COMMERCIAL STUDIES STD- IX 2017-2018 Chapter 7- CAPITAL AND REVENUE EXPENDITURE / INCOME Capital Expenditure Capital expenditure means the expenditure benefit of which is not exhausted within the current period but is enjoyed over a long time period. Such expenditure is of non- recurring nature and results in acquisition of permanent assets. All expenditure incurred to acquire or increase the value of the fixed assets which are used in the business for the purpose of earning revenue are called capital Features of capital expenditure 1) Capital expenditure results in the acquisition of permanent assets such as land and buildings, plant and machinery, furniture etc. 2) These assets are intended to be used in business for earning revenue over several years. 3) Capital expenditure includes expenses incurred for making the asset ready for use. e.g.: Wages paid for erecting machines, cost of the platform on which the machine will be fixed, cartage paid on acquiring plant and machinery. 4) Expenditure incurred for the extension of our improvement in fixed assets is also capital Such expenditure e.g. hauling of second hand machinery, etc. helps to increase the profit earning capacity of the business by increasing output or reducing costs. 5) Capital expenditure includes the expenses incurred to acquire the right to carry on business E.g.: cost of license, legal fees and brokerage paid to acquire an asset. 6) Expenses incurred to acquire intangible assets such as goodwill, patents, etc. are also capital 7) Expenses incurred to establish a business, e.g. preliminary expenses for incorporation of a company, etc. 8) Expenses incurred on issuing shares and debentures. 9) Expenses incurred on raising loans for the business. 10) Expenses incurred to reduce operating costs e.g. conversion of hand driven machinery into power driven machinery. 11) Expenses incurred in tea and rubber plantations, horticulture etc. during the development process before they begun to yield any income. Such expenditure is called development Examples of Capital Expenditure a) Purchase of land, building, plant and machinery, equipment furniture, loose tools, etc. b) Cost of addition, extension and improvements to existing fixed assets. c) Cost of overhauling second hand machines. ( 1 )
d) Expenses incurred for putting an asset into working condition. e) Cost of increasing or improving the earning capacity or installed capacity of the business. f) Cost of intangible assets such as goodwill. g) Expenses incurred in connection with the purchase of land or building such as fees paid to lawyer or registration etc. REVENUE EXPENDITURE Revenue expenditure means the expenditure that benefit of which is exhausted within the current year. Such expenditure is of recurring nature and does not result in the acquisition of permanent assets. All the expenses incurred on day-to-day administration of a firm and the effect of which is completely exhausted within the current accounting are called revenue Types of Revenue Expenditure 1) Expenses incurred for the day-to-day running of the business: These expenses do not yield any benefit beyond the current year and their effect is short-lived.e.g. Rent, salaries, wages, power and fuel etc. These expenses do not add to the profit earning capacity of the business. 2) Expenses incurred for the upkeep of fixed assets: Fixed assets represent capital expenditure but expenses incurred to keep them in good working condition such as repairs and maintenance are revenue 3) Expenses incurred on purchase of stocks of materials and goods: These include the goods for purchased for resale and raw materials purchased for converting them into finished goods. The amount used during the year is revenue expenditure and the remaining amount will be an asset. 4) Depreciation on fixed assets: Fixed assets lose part of their value every year due to wear and tear and even with the passage of time. Such reduction in value is called depreciation and it is treated as a revenue 5) Loss from sale of fixed assets. 6) Replacement of worn-out parts of existing machines. 7) Interest on loan and interest on capital for the period after the asset is put to use. REVENUE EXPENDITURE TREATED AS CAPITAL EXPENDITURE The following expenses are revenue in nature but are treated as Capital expenditures in the following circumstances. 1. Raw materials and stores When these are used for manufacturing a fixed asset, these expenses are treated as capital 2. Carriage and Freight- If these expenses are paid on the transportation of newly acquired fixed asset, these are treated as capital 3. Wages- Wages are paid for construction of a building or for the installation of a machine are treated as capital expenditure and are added to the cost of asset. 4. Repairs- Expenses incurred to repair a second hand machine, purchase by the firm, to make it usable are treated as capital 5. Preliminary Expenses Expenses incurred on the formation of a company are treated as capital expenses because their benefit will be available over a long period of time. 6. Brokerage- Brokerage paid on the purchase of a fixed asset is treated as capital ( 2 )
