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Lesson-7

Basic Principles of Preparing Final Account (Capital and Revenue)
Learning Objectives

To understand the meaning of capital expenditure
To understand the meaning of revenue expenditure

Capital Expenditure
1. Capital expenditure is that expenditure the benefits of which are not fully consumed
in a year but spread over several years.
2. It is the expenditure which results in the purchase or acquisition of asset or property.
3. It is the expenditure incurred in connection with the purchase of asset.
4. It is the expenditure incurred to bring an old asset into working condition.
5. It is the expenditure incurred for extending or improving an existing asset to increase
its productivity or to increase the earning capacity of business or to decrease working
expenditure.
It can be said that the capital expenditure benefits not only in the current accounting year
but also many years in the future. The expenditure is generally non-recurring and the
amount spent is normally large. However, it should be noted that not every big
expenditure is capital expenditure. Capital expenditures are shown in balance sheet.
Revenue Expenditure
1. Revenue expenditure is the expenditure which benefits in the current accounting
year. It is not carried forward to the next year or years.
2. It is the expenditure which is incurred in the normal course of business to run the
business and to maintain the fixed assets of business.
3. It is the expenditure which is incurred on purchase of goods meant for resale or to
purchase materials which will be used to convert them into final product.
Therefore, revenue expenditure is a recurring expenditure made to maintain the business.
The amount spent is generally small and the benefit is for a short period which is not
more than a year. All revenue expenditure are charged to trading and profit and loss
account.
Deferred Revenue Expenditure
Deferred revenue expenditure is the expenditure which is originally revenue in nature but
the amount spent is so large that the benefit is received for not a year but for many years.
A proportionate amount is charged to profit and loss account of each year and balance is
carried forward to subsequent years as deferred revenue expenditure. It is shown as an
asset in the balance sheet, e.g., heavy expenditure incurred on advertisements.
Capital Receipts

65

For example.00. It is a receipt against supply of goods or services. issue of shares or debentures. Both the reason for repairs and the amount are not important. profit on sale of asset and premium received on issue of shares.000. registration charges and on other legal expenses.00. Money obtained from the sale of fixed assets or investments. The cost of the building is now Rs. 1. 1. An old machinery is purchased for Rs. 1.It is revenue expenditure as it is incurred to keep the plant in normal working condition. 66 .000 for all the incidental expenses for buying the asset. 4. These are non-recurring receipts. Capital receipts are shown as liability reduced from assets appearing in the balance sheet. These types of profits are normally not taken to profit and loss account but are shown in the liabilities side of the balance sheet. The money obtained from sales.000 has been spent as expenses like brokerage. Capital Losses The losses which are not suffered during the regular course of business are called capital losses.000 and Rs. The machinery will now be used for many years and its cost is Rs.It is revenue expenditure because it is incurred for maintaining the building.25.00.000.000 has been spent to make the machinery productive. are examples of revenue receipts. Capital Profit Those profits which are not earned during the regular course of business and which are not earned on account of the day-to-day trading activities of the business are capital profits. Answer-. dividend. 10.Both the above expenses are capital expenditures as Rs. loans taken are some of the examples of capital receipts. 2. Revenue receipts are credited to profit and loss account. 25. 25. stamp duty. Revenue Receipts Revenue receipts are receipts obtained in the normal course of business. For example.000 has been spent for the purchase of asset and Rs.Capital receipts are the receipts which are not received in the ordinary course of business. Amount spent for the replacement of defective and worn out parts of an old plant Answer-. 1.00. 10. Answer-. 11.00.00.000 has been spent to bring it in working condition. Problem 1 1.00.Both the above expenditures are capital expenditures as Rs.000 has been spent to acquire the asset and Rs.000 and Rs. transfer fees etc. 1. discount on issue of shares. 3. interest. A building is purchased for Rs. Repairs to building Answer-. No new asset comes into existence.

