Capital & Revenue Expenditure/Income

Capital and Revenue- Meaning and Distinction

Objectives

After going through this lesson, you shall be able to understand the following concepts.

• Capital and Revenue Items and need for their Classification

• Capital and Revenue Expenditure

• Difference between Capital and Revenue Expenditure

• Capital and Revenue Receipts

• Difference between Capital and Revenue Receipts

• Deferred Revenue Expenditure

• Capital and Revenue Profits

• Difference between Capital and Revenue Profits

• Capital and Revenue Losses

• Difference between Capital and Revenue Losses

• Capital and Revenue Income

• Difference between Capital and Revenue Income

Capital and Revenue Items and need for their Classification

Every business organisation incurs various expenses and earns various incomes during
the year for carrying the business activities. Some of these expenditure and incomes
may involve huge amounts while some of them are of small amounts.

This is the main basis to distinguish a transaction or an item into capital and revenue.
From the financial point of view, there is a difference between capital and revenue
items. All the items which results in profits or benefits for more than a year are
categorised as Capital items. While on the other hand, the items which results in profits
or benefits only for the related year are categorised as Revenue items.

We know that financial statements i.e. Trading and Profit and Loss Account and
Balance Sheet of an organisation are prepared on the basis of Trial Balance. Trading
and Profit and Loss Account records all the revenue nature items appearing in the Trial
Balance. However, the capital nature items appearing in the Trial Balance are recorded
in the Balance Sheet.

In other words, we can say that the transfer of items from the Trial Balance to the
Trading and Profit and Loss Account depends on the nature of item. In case the
transactions are not properly recorded from the Trial Balance to the Trading and Profit
and Loss Account and in the Balance Sheet i.e. an item of revenue nature is wrongly
treated as capital item or vice-versa while transferring from the Trial Balance, then in
this case the financial statements fails to reveal the correct profit or loss and also fail to
exhibit the true financial position of the firm.

Therefore, it becomes necessary to classify the items on the basis of their nature. This
helps in transferring the items from the Trial Balance to the financial statements
correctly. On the basis of nature the classification of capital and revenue expenditure
and receipts are discussed below in detail.

Expenditure

Capital Expenditure

Capital Expenditures are those expenditures that are incurred to acquire fixed assets or
to increase or to add the value to an existing fixed asset. Fixed assets include both
tangible as well as intangible assets.These assets are not meant for the purpose of
resale and are used in the business to generate the revenues. Capital expenditure is
not incurred on regular basis and the amount of this expenditure is relatively higher than
the revenue expenditure.
The capital expenditure results in an income or benefits for a longer period that extends
for period of more than a year. This expenditure is shown in the Balance Sheet on the
Assets Side. Some of the examples of such expenditures are purchase of plant,
furniture, vehicles, goodwill, wages paid for extension of land, wages paid for
constructing additional rooms in a building, etc.

Capital Expenditure
Some examples of a capital expenditure are as follows:

a) When a fixed asset is acquired by the firm like furniture, machinery, land &
building, motor vehicles, etc.

b) When expenditure is incurred on making a fixed asset operational like

installation charges on the machinery, freight and carriage paid on the fixed asset, etc.

c) When any modification is made to an existing fixed asset like adding a floor to
the building or construction of offices, etc.

d) When any intangible asset is purchased like patents, trademarks, copyrights,

Goodwill, etc.

Features of Capital Expenditure

The given below are some features of capital expenditure.

i. This is incurred to purchase the fixed assets or to add the value to an existing fixed
asset. Fixed assets includes both tangible assets such building, plant, etc. and
intangible assets such as patents, goodwill, copyrights, etc.

ii. It results in improving the working capacity and also increases the earning capacity
of an organisation.

iii. Assets purchased are not meant for resale in the business.

iv. It is non-recurring in nature i.e. it is not incurred on regular basis.

v. The benefits from this expenditure are availed for a period more than an
accounting year.

vi. This expenditure includes all the expenses that are incurred at the time of
purchase of assets or to make the asset in ready to use condition. Some of the
examples are cost of installation of assets, erection charges, overhauling of
existing or second-hand assets, legal expenses/registration, interest on loan taken
to acquire fixed assets, carriage, preliminary expenses for obtaining license, etc.

vii. It is shown on the Assets Side of the Balance Sheet.

