Capital and revenue expenditure – CA Foundation, CPT notes, PDF
3.1 CAPITAL EXPENDITURE:
Capital and revenue expenditure
♦ Any amount spent by actual payment or for which a liability is incurred is known as an expenditure.
♦ Capital Expenditure is that expenditure which results in the acquisition of an asset (tangible or intangible) which can be later sold and converted into cash or which results in an increase in the earning capacity of the business or which affords some other advantage to the firm.
♦ In a nutshell, if the benefits of expenditure are expected to accrue for a long time, the expenditure is capital expenditure.
♦ Obvious examples of capital expenditure are land, building, machinery, patents, etc.
♦ All these things stay with the business and can be used over and over again.
♦ Expenditure which does not result in an increase in capacity or in the reduction of day-to-day expenses is not capital expenditure unless there is a tangible asset to show for it.
♦ All amounts spent up to the point an asset is ready for use should be treated as capital expenditure.
♦ Examples are Fees paid to a lawyer for drawing up the purchase deed of land, overhauling expenses of secondhand machinery, interest paid on loans raised to acquire the assets but only for the period before the asset is ready for use.
♦ Any expenditure incurred to bring such an asset into usable condition for the 1 st time is also a capital expenditure like installation expenses etc.
♦ Additional expenditure on such assets in the future will be capitalized only if it results in significant improvement over and above its originally assessed performance.
3.2 REVENUE EXPENDITURE:
♦ An item of expenditure whose benefit expires within the year or expenditure which merely seeks to maintain the business or keep assets in good working conditions is revenue expenditure.
♦ Examples are Salaries and Wages, the power used to drive machinery, electricity used to light the factory or offices, etc.
♦ Such expenditure does not increase the efficiency of the firm, nor does it result in any acquisition of the fixed assets.
♦ Diminution in the value of assets due to wear and tear or passage of time is revenue expense.
♦ For instance, a piece of machinery is bought at the beginning of the year for Rs. 10,000. At the end of the year, its value to the business may only be Rs. 9,000. This diminution in value Rs. 1,000 is a revenue loss.
♦ Stocks of materials bought will be an asset unless consumed, to the extent the materials are used up. they will be revenue expenditure.
♦ Capital expenditure is shown in the Balance Sheet as assets whereas revenue expenditures are debited to P & L a/c.
♦ When reduction of asset or Increase of liability in return, gives some benefit to the entity it is known as Expenses like salary, Depreciation, etc.
♦ When the reduction of an asset or increase of liability is not coupled by the corresponding benefit, it is known as a loss like Bad Debts, theft of cash, etc.
♦ Both arcs charged to P & L a/c.
3.4 DEFERRED REVENUE EXPENDITURE & PREPAID EXPENSES:
♦ The Guidance Note on Terms used in Financial Statement’, issued by the Institute of Chartered Accountants of India, defines “deferred revenue expenditure as those expenditure” “for which payment has been made or a liability incurred but which is carried forward on the presumption that it will be of benefit over a subsequent period or periods,”
♦ In short, it refers to that expenditure that is, for the time being, deferred from being charged against income.
♦ So long as deferred revenue expenditure is not written off, this is shown on the assets side of the balance sheet under the head “Miscellaneous Expenditure.”
In the case of Companies, in Schedule III this head has been removed, hence if any expenditure is deferred in accordance with an Accounting Standard then the same will be shown in Current or Non-Current Assets depending upon the period of amortization.
♦ Deferred revenue expenditure should be revenue expenditure by nature in the first instance, for example, advertisement. But its matching with revenue may be deferred considering the benefit to be accrued in the future.
♦ A thin line of difference exists between deferred revenue expenses and prepaid expenses.
♦ The benefits available from prepaid expenses can be precisely estimated but that is not so in case of deferred revenue expenses.
♦ Heavy advertising to launch a new product is a deferred expense since the benefit from it will be available over the next three to five years but one cannot say precisely how long.
♦ On the other hand, insurance premium paid, say, for the year ending 30th June 2006, when the accounting year ends on 31st March 2006 will be an example of prepaid expense to the extent of premium relating to three months’ period i.e. from 1st April 2006 to 30th June 2006.
♦ Thus the insurance protection will be available precisely for three months after the close of the year and the amount of the premium to be carried forward can be calculated exactly.
As per Accounting Standards 26, only those expenditures should be deferred which are expected to give future benefits. While solving the problem, the student should deffer an expense item only if specifically so required by the question.
3.5 CAPITAL RECEIPTS AND REVENUE RECEIPTS:
♦ Receipts that are obtained in the course of normal trading operations are revenue receipts (e.g. sale of goods, interest income, etc.).