But. Answer-. New equipment for existing machinery were bought for Rs.000 spent on the purchase of asset and Rs. it should be treated as capital expenditure and should be added to the cost of machinery. Heavy expenditure incurred on advertisements. 10. Proportionate amount will be written off every year by debiting profit and loss account and the remaining amount will be shown in the balance sheet on the asset side. 1980.000 is imported on which freight and insurance of Rs.000 and installation charges of Rs. In this case. custom duty of Rs.As repainting is a normal expenditure made for maintenance of the factory. 67 . A machinery costing Rs.000. Dr. 2. The benefits of it will be received for many years.Normally. Answer-. Problem 2 1. Taxes paid Answer-. 5.. 13. 30. Ltd. for the year ended on March 31. Problem 3 Following is the summarized trading account of Kinnar Co. Rs.Rs.00. it will be treated as deferred revenue expenditure. advertisement is revenue expenditure. 3.000 to increase the production by 25% Answer-. 4.It is revenue expenditure as it is a regular expense of the business. 5. 35.As the traveling expenses is incidental expenditure to purchase machinery. it is revenue expenditure. Expenditure for repainting the factory shed Answer-.000 were incurred.000. The benefit is only for one year. Traveling expenses of directors for a trip abroad for purchasing imported machinery Answer-. if directors purchase the machinery. 7.The above expenditure is capital expenditure as it increases the production capacity and thereby increases the earning capacity of the business. Particulars Rs. It is a recurring expense and no new asset comes into existence.000 spent on other incidental expenses should be considered as capital expenditure until the machinery comes in working condition. The cost of machinery will be Rs.5. 5. 5. It is a recurring expense. an iron manufacturing company.000.35.00. 5. it would be deferred revenue expenditure and would be written off over a reasonable period of say 3 to 5 years. Particulars Cr. as heavy expenditure is incurred. clearing charges of Rs. It is a nonrecurring expense and should be added to the value of asset.

fig.000 By Building (bal.000 90.500 The total production during the year was 6.500 4.000 To Wages 90.000 3.500 400 600 6.000 90. 5. 4.500 6.500 Dr. Exp.500 tons) By building a/c (500 tons) To Materials 2.000 92.000 tons out of which some amount was used for the construction of company’s building.000 90.500 tons) By (Closing) Stock (400 tons) 4.10.000 for the construction of building.500 to Gross Profit c/d 4. 2.000 = Rs. 5.10.000 68 .38.77. Exp.12. Wages include Rs.12.000 and other manufacturing expenses include Rs.000 4. To Gross Profit c/d 30.000 4.500 26.500 Cost per ton Particulars Materials Consumed Wages Manufacturing Expenses Total Cost for Manufacturing 6.500 39.000 tons Rs.90. Particulars To (Opening) 30. _2.500 By Sales (5.000 2.10.000 to other Mfg.To (Opening) Stock (500 tons) To Materials Consumed To Wages To Other Mfg. 90. Cr. Particulars To (Opening) Stock To Production Quantity Tons Particulars By Sales 500 By (Closing) Stock 6.) Cr.000 capitalized) By (Closing) Stock Less for Building 92. Rs.38.000 By Sales Stock (5. Rs.000 (400 tons) Less for Building 57. cost per ton = 3.000 Cost of 600 tons of iron used for building = 600 x 65 = 39.000 (Amount of cost of 95.77.000 26. 65 6.500 Working Notes Dr.000 11. Recast the trading account and ascertain the amount to be capitalized to the building account.000 95.000 Consumed iron to be _5. 2.000 Therefore. Solution Trading A/c for the year ended on 31st March 1980 Particulars Rs.

the above expense should be considered as revenue expenditure. umbrellas and raincoats for staff and employees Answer-. Expenditure incurred to prepare a project report 69 . It will also increase the earning capacity of the bus as diesel will cost less than petrol.It is a normal expenditure incurred on staff welfare and should be considered as revenue expenditure. It is an example of deferred revenue expenditure and is written off over a period of many years.000 Total 46.The above expenditure is not increasing the earning capacity of business. A petrol driven engine of a passenger bus replaced by a diesel engine Answer-. The preliminary expenses come under the head miscellaneous expenses on the assets side of the balance sheet.000 Problem 4 1.000 for additional features Answer-. It is spent to maintain the asset. Legal expenses are also debited to preliminary expenses. 3. Such expenses are known as revenue expenditure. 10.When a machine is purchased. Therefore.000 39. 5. the expenses incurred are debited to machinery repairs account. 2.Amount Capitalized to Building A/c Particulars Wages Manufacturing Expenses Iron Rs. It decreases the working expenditure. Customs duty paid on import of raw materials Answer-. Answer-. Problem 5 1. 5. 4. 2.It is capital expenditure. Cost of goodwill purchased Answer-. Legal expenditure incurred in connection with the issue of share capital. Also. the cost spent is debited to the machinery account. 3. A cinema theatre spent Rs. The amount spent will give benefit for many years. when any part of the machine is replaced on subsequent occasion.Any expenditure incurred at the time of formation of company is debited to preliminary expense account.000 2. no new asset comes into existence. Purchase of uniforms.It is revenue expenditure as raw materials are trading goods and all expenses related to the purchase of trading goods are revenue. It is a usual expense.It is capital expenditure as it is a non-recurring expense and will improve the efficiency of the bus. But. Cost of replacement of defective part of the machinery Answer-.

