Revenue Profits

Revenue profit is the profit which a business earns during the ordinary course of business.

9. Capital Loss

It is the amount of loss that a business incurs on the sale of fixed assets.

10. Revenue Loss

It is the amount of loss that a business incurs during the ordinary course of business.

Rules for Determination of Capital Expenditure

The following expenses are termed as Capital expenditure:

1. Any expenditure on the purchase of fixed assets or long-term assets for use in business in order to earn profits is capital expenditure. However, expenditure on fixed assets purchased for resale does not amount to capital expenditure.
2. Any expenditure on the improvement or alteration in the present condition of a fixed asset to bring it to the working condition is a capital expenditure and thus we need to add it to the cost of the asset.
3. Any expenditure of any sort which increases the earning capacity of the business is also capital expenditure.
4. Preliminary expenses incurred before the commencement of business are also capital expenditure.

Rules for Determination of Revenue Expenditure

The following expenses are termed as the revenue expenditure:

1. Any expenditure for the day-to-day conduct of the business is revenue expenditure. The benefits of these expenses last only for the period of one year.
2. Any expenditure on the consumable items and on goods and services.
3. Any expenditure on the maintenance of fixed assets such as repairs and renewals.

Deferred Revenue Expenditure

Deferred revenue expenditure refers to the expenditure which is revenue in nature but involves a lump sum amount and the benefits that extend for a period of more than one year. We need to write off these expenses over a period of 3 to 5 years. On the other hand, the balance which is not written off is carried forward and shown on the Assets side of the Balance Sheet. Heavy advertisement expenditure is a good example of such expenditure.

The following are the types of capital and revenue items in accounting:

1. Capital Receipts
2. Revenue Receipts
3. Capital Profits
4. Revenue Profits
5. Capital Losses
6. Revenue Losses

(A) Capital Receipts:

Capital Receipts is the amount received in the form of additional Capital (by issuing shares) loans or by the sale proceeds of any fixed assets. Capital Receipts are shown in Balance Sheet.

(B) Revenue Receipts:

Revenue Receipts are the amount received in the ordinary course of a business. It is the incomes earned from selling merchandise, or in the form of discount, commission, interest, transfer fees etc. Income received by selling waste paper, packing cases etc. is also a revenue receipt. Revenue Re­ceipts are shown in the Profit and Loss Account.

(C) Capital Profit:

Capital profits are earned as a result of selling some fixed assets or in connection with raising capital for the firm. For example a land purchased by a business for Rs 2, 00,000 is sold for Rs. 2, 50,000. Rs 50,000 are a profit of capital nature. Another example, suppose a company issues its shares of the face value of Rs 100 for Rs 110 each, i.e. issue of shares at premium, the premium on shares i.e. Rs 10 is capital profit. Such profits are (a) transferred to Capital Account or (b) transferred to Capital Reserve Account. This amount is utilised for meeting Capital losses. Capital Reserve ap­pears in the Balance Sheet as a liability.

(D) Revenue Profits:

evenue Profits are earned in the ordinary course of business. Revenue profits appear in the Profit and Loss Account. For example, profit from sale of goods, income from investments, discount received, Interest Earned etc.

(E) Capital Losses:

Capital losses occur when selling fixed assets or raising share capital. A building purchased for Rs 2, 00,000 is sold for Rs 1, 50,000. Rs 50,000 are a capital loss. Shares of the face value of Rs 100 issued at Rs 95, i.e. discount of Rs 5. The amount of discount is a capital loss.

Capital Loss is not shown in the Profit and Loss Account. They are shown in the asset side of Balance Sheet. When Capital Profit arises, Capital losses are gradually written off against them. If capital losses are huge, it is common to spread them over a number of years and a proportionate amount is charged to Profit and Loss Account every year.

Balance amount is shown in the Balance Sheet as an asset and it is written off in future years. If the loss is manageable, they are debited to Profit and Loss Account of the same year.

(F) Revenue Losses:

Revenue losses arise during the normal course of business. For instance, sale of goods, loss may incur. Such losses are debited in the Profit and Loss Account.