Revenue Expenditure Revenue Expenditure is the expenditure that is incurred to earn
or to generate revenue during an accounting year. This expenditure is incurred for
normal operating activities of business and for its efficient or smooth working. In other
words, this expenditure does not help in increasing the earning capacity, rather it helps
to earn and generate the income from the business.

The benefits of this expenditure can be availed for period of only one year in which such
expenditure is incurred. These expenditures are incurred frequently by an organisation
and also include the decrease in the value of an asset in form of depreciation. This
expenditure is shown on the debit side of the Trading and Profit and Loss Account.
Some of the examples of such expenditure are rent, repairs, depreciation, loss on sale
of fixed assets, etc.

Features of Revenue Expenditure

The given below are some features of revenue expenditure.

i. It is incurred to carry on day-to-day business activities.

ii. It does not result in increasing the earning capacity of an organisation.

iii. It helps to maintain and improve the working capacity of the fixed assets but does
not increase their value.
 iv. The benefits from this expenditure are availed for a period of an accounting year
in which it is incurred.

v. It is recurring in nature. That is, it is incurred on regular basis.

vi. It includes the decrease or fall in the value of an asset.

vii. It is shown on the debit side of Trading and Profit and Loss Account.

Difference between Capital Expenditure and Revenue Expenditure

The points of difference between Capital and Revenue expenditure are given below.

Basis of
Capital Expenditure Revenue Expenditure
Difference
It is incurred to increase the It is incurred to maintain the
Meaning
earning capacity of a business. earning capacity of a business.
It is incurred to acquire fixed It is incurred to carry day-to-day
Purpose
assets. business activities.
 The benefits of such expenditure The benefits of such expenditure
Benefits can be availed for a period of can be availed only for a period
more than an accounting year. of one accounting year.
Nature It is non-recurring in nature. It is recurring in nature.
It is shown on the debit side of
It is shown on the Assets side of
Shown the Trading and Profit and Loss
the Balance Sheet.
Account.
Depreciation on Building, Rent
Purchase of Building, Purchase of
Examples paid, Loss on Sale of Furniture,
Patents or Trade Marks, etc.
etc.

Points to be taken into consideration for the classification of expenditure as

Capital or Revenue

1) Benefit derived: Normally, the benefit of a capital expenditure is derived for a longer
period of time i.e. exceeding a financial year or so as against Revenue Expenditure. For
example: When you purchase a computer is usually lasts for 4 to 5 years and hence is a
capital expenditure by you.

2) Consideration: The amount incurred on a capital expenditure far exceeds that of

revenue expenditure and is usually a big amount. For example: When you purchase a
house, the amount paid to acquire it is greater than the amount you pay for buying food
to eat.

3) Frequency of Payments: A capital expenditure is incurred once or in lump sum

mostly as against revenue expenditure which is periodic in nature. For example: You
frequently purchase fruits to eat hence it is a revenue expenditure but land is purchased
once in a while.

4) Source of making the payments: As a general rule, the capital expenditure is paid
out of capital owing to its large amount and the revenue expenditure is paid out of
revenue receipts like sales, etc. However, it is not a mandatory rule.

Example:

State with the reasons whether the following items of expenditure are of capital or
revenue nature.

i. Goodwill purchased for Rs 19,000.

ii. Repairs paid for machinery Rs 5,000

iii. Fees paid for obtaining license to start business.

 iv. Duty paid for importing a new machine.

v. Agriculture Land purchased for Rs 1,10,000, Also paid Rs 5,000 for land revenue.

vi. Fees paid for renewal of license Rs 1,000.

Solution

i. Capital Expenditure- It is a capital expenditure because it is related to the purchase

of an intangible asset.

ii. Revenue Expenditure- It is revenue expenditure because it is incurred under

normal course of business for the maintenance of machinery.

iii. Capital Expenditure- It is a capital expenditure because it is an initial expenditure

incurred for starting a new business.

iv. Capital Expenditure- It is a capital expenditure because it is paid for acquiring a

new asset.

v. Agriculture Land purchased for Rs 1,10,000 is a capital expenditure as it is related

to the purchase of an asset and land revenue of Rs 5,000 is a revenue
expenditure.

vi. Revenue Expenditure- It is revenue expenditure because it is paid for renewal of

license and not for obtaining a new license.

