THEORETICAL FRAMEWORK 1.

UNIT – 3 CAPITAL AND REVENUE EXPENDITURES

AND RECEIPTS

LEARNING OUTCOMES
After studying this unit, you will be able to:
 Learn the criteria for identifying Revenue Expenditure
and distinguishing from Capital Expenditure
 Learn the distinction between capital and revenue receipts.
 Understand the linkage of such distinction with the
preparation of final accounts.

UNIT OVERVIEW

•Paymen
Capit ts
•Receipts
al •Paymen
Revenu ts
•Receipts
e
3.1 INTRODUCTION
Accounting aims in ascertaining and presenting the results of the business for an
accounting period. For ascertaining the periodical business results, the nature of
transactions should be analyzed whether they are of capital or revenue nature.
Revenue Expense relates to the operations of the business of an accounting period
or to the revenue earned during the period or the items of expenditure, benefits of
which do not extend beyond that period. Capital Expenditure, on the other hand,
generates enduring benefits and helps in revenue generation over more than one
accounting period. Revenue Expenses must be associated with a physical activity of
the entity. Therefore, whereas production and sales generate revenue in the
earning process, use of goods and services in support of those functions causes
expenses to occur.

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Expenses are recognised in the Profit & Loss Account through matching principal
which tells us when and how much of the expenses to be charged against revenue.
A part of the expenditure can be capitalised only when these can be traced directly
to definable streams of future benefits.
The distinction of transaction into revenue and capital is done for the purpose of
placing them in Profit and Loss account or in the Balance Sheet. For example:
revenue expenditures are shown in the profit and loss account as their benefits
are for one accounting period i.e., in which they are incurred while capital
expenditures are placed on the asset side of the balance sheet as they will
generate benefits for more than one accounting period and will be transferred to
profit and loss account of the year on the basis of utilisation of that benefit in
particular accounting year. Hence, both capital and revenue expenditures are
ultimately transferred to profit and loss account.
Revenue expenditures are transferred to profit and loss account in the year of
spending while capital expenditures are transferred to profit and loss account of
the year in which their benefits are utilised. Therefore, we can conclude that it is
the time factor, which is the main determinant for transferring the expenditure to
profit and loss account. Also, expenses are recognized in profit and loss account
through matching concept which tells us when and how much of the expenses to be
charged against revenue. However, distinction between capital and revenue creates
a considerable difficulty. In many cases borderline between the two is very thin.

3.2 CONSIDERATIONS IN DETERMINING CAPITAL

AND REVENUE EXPENDITURES
The basic considerations in distinction between capital and revenue expenditures are:
(a) Nature of business: For a trader dealing in furniture, purchase of furniture
is revenue expenditure but for any other trade, the purchase of furniture
should be treated as capital expenditure and shown in the balance sheet as
asset. Therefore, the nature of business is a very important criteria in
separating an expenditure between capital and revenue.
(b) Recurring nature of expenditure: If the frequency of an expense is quite
often in an accounting year then it is said to be an expenditure of revenue
nature while non- recurring expenditure is infrequent in nature and do not
occur often in an accounting year. Monthly salary or rent is the example of
revenue expenditure as they are incurred every month while purchase of
assets is not the transaction done regularly therefore, classified as capital
expenditure unless materiality criteria defines it as revenue expenditure.

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 THEORETICAL FRAMEWORK 1.3

(c) Purpose of expenses: Expenses for repairs of machine may be incurred in

course of normal maintenance of the asset. Such expenses are revenue in
nature. On the other hand, expenditure incurred for major repair of the asset
so as to increase its productive capacity is capital in nature. However,
determination of the cost of maintenance and ordinary repairs which should
be expensed, as opposed to a cost which ought to be capitalised, is not
always simple.
(d) Effect on revenue generating capacity of business: The expenses
which help to generate income/ revenue in the current period are revenue in
nature and should be matched against the revenue earned in the current
period. On the other hand, if expenditure helps to generate revenue over
more than one accounting period, it is generally called capital expenditure.
When expenditure on improvements and repair of a fixed asset is done, it has
to be charged to Profit and Loss Account if the expected future benefits from
fixed assets do not change, and it will be included in book value of fixed
asset, where the expected future benefits from assets increase.
(e) Materiality of the amount involved: Relative proportion of the amount
involved is another important consideration in distinction between revenue
and capital.