♦ On the other hand, receipts that are not revenue in nature are capital receipts (e.g. sale of fixed assets, secured or unsecured loans, owners’ contributions, etc.).
♦ Subscriptions by shareholders towards the share capital of a company or for purchasing its debentures are considered by the company as capital receipts.
♦ By the same criterion, contributions by partners or proprietors to capital of their business are capital receipts.
♦ The sale value of fixed assets is also capital receipts since these are distinguishable from revenue receipts, e.g., those from the sale of merchandise, rent on the property, interest on investment, the professional fee for services rendered, etc.
♦ It will be evident that capital receipts emanate out of a fund already held or arise on the conversion of an asset, whereas revenue receipts I low from personal exertion, use of a capital asset or from sale or transfer of floating assets like goods.
♦ Revenue and capital receipts are recognized on an accrual basis as soon as the light of receipt is established.
♦ Revenue receipts are credited to the profit and loss account.
♦ On the other hand, capital receipts are not directly credited to the profit and loss account.
♦ For example, when a fixed asset is sold, the entire capital receipts are not credited to Profit and Loss Account. Profit or loss on the sale of fixed assets is calculated and recorded in Profit and Loss Account.
STATE WHETHER TRUE OR FALSE:
- The lease premium will be treated as revenue expenditure.
- The amount received by the issue of debentures is a capital receipt.
- Capital expenditure is done to restore the efficiency of an asset.
- Revenue loss is not the same thing as revenue expenditure.
- Any expenditure which increases the value of fixed assets is termed as capital expenditure.
- Preliminary expenses are classified under deferred revenue expenditure.
- Wages paid to workers for erecting machines will be treated as revenue expenditure.
- 8. Any heavy expenditure of revenue nature the benefit of which will be availed over a number of a years can be classified as capital expenditure.
- Capital receipts are either shown as an increase in liabilities or as a reduction in the value of the assets.
- Money spent to reduce working expenses is treated as capital expenditure.
- Interest paid on the purchase of an asset in all cases will be treated as capital expenditure.
- The amount spent on experimenting which did not result in success will be treated as a capital loss.
- A building of book value Rs. 45,000 got demolished and a new building having a book value Rs. 17,00,000 was constructed. Thus, Rs. 45,000 is a revenue loss and Rs. 17,00,000 is a capital receipt.
- Repairs amount spent on the second-hand machine, purchased recently, before using it will be treated as capital expenditure.
- Rs. 10 lakhs were spent on the construction of a mess hall for the welfare of the employees. Rs. 6 lakhs were received from the Government as a grant. In this case Rs. 4 lakhs will be treated as capital expenditure and Rs. 6 lakhs as capital receipt.
- The amount spent in connection with the issue of capital should be considered as a capital expenditure, but legal expenses spent in connection with the issue of capital shall be considered as revenue expenditure.
ANSWERS WITH EXPLANATIONS
- False; Lease premium is a capital expenditure.
- True; Money received by way of issue of shares or debentures by a company is a capital receipt.
- False; Capital expenditure is done to improve the efficiency of an asset.
- True; Revenue expenditure is incurred to receive a benefit during a current year. Revenue loss occurs in the normal course of business and provides no benefit.
- True; Expenditure that is done in connection with the acquisition of fixed assets or which leads to the increment in the value of fixed assets is classified under capital expenditure.
- False; Expenditure done in connection with the erection of machines is an example of capital expenditure.
- False; The expenditure of this kind will be termed as Deferred revenue expenditure.
- True; Preliminary expenses are treated as deferred revenue expenditure as these can be written off over a maximum of 4-5 years. Though according to AS 26, Preliminarily expenses spent in the incorporation of a company should be written off in the year it is incurred.
- True; Capital receipts are shown in the balance sheet as an increase in liabilities or as a reduction in the value of assets.
- True; Any expenditure that reduces the working expenses will be treated as capital expenditure.
- False; Such expenditure is classified under the head of capital expenditure if it is paid during the production/ construction period. The expenditure will be treated as revenue after the assets is put to use.
- False; It will be considered as a deferred revenue expenditure so that the burden of loss is shifted over a number of years.
- False; Rs. 45,000 is a revenue loss but Rs. 17,00,000 is a capital expenditure.
- True; Overhaul expenses (repairs) incurred to put a second-hand machine in useable condition to derive its benefit for future periods is a capital expenditure.
- False; Rs. 10,00,000 will be treated as capital expenditure since it is spent on the construction of the mess hall.
- False: Legal expenses incurred on the issue of capital will be treated as capital expenditure.