Receipts

Capital Receipts
Capital receipts are those receipts that are received from disposal or sale of an asset or
received in form of additional capital introduced. It also includes the receipts in form of
loan taken by a business organisation. These are non-recurring in nature i.e. these are
not frequently received. Capital receipts are shown on the Liabilities Side of the Balance
Sheet. When the assets of a firm are sold it decreases the fixed assets and when the
loan is taken or additional capital is introduced it increases the liability. In both the cases
the amount so received is regarded as capital receipts. From this discussion it can be
stated that capital receipts reduce the fixed assets and increases the liabilities of the
business organisation. Some of the examples of such receipts are sale of plant, loan
from bank, etc.

Features of Capital Receipts

The given below are some of the features of capital receipts.

i. It is received from sale of fixed assets.

ii. It also consists of amount of loan taken and additional capital introduced.

iii. It is non-recurring in nature.

iv. It is shown on the Liabilities Side of the Balance Sheet.

Revenue Receipts
Revenue receipts are those receipts that are received in conduct of ordinary and day
to day business activities. The sale of goods and services are the main source of
revenue receipts. These receipts or incomes are received frequently in the normal
course of business operations. Revenue receipts are shown on the credit side of the
Trading and Profit and Loss Account.

Features of Revenue Receipts

The given below are some features of revenue receipts.

i. It is received from sale of goods and services.

ii. It is recurring in nature i.e. it is received on regular basis.

iii. It is shown on the Credit Side of the Trading and Profit and Loss Account.
Difference between Capital Receipts and Revenue Receipts
The points of difference between Capital and Revenue receipts are given below.

Basis of
Capital Receipts Revenue Receipts
Difference
It is the amount received from
the sale of fixed assets, loan It is the amount received from
Meaning
taken or additional capital sale of goods and services.
introduced.
These are not received from the These are received from the
Activities
ordinary business activities. ordinary business activities.
Nature It is non-recurring in nature. It is recurring in nature.
It is shown on the Credit Side
It is shown on the Liabilities Side
Shown of Trading and Profit and Loss
of Balance Sheet.
Account.
Sale of Goods, Rent Received,
Sale of Furniture, Loan from
Examples Profit on Sale of Machinery,
Bank, etc.
etc.
 Example:
State with the reasons whether the following items of receipts are of capital or revenue
in nature.

i. Amount received from sale of goods worth Rs 7,500.

ii. Started business with cash Rs 15,000.

iii. Sale of Old Machine Rs 19,500.

iv. Dividend received from investment of shares.

v. Amount received from sale of old newspapers Rs 2,300.

Solution:

i. Revenue Receipt- It is a revenue receipt because it is earned from normal

business activity i.e. sale of goods.

ii. Capital Receipt- It is a capital receipt because it is introduced or invested in the

business for its commencement and non-recurring in nature.

iii. Capital Receipt- It is a capital receipt because it is received from sale of fixed
assets (old machine) and not from the normal activity of business.

iv. Revenue Receipts- It is a revenue receipt because it is a regular income for an

investor.

v. Revenue Receipts- It is a revenue receipt because sale of newspapers is routine in

nature.

Deferred Revenue Expenditure

Sometimes, the benefits from revenue expenditure are not restricted to only one year
but are extended over many years. Such class of revenue expenditure is regarded as
deferred revenue expenditure. Such revenue expenditure involves the payment of huge
amount. Therefore, instead of charging the total amount of expenditure from Profit and
Loss Account the expenditure is written-off over certain years.

The expenditure written-off in the current accounting year is shown on the debit side of
the Profit and Loss Account and the remaining expenditure is shown on the Assets Side
of the Balance Sheet as deferred revenue expenditure.

For example, heavy expenditure of say Rs 90,000 is incurred on an advertisement

campaign the benefit of which is likely to be availed for a period of five years. In this
case, the whole amount of Rs 90,000 is not charged from the profits of the current
accounting year. Rather, expenditure will be spread over the period of 5 years. This

implies that, Rs 18,000 will be charged each year as revenue expenditure for
a period of 5 years. Thus, Rs 18,000 will be recorded as an advertisement expense on
the debit side of the Profit and Loss Account and the remaining portion of expenditure
i.e. Rs 72,000 (90,000 – 18,000) will be shown as Deferred Revenue expenditure on the
Assets Side of the Balance Sheet.