3.3 CAPITAL EXPENDITURES AND

REVENUE EXPENDITURES
As we have already discussed, capital expenditure contributes to the revenue
earning capacity of a business over more than one accounting period whereas
revenue expense is incurred to generate revenue for a particular accounting period.
The revenue expenses either occur in direct relation with the revenue or in relation
with accounting periods, for example cost of goods sold, salaries, rent, etc. Cost of
goods sold is directly related to sales revenue whereas rent is related to the
particular accounting period. Capital expenditure may represent acquisition of any
tangible or intangible fixed assets for enduring future benefits. Therefore, the
benefits arising out of capital expenditure last for more than one accounting period
whereas those arising out of revenue expenses expire in the same accounting
period.

3.3.1 Key differences between Capital and Revenue Expenditures

Key Differences Capital Expenditure Revenue Expenditure
Period of benefit Any expenditure incurred to Any expenditure incurred to
provide a benefit over a long- provide a benefit during the
term period is capital current period is revenue
expenditure. expenditure.

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Enhancement Capital expenditure is Revenue expenditure is

incurred for the purpose of incurred to maintain the
vs Maintenance increasing the capacity of the earning capacity of the
business. Alternatively, it business.
also includes an expenditure
to reduce the costs of the
business.
Examples Purchase of machine, Repairs and maintenance,
car, furniture, etc. salary of accounting staff,
etc.
ILLUSTRATION 1
State with reasons whether the following statements are ‘True’ or ‘False’.
(1) Overhaul expenses of second-hand machinery purchased are Revenue Expenditure.
(2) Money spent to reduce working expenses is Revenue Expenditure.
(3) Legal fees to acquire property is Capital Expenditure.
(4) Amount spent as lawyer’s fee to defend a suit claiming that the firm’s
factory site belonged to the plaintiff’s land is Capital Expenditure.
(5) Amount spent for replacement of worn out part of machine is Capital Expenditure.
(6) Expense incurred on the repairs and white washing for the first time on
purchase of an old building are Revenue Expenses.
(7) Expenses in connection with obtaining a license for running the cinema is
Capital Expenditure.
(8) Amount spent for the construction of temporary huts, which were necessary
for construction of the Cinema House and were demolished when the cinema
house was ready, is Capital Expenditure.
SOLUTION
(1) False: Overhaul expenses are incurred to put second-hand machinery in
working condition to derive endurable long-term advantage. So it should
be capitalised.
(2) False: It may be reasonably presumed that money spent for reducing
revenue expenditure would have generated long-term benefits to the entity.
So this is capital expenditure.
(3) True: Legal fee paid to acquire any property is part of the cost of that
property. It is incurred to possess the ownership right of the property and
hence a capital expenditure.

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(4) False: Legal expenses incurred to defend a suit claiming that the firm’s
factory site belongs to the plaintiff is maintenance expenditure of the
asset. By this expense, neither any endurable benefit can be obtained in
future in addition to that what is presently available nor the capacity of the
asset will be increased. Maintenance expenditure in relation to an asset is
revenue expenditure.
(5) False: Amount spent for replacement of any worn out part of a machine is
revenue expense since it is part of its maintenance cost.
(6) False: Repairing and white washing expenses for the first time of an old
building are incurred to put the building in usable condition. These are the
part of the cost of building. Accordingly, these are capital expenditure.
(7) True: The Cinema Hall could not be started without license. Expenditure
incurred to obtain the license is pre-operative expense which is capitalised.
Such expenses are amortised over a period of time.
(8) True: Cost of temporary huts constructed which were necessary for the
construction of the cinema house is part of the construction cost of the
cinema house. Therefore such costs are to be capitalised.
ILLUSTRATION 2
State with reasons whether the following are Capital or Revenue Expenditure:
(1) Expenses incurred in connection with obtaining a license for starting the factory
for
` 10,000.

(2) ` 1,000 paid for removal of Inventory to a new site.