Expenditure incurred to train employees for the better running of machinery will result into greater efficiency and hence will increase the profit of the business. Legal expenses incurred in income tax appeal Legal expenses incurred in connection with income tax appeal are revenue expenses because they are normal business expenses incurred while doing business.As it is a regular income. it is not certain as to whether the project would materialize or not. 5. And in case of a project which does not materialize. Problem 6 1. In such a case. Hence. 3.It is revenue expense because such expenses are ordinary and normal expenses are incurred in the ordinary course of business. 70 . Damages paid for breach of contract Answer-. 2. they are treated as capital expenditure. 2. When expenses are incurred. the profit will be treated as capital gain.500 received from insurance company Answer-. Stock of Rs.000 destroyed by fire and Rs.Anytime when the project report is being prepared. such expenses are treated as revenue expenditure as they do not result into acquisition of any tangible assets. the project expenses are treated as revenue expenditure. Profit on sale of investment Answer-. certain expenses are required to be incurred such as market survey expenses. it is categorized as revenue receipt. 3. On a subsequent date. Expenditure incurred to train employees for better running of machinery Answer-. 4. Problem 7 1. Compensation for loss of goodwill Answer-. Dividend on investment Answer-. the profit on sale will be treated as revenue receipt and will be shown on the credit side of profit and loss account. Expenditure incurred for repairing cinema screen Answer-. If the project materializes and expenses incurred are sizeable.When the cinema screen is first constructed. 4. the expenses incurred are capitalized.If the investments are trading assets.The recovery of Rs. However.It is capital receipt as goodwill is an asset. any amount received on loss of an asset should be treated as capital receipt. 5. part of the expenses will be treated as revenue expenditure and the balance amount will be treated as capital expenditure. 3. expenditure incurred for repairs is treated as revenue expenditure. The case would be different if the cinema screen is replaced by a wider screen. when the screen is repaired. If investments are not trading assets.500 from insurance company is revenue receipt because it is on account of trading asset. The loss is revenue loss as stock is a trading asset and this loss will be debited to profit and loss account.Answer-.

It is an ordinary business expenditure and hence revenue expenditure. iv) Legal Charges Legal charges paid in the normal course of business are revenue expenses.If wages are paid for the construction work resulting in the extension of building. But carriage inward paid on the purchase of plant.3. i) Carriage Carriage inward on goods purchased is revenue expense. Wages paid for the extension of building Answer-. furniture etc. Raw materials are trading assets. The following are the examples of five revenue expenditure that can be treated as capital expenditure in certain circumstances. when the amounts are spent by way of repairs to put second hand machinery in working order. 3. Import duty on raw materials purchased Answer-. i. manufacture of tools or erection of plant. Capital expenditure are shown in balance sheet. 71 .It is revenue expenditure. legal charges paid in connection with the purchase of properties should be added to the cost of property. Sale of old machinery Answer-. they should be capitalized. iii) Wages Wages paid to workers engaged in the production of goods is revenue expense. 4. Summary 1. But where workers are engaged in extension of buildings. All revenue expenditure are charged to trading and profit and loss account. ii) Repairs Repairs to fixed assets to maintain them in a state of working efficiency is revenue expenditure. 2. 5. However. should be capitalized and treated as part of the cost of the assets. 4. the wages paid should be capitalized and treated as a part of the plant or the cost of the asset concerned. Capital expenditure is generally non-recurring and the amount spent is normally large.e.The amount received on sale of old machinery should be considered as capital receipt as it is not a receipt that arises in the ordinary course of business. Import duty paid on materials purchased is an expenditure relating to the purchase of trading assets. such repairs should be capitalized. Such expenses will be capitalized. 5. they are treated as capital expenditure as they create fixed assets. However. Revenue expenditure is a recurring expenditure made to maintain the business.

000 received from issue of shares out of which Rs. removing and reinstalling the old plant (p) Machinery of value Rs. 5. 4. 10. fixed assets or investments should be capitalized. revenue or deferred revenue: (a) Expenditure incurred in overhauling machinery (b) Amount brought by proprietor as capital (c) Building of cost Rs.00. Questions 1. 2.50.500 (q) Charges paid to workers for erecting new machinery (r) Rs. 7.000 sold for Rs.v) Brokerage Brokerage paid on purchase of properties. 6. 8. 2. 1.000 are issue expenses 72 .00.000 sold for Rs. 2. 10. What is capital expenditure? What is revenue expenditure? What is deferred revenue expenditure? What do you mean by capital receipts? What do you mean by revenue receipts? What is capital profit? What is capital loss? State with reasons whether the following items are capital. 10. 3.000 (d) White washing of office building (e) Expenditure incurred for training employees (f) Received a gift from parents and introduced the amount in business (g) Insurance of godown (h) Renewal of license (i) Expenses incurred on research of a product not resulting in success (j) Bad debts recovered (k) Depreciation on assets (l) Shares purchased and brokerage paid on purchase (m) Loss on sale of plant (n) Preliminary expenses (o) Cost of dismantling.