It should be noted that deferred revenue expenditure is a fictitious asset. Some of the
examples of such expenditure are preliminary expenses, huge advertisement
expenditure, underwriting commission, etc.

Features of Deferred Revenue Expenditure

The given below are some features of deferred revenue expenditure.

i. The benefit of this expenditure continues for more than one year.

ii. Amount of this expenditure is huge.

iii. Total expenditure is spread over certain years.

iv. It is a fictitious asset and shown in the Balance Sheet on the Assets Side.

Profits

Capital Profits
Capital profits are those profits that are earned from the disposal or sale of an asset and
redemption of debentures. These are not earned in the course of normal business
operations and are non-recurring in nature i.e. these are not frequently earned. Capital
profits are transferred to Capital Reserve and are shown on the Liabilities Side of the
Balance Sheet. When the assets of a firm are sold at a price above their book values,
then the amount realised in excess of the book value is regarded as capital profit.

Revenue Profits
Revenue profits are those profits that are earned in conduct of ordinary and day to day
business activities. The sale of goods and services at a price above their cost price,
results in revenue profits. These profits are received frequently in the normal course of
business operations. Revenue profits are shown on the credit side of the Profit and Loss
Account.

Difference between Capital Profits and Revenue Profits

The points of difference between Capital and Revenue profits are given below.
 Basis of
Capital Profits Revenue Profits
Difference
It is the amount earned from the It is the amount earned from the
Meaning disposal or sale of an asset and sale of goods and services at a
redemption of debentures. price above their cost price.
These are not earned from the These are earned from the
Activities
ordinary business activities. ordinary business activities.
Nature It is non-recurring in nature. It is recurring in nature.
It is shown on the Liabilities Side It is shown on the Credit Side of
Shown
of Balance Sheet. Profit and Loss Account.
Source Creation of Capital Reserves Creation of Revenue Reserves

Losses

Capital Loss
Capital losses are those losses that are incurred from the disposal or sale of an asset
and redemption of debentures. These are not incurred in the course of normal business
operations and are non-recurring in nature i.e. these are not frequently incurred. Capital
losses are made good or settled against the capital profits.

In case the amount of capital losses is more than the capital profit, then the excess
amount is shown on the Assets Side of the Balance Sheet. When the assets of a firm
are sold at a price lesser than their book values, then the amount lost in excess of the
book value is regarded as capital loss.

Revenue Loss
Revenue losses are those losses that are incurred in conduct of ordinary and day to day
business activities. The sale of goods and services at a price lesser than their cost
price, results in revenue losses. These losses are incurred frequently in the normal
course of business operations. Revenue losses are shown on the debit side of the Profit
and Loss Account.

Difference between Capital Loss and Revenue Loss

The points of difference between Capital and Revenue loss are given below.

Basis of
Capital Loss Revenue Loss
Difference
It is the loss incurred from the It is the loss incurred from the
Meaning disposal or sale of an asset and sale of goods and services at a
redemption of debentures. price lesser than their cost price.
 These are not incurred from the These are incurred from the
Activities
ordinary business activities. ordinary business activities.
Nature It is non-recurring in nature. It is recurring in nature.
It is shown on the Assets Side of It is shown on the Debit Side of
Shown
Balance Sheet. Profit and Loss Account.
It can be set-off against capital It cannot be set-off against
Set-off
profits capital profits.

Incomes

Capital Income
Capital incomes are those incomes that do not arise in the normal course of business
operations. Such incomes arise from the capital itself, without involving any production
work. For example, premium received from the issue of shares or debentures.

Revenue Income
Revenue incomes are those incomes that are earned in the conduct of ordinary and day
to day business activities. Such incomes are earned frequently. For example, profit
earned from the sale of goods, commission earned etc.

Difference between Capital Income and Revenue Income

The points of difference between Capital and Revenue income are given below.

Basis of
Capital Income Revenue Income
Difference
Incomes arising from the capital Incomes earned in conduct of
Meaning itself, without involving any ordinary and day to day
production work business activities
These are not earned from the These are earned from the
Activities
ordinary business activities. ordinary business activities.
Nature It is non-recurring in nature. It is recurring in nature.
It is shown on the Liabilities It is shown on the Credit Side of
Shown
Side of Balance Sheet. Profit and Loss Account.