Distinction between Capital and Revenue

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Distinction between Capital and Revenue

A very important is the Distinction between Capital and Revenue Items in accounting. The distinction has important implications for creating the trading and profit and loss account and record. The revenue items form a part of the trading and profit and loss account, the capital items help within the preparation of a record.

Expenditure

Whenever payment and/or incurrence of an outlay are made for a purpose aside from the settlement of existing liability, it’s called expenditure. The expenditures are incurred with a viewpoint they might give benefits to the business. The advantage of expenditure may extend up to at least one accounting year or quite one year. If the advantage of expenditure extends up to at least one accounting period, it’s termed as revenue expenditure.

Normally, they’re incurred for the day-to-day conduct of the business. An example is often the payment of salaries, rent, etc. The salaries paid in the current period will not benefit the business in the next accounting period, as the workers have put in their efforts in the current accounting period. They will need to be paid the salaries within the next accounting period also if they’re made to figure. 

If the benefit of expenditure extends more than one accounting period, it is termed as capital expenditure. An example can be the payment to acquire furniture for use in the business. Furniture acquired in the current accounting period will give benefits for many accounting periods to come. The usual samples of cost are often the payment to accumulate fixed assets and/or to form additions/extensions within the fixed assets.

The following points of distinction between capital expenditure and revenue expenditure are worth noting :

  1. Capital expenditure increases the earning capacity of a business whereas revenue expenditure is incurred to maintain the earning capacity.
  2. Capital expenditure is incurred to acquire fixed assets for the operation of business whereas revenue expenditure is incurred on the day-to-day conduct of business.
  3. Revenue expenditure is generally recurring expenditure and capital expenditure is non-recurring by nature.
  4. Capital expenditure benefits more than one accounting year whereas revenue expenditure normally benefits one accounting year.
  5. Capital expenditure (subject to depreciation) is recorded in the balance sheet whereas revenue expenditure (subject to adjustment for outstanding and prepaid amount) is transferred to trading and profit and loss account.

Sometimes, it becomes difficult to classify the expenditure into revenue or capital category. In normal usage, the advertising expenditure is termed as revenue expenditure. The heavy expenditure incurred on advertising is probably going to profit the firm for quite one accounting period. Such revenue expenditures, which are likely to offer benefit for quite one accounting period, are termed deferred revenue expenditure.

It must be understood that expenditure may be a wider term and includes expenses. Expenditure is an outlay made/incurred by the firm. The part of the expenditure, which it seemed to are used or consumed within the current year, is termed because of the expense of the present year.

Revenue expenditure is treated as an expense for the present year and is shown within the trading and profit and loss account. For example, the salary paid by the firm is treated as an expense of the present year. Capital expenditures are charged to the earnings report and are cover in quite one accounting period.

Hence, furniture of Rs. 50,000, is predicted to be used for five years, are going to be treated as expense @ Rs. 10,000 per year. The name given for the expense is depreciation. The treatment of deferred revenue expenditure is the same as cost. They are also written-off over their expected period of benefit.

Receipts

A similar treatment is given to the receipts of the business. If the receipts imply an obligation to return the cash, these are capital receipts. The example is often a further capital brought in by the owner or a loan taken from the bank. Both receipts are resulting in obligations, the primary to the owner (called equity) and therefore the other to the outsiders (called liabilities).

Another example of a capital receipt is often the sale of a hard and fast asset like old machinery or furniture. However, if a receipt doesn’t incur an obligation to return the cash or isn’t within the sort of a purchase of a hard and fast asset, it’s termed as revenue receipt. The samples of revenue receipts sales made by the firm and interest on investment received by the firm.

Importance of Distinction between Capital and Revenue

The distinction between capital and revenue items has important implications for the preparation of trading and profit and loss account and thus the record as all items of revenue value are to means within the trading and profit and loss account and thus the things of capital nature within the record.

If any item is wrongly classified, i.e. if any item of revenue nature is treated as a capital item or vice-versa, the ascertainment of profit or loss is going to be incorrect. for instance, the revenues earned during an accounting period are Rs. 10,00,000 and therefore the expenses are shown are Rs. 8,00,000, the profit shall compute as Rs. 2,00,000. On scrutiny of the small print, you discover that a revenue item of Rs. 20,000 (an expenditure on repairs of machinery) has been treated as cost (added to the worth of machinery and debited to machinery account, to not repairs account), and hence, doesn’t form a neighbourhood of the expenses for the quantity. It means the particular expenses for the amount are Rs. 8,20,000 and not Rs. 8,00,000. So, the right profit is Rs. 1,80,000, not Rs. 2,00,000. In other words, the profit has been overstated. Similarly, if any cost is wrongly shown as revenue expenditure (for example, purchase of furniture shown as purchases), it’ll end in an irony of profits, and also an irony of assets.

Thus, the financial statements won’t reflect the truth and a fair view of the affairs of the business. Hence, it is necessary to identify the proper nature of each item and treat it accordingly within the book of accounts. it’s also important from the taxation point of view.

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