(3) Rings and Pistons of an engine were changed at a cost of ` 5,000 to get fuel efficiency.
(4) Money paid to Mahanagar Telephone Nigam Ltd. (MTNL) ` 8,000 for installing
telephone in the office.
(5) A factory shed was constructed at a cost of ` 1,00,000. A sum of ` 5,000 had
been incurred in the construction of temporary huts for storing building
material.
SOLUTION
(1) Money paid ` 10,000 for obtaining license to start a factory is a capital
expenditure. This is an item of expenditure incurred to acquire the right to
carry on business.
(2) ` 1,000 paid for removal of Inventory to a new site is revenue
expenditure. This is neither bringing enduring benefit nor enhancing the
value of the asset.

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(3) ` 5,000 spent in changing Rings and Pistons of an engine to get fuel
efficiency is capital expenditure. This is an expenditure on improvement of a
fixed asset. It results in increasing profit-earning capacity of the business by
cost reduction.
(4) Money deposited with MTNL for installation of telephone in office is not
expenditure. This is treated as an asset and the same is adjusted over a
period of time against actual telephone bills.
(5) Cost of construction of building including cost of temporary huts is capital
expenditure. Building is fixed asset which will generate enduring benefit to
the business over more than one accounting period. Construction of
temporary huts is incidental to the main construction. Such cost is also
capitalised with the cost of building.
ILLUSTRATION 3
Best Tech Solutions buys and sells computers as a part of its business. It purchased
20 computers for resale to its customers. Cost of each computer is ` 20,000. It also
purchased a computer costing ` 24,000 for its accountant to be able to maintain
the accounting records and printing of invoices. Suggest whether above
transactions qualify as capital expenditure or revenue expenditure transactions?
SOLUTION
Best Tech Solutions is in the business of buying and selling of computers. Any
computers purchased for resale to its customers will qualify as revenue
expenditure. Hence, a purchase of 20,000 x 20 = ` 4,00,000 will be a part of
revenue expenditure.
At the same time, the computer purchased for maintaining the records and
invoicing is to be able to operate the business for a longer period of time. Therefore,
the purchase of ` 24,000 qualifies as a capital expenditure. This amount will be a
part of assets in the Balance Sheet.

3.4 CAPITAL RECEIPTS AND REVENUE RECEIPTS

Just as a clear distinction between Capital and Revenue expenditure is necessary, in
the same manner capital receipts must be distinguished from revenue receipts.
Receipts which are obtained in course of normal business activities are revenue
receipts (e.g., receipts from sale of goods or services, interest income etc.). On
the other hand, receipts which are not revenue in nature are capital receipts (e.g.,
receipts from sale of fixed assets or investments, secured or unsecured loans,
owners’ contributions etc.). Revenue and capital receipts are recognised on accrual
basis as soon as the right of receipt is established. Revenue receipts should not be
equated with the actual cash receipts. Revenue receipts are credited to the Profit
and Loss Account.

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On the other hand, Capital receipts are not directly credited to Profit and Loss
Account. For example, when a fixed asset is sold for ` 92,000 (cost ` 90,000), the
capital receipts ` 92,000 is not credited to Profit and Loss Account. Profit or Loss on
sale of fixed assets is calculated and credited to Profit and Loss Account as follows:
Sale Proceeds ` 92,000
Cost (` 90,000)
Profit ` 2,000
ILLUSTRATION 4
State with reasons whether the below items relating to the business of AB td
are capital or revenue receipts?
(a) A machine with a book value of ` 10 lakh is sold for ` 12 lakh.
(b) Premium amounting to ` 1 Lakh received on issue of shares
(c) An amount of ` 20,000 received from goods sold in cash.
(d) An amount of ` 5 lac received on the maturity of fixed deposit from bank.
Also, an interest of ` 40,000 was received in addition to the maturity
amount of the fixed deposits.
SOLUTION
(a) The amount of ` 12 lac is a capital receipt. There is a profit on sale of the
machine to the extent of ` 2 lac (12 – 10)
(b) Premium received on issue of shares is an example of capital receipt.
(c) Amount received from cash sale is a revenue receipt.
(d) Amount received on the maturity of fixed deposit is the recovery of
the deposit amount, and is a capital receipt. Interest income is an
example of revenue receipt.

ILLUSTRATION 5
Good Pictures Ltd., constructs a cinema house and incurs the following
expenditure during the first year ending 31st March, 2022.
(1) Second-hand furniture worth ` 9,000 was purchased; repainting of the furniture
costs
`1,000. The furniture was installed by own workmen, wages for this being ` 200.
(2) Expenses in connection with obtaining a license for running the cinema worth
` 20,000. During the course of the year the cinema company was fined `
1,000, for contravening rules. Renewal fee `2,000 for next year also paid.
(3) Fire insurance, ` 1,000 was paid on 1st October, 2021 for one year.