7. Legal Expenses- Stamp duty and other legal expenses incurred in connection with the acquisition of fixed assets are treated as capital 8. Advertising- Advertising expenses incurred for introducing a new product in the market are treated as capital 9. Interest Interest paid on loan and capital when paid during the construction of a fixed asset is treated as capital Distinction between Capital Expenditure and Revenue Expenditure Basis of Distinction Capital Expenditure Revenue Expenditure 1.Purpose 2.Earning capacity 3.Period of benefit 4.Accounting treatment 5.Nature 6.Effect on Assets Capital Expenditure is incurred for acquisition or erection of fixed assets to be used in the business. Capital Expenditure increases the earning capacity of the business. The benefit of capital expenditure extends to more than one year. Capital Expenditure is shown in the Balance Sheet as an asset. Capital Expenditure is of nonrecurring nature because such expenditure is not incurred every day. Capital Expenditure leads to increase in the value of fixed asset. Revenue Expenditure is incurred for day to day conduct of the business. Revenue Expenditure does not increase the earning capacity as it is incurred for maintaining the existing earning capacity. The benefit of revenue expenditure extends only to the current year. It is shown on the expense side of the Trading and Profit and Loss Account. Revenue Expenditure is of recurring nature because such expenditure is incurred on day to day operations. It does not result in the increase of the value of fixed assets. Deferred Revenue Expenditure Q. What is meant by Deferred Revenue Expenditure? Ans: Deferred Revenue Expenditure means revenue expenses the benefit of which extends beyond the current accounting year. For example: heavy advertising expenditure incurred in launching a new product in the market is deferred revenue Illustration 1: State with reasons whether the following are capital or Revenue Expenditure. 1) An amount of Rs.5,000 spent on incorporation of a company to start the business. Ans: Rs. 5,000 spent on incorporation of a company is a capital expenditure because it was paid to acquire a right to carry on the business. 2) Rs. 2,500 spend on repairing various machines. ( 3 )
Ans: It is a revenue expenditure as the sum was spent to maintain the existing machines. 3) Rs. 6,700 spent on conversion of a hand-driven machine into power driven machine. Ans: It is a capital Expenditure because the money was paid to add the earning capacity of the machine. 4) A sum of Rs.15, 000 spent on the overhauling of a second-hand delivery van. Ans: Rs15,000 spend on the overhauling of the second-hand delivery van is capital expenditure as it was spent to make a capital asset fit for use. Illustration 2: State with reasons whether the following are Capital or Revenue Expenditure or Deferred Revenue Expenditure. 1) Cleaning and greasing of the fans. Ans: Revenue Expenditure as it is incurred for maintaining an existing asset. 2) Money spent on experimentation of a new product design and the experiment failed. Ans: Deferred Revenue Expenditure because so that the entire burden does not fall on the current year s profits. 3. Purchase of a second hand pump and its repairs for making it workable. Ans: Capital Expenditure because of fixed asset is acquired and made workable. 4. Preliminary expenses of Rs. 10,000. Ans: Deferred revenue expenditure as its benefit will be available beyond the current year. II. Capital Receipts and Revenue Receipts Q. Distinguish between Capital Receipts and Revenue Receipts. Capital Receipts 1. Capital Receipts create liabilities or increase share capital. It creates reduction in the value of fixed assets. 2. Capital Receipts are of non- recurring nature. E.g.: additional capital from owners, loans raised by the firm. 3. Capital Receipts are shown on the liabilities side of the Balance sheet. Revenue Receipts 1. Revenue Receipts do not create liability or reduction of fixed assets. 2. Revenue Receipts are of recurring nature. E.g.: Sale proceeds of goods and services, interest received, dividend received etc. Revenue Receipts are credited to the Trading and Profit and Loss account. III. Capital and Revenue Losses Capital losses are the losses which are not related to with the normal course of the business. Examples: a) Loss on issue of shares and debentures ( 4 )
b) Loss on sale of fixed assets c) Loss on fixed assets like plant and building, etc. by fire or accident. d) Loss by theft after business hours. Revenue Losses are the losses which are incurred in the normal course of the business. Examples: a) Bad debts Illustration: b) Loss of stock by theft or fire. c) Embezzlement or misappropriation of cash by employees during usual business hours. State with reasons whether the following are Capital or Revenue Losses. 1. Theft of cash by the cashier (a) during business hours (b) after business hours. Ans: Theft of cash during business hours is revenue loss and that after business hours is capital loss. 2. A part of factory building worth Rs. 60,000 has been destroyed by the earthquake. Ans: Rs. 60,000 is a capital loss because a fixed asset was destroyed. IV. Capital and Revenue Profits Capital Profits refer to profits earned on sale of fixed assets and in connection with the issue of shares and debentures. Example: When shares are issued at a premium, the amount of premium is called capital Profit. Revenue profits means the profits earned in the normal course of business. Example: If Goods costing Rs 50,000 are sold at Rs 60,000, Rs 10000 is the revenue profit. Illustration State with reasons whether the following are Capital Profits or Revenue Profits. 1. Rs. 50,000 received as a premium on issue of shares. Ans: Capital Profit because the amount of premium is in connection with share capital. 2. Goods purchased for Rs.1, 00,000 and sold for 1,30,000. Ans: Revenue Profit since it is earned in the normal course of the business. ( 5 )