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(4) Temporary huts were constructed costing ` 1,200. They were necessary for
the construction of the cinema. They were demolished when the cinema
was ready.
Point out how you would classify the above items.
SOLUTION
(1) The total cost of the furniture should be treated as ` 10,200 i.e., all the
amounts mentioned should be capitalised since without such expenditure
the furniture would not be available for use. If ` 1,000 and ` 200 have been
respectively debited to the Repairs Account and the Wages Account, these
accounts will be credited to the Furniture Account.
(2) License for running the cinema house is necessary, hence its cost should be
capitalised. But the fine of ` 1,000 is revenue expenditure. The renewal fee
for the next year is also revenue expenditure but pertains to the next year;
hence, it is a prepaid expense.
(3) Half of the insurance premium pertains to the year beginning on 1st April,
2021. Hence such amount should be treated as prepaid expense. The
remaining amount is revenue expense for the current year.
(4) Since the temporary huts were necessary for the construction, their cost
should be added to the cost of the cinema hall and thus capitalised.
ILLUSTRATION 6
State with reasons, how you would classify the following items of expenditure:
(1) Overhauling expenses of ` 25,000 for the engine of a motor car to get better fuel
efficiency.
(2) Inauguration expenses of ` 25 lacs incurred on the opening of a new
manufacturing unit in an existing business.
(3) Compensation of ` 2.5 crores paid to workers, who opted for voluntary retirement.
SOLUTION
(1) Overhauling expenses are incurred for the engine of a motor car to derive
better fuel efficiency. These expenses will reduce the running cost in future
and thus the benefit is in form of endurable long-term advantage. So this
expenditure should be capitalised.
(2) Inauguration expenses incurred on the opening of a new unit may help to
explore more customers This expenditure is in the nature of revenue
expenditure, as the expenditure may not generate any enduring benefit to
the business over more than one accounting period.
(3) The amount paid to workers on voluntary retirement is in the nature of
revenue expenditure. Since the magnitude of the amount of expenditure is
very significant, it may be better to defer it over future years.

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ILLUSTRATION 7
Classify the following expenditures and receipts as capital or revenue:
(i) ` 10,000 spent as travelling expenses of the directors on trips abroad for
purchase of capital assets.
(ii) Amount received from Trade receivables during the year.
(iii) Amount spent on demolition of building to construct a bigger building on the same site.
(iv) Insurance claim received on account of a machinery damaged by fire.
SOLUTION
(i) Capital expenditure.
(ii) Revenue receipt.
(iii) Capital expenditure.
(iv) Capital receipt.
ILLUSTRATION 8
Are the following expenditures capital in nature?
(i) M/s ABC & Co. run a restaurant. They renovate some of the old cabins.
Because of this renovation some space was made free and number of cabins
was increased from 10 to 13. The total expenditure was ` 20,000.
(ii) M/s New Delhi Financing Co. sold certain goods on installment payment basis.
Five customers did not pay installments. To recover such outstanding
installments, the firm spent ` 10,000 on account of legal expenses.
(iii) M/s Ballav & Co. of Delhi purchased a machinery from M/s Shah & Co. of
Ahmedabad. M/s Ballav & Co. spent ` 40,000 for transportation of such
machinery. The year ending is 31st Dec, 2022.
SOLUTION
(i) Renovation of cabins increased the number of cabins. This has an effect on
the future revenue generating capability of the business. Thus, the
renovation expense is capital expenditure in nature.
(ii) Expense incurred to recover installments due from customer do not increase
the revenue generating capability in future. It is a normal recurring expense
of the business. Thus, the legal expenses incurred in this case is revenue
expenditure in nature.
(iii) Expenses incurred on account of transportation of fixed asset is capital
expenditure in nature.

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 1.10 ACCOUNTING

SUMMARY
 Revenue expenditures are shown in the profit and loss account while capital
expenditures are placed on the asset side of the balance sheet since they
generate benefits for more than are accounting period.
 Prepaid expenses are future expenses that have been paid in advance. These
are shown in the balance sheet as an asset.
 Receipts obtained should be classified between revenue receipts and
capital receipts.

TEST YOUR KNOWLEDGE

True and False
1. The nature of business is not an important criteria in separating an
expenditure between capital and revenue.
2. Expenditure incurred for major repair of the asset so as to increase its
productive capacity is Revenue in nature.
3. Amount spent as lawyer’s fee to defend a suit claiming that the firm’s
factory site belonged to the plaintiff’s land is Capital Expenditure.
4. Amount spent for replacement of worn-out part of machine is Capital Expenditure.
5. Legal fees to acquire property is Capital Expenditure.
6. Amount spent for the construction of temporary huts, which were necessary
for construction of the cinema house and were demolished when the cinema
house was ready, is Capital Expenditure.

Multiple Choice Questions

1. Money spent ` 10,000 as traveling expenses of the directors on trips abroad
for purchase of capital assets is
(a) Capital expenditures
(b) Revenue expenditures
(c) Prepaid revenue expenditures

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2. Amount of ` 5,000 spent as lawyers’ fee to defend a suit claiming that the
firm’s factory site belonged to the plaintiff’s land is
(a) Capital expenditures
(b) Revenue expenditures
(c) Prepaid revenue expenditures
3. Entrance fee of ` 2,000 received by Ram and Shyam Social Club is
(a) Capital receipt
(b) Revenue receipt
(c) Capital expenditures
4. Subsidy of ` 40,000 received from the government for working
capital by a manufacturing concern is
(a) Capital receipt
(b) Revenue receipt
(c) Capital expenditures
5. Insurance claim received on account of
(a) Capital receipt
(b) Revenue receipt
(c) Capital expenditures
6. Interest on investments received from
(a) Capital receipt
(b) Revenue receipt
(c) Capital expenditures
7. Amount received from IDBI as a medium term loan for augmenting working capital is
(a) Capital expenditures
(b) Revenue expenditures
(c) Capital receipt
8. Revenue from sale of products, ordinarily, is reported as part of the earning in the period in
which
(a) The sale is made.
(b) The cash is collected.
(c) The products are manufactured.

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9. If repair cost is ` 25,000, whitewash expenses are ` 5,000, (both these

expenses relate to presently used building) cost of extension of building is `
2,50,000 and cost of improvement in electrical wiring system is `19,000;
the amount to be expensed is
(a) ` 2,99,000.

(b) ` 44,000.

(c) ` 30,000.

Theoretical Questions
1. What are the basic considerations in distinguishing between capital and
revenue expenditures?
2. Define revenue receipts and give examples. How are these receipts treated?

ANSWERS/HINTS
True and False
1. False: The nature of business is a very important criteria in separating an
expenditure between capital and revenue. For example- For a trader
dealing in furniture, purchase of furniture is revenue expenditure but for any
other trade, the purchase of furniture should be treated as capital
expenditure and shown in the balance sheet as asset. .
2. False: Expenditure incurred for major repair of the asset so as to increase its
productive capacity is capital in nature.
3. False: Legal expenses incurred to defend a suit claiming that the firm’s
factory site belongs to the plaintiff is maintenance expenditure of the
asset. By this expense, neither any endurable benefit can be obtained in
future in addition to that what is presently available nor the capacity of the
asset will be increased. Maintenance expenditure in relation to an asset is
revenue expenditure.
4. False: Amount spent for replacement of any worn out part of a machine is
revenue expense since it is part of its maintenance cost.
5. True: Legal fee paid to acquire any property is a part of cost of that property.
It is incurred to possess the ownership right of the property and hence a
capital expenditure.
6. True: Since temporary huts were necessary for the construction, their cost
should be added to the cost of the cinema hall and thus capitalised.

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Multiple Choice Questions

1. (a) 2. (b) 3. (a) 4. (b) 5. (a) 6. (b)

7. (c) 8. (a) 9. (c)

Theoretical Questions
1. The basic considerations in distinction between capital and revenue expenditures are:
(a) Nature of business.
(b) Recurring nature of expenditure.
(c) Purpose of expenses.
(d) Effect on revenue generating capacity of business.
(e) Materiality of the amount involved.
2. Receipts which are obtained in course of normal business activities
are revenue receipts (e.g,. receipts from sale of goods or services, interest
income etc.).
Revenue receipts should not be equated with the actual cash receipts.
Revenue receipts are credited to the Profit and Loss Account.

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