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Accounting For Managers - Revenue Recognition

Capital And Revenue Profits, Receipts And Losse

   Posted On :  26.01.2018 06:37 am

Capital profit is a profit made on the sale of a fixed asset or a profit earned on getting capital for the business. For example, if the original cost of a fixed asset is rs.50,00,000 and if it is sold for rs.60,00,000 then rs.10,00,000 is capital profit.

Capital and revenue profits:

Capital profit is a profit made on the sale of a fixed asset or a profit earned on getting capital for the business. For example, if the original cost of a fixed asset is rs.50,00,000 and if it is sold for rs.60,00,000 then rs.10,00,000 is capital profit. Similarly if the shares having an original cost of rs.4,000 are sold for rs.5,000, the profit of rs.1,000 thus made is capital profit. Capital profits should not be transferred to the profit and loss account but should be transferred to capital reserve which would appear as a liability in the balance sheet. Revenue profit, on the other hand, is a profit by trading, e.g. Profit on sale of goods, income from investments, discount received, commission earned, rent received, interest earned etc. Such profits are taken to profit and loss account.

Capital And Revenue Receipts: 

The distinction between capital receipts and revenue receipts is also important. Money obtained from the sale of fixed assets of investments, issue of shares, debentures, money obtained by way of loans are examples of capital receipts. On the other hand, revenue receipts are cash from sales, commission received, interest on investments, transfer fees, etc. Capital receipts are shown in the balance sheet and revenue receipts in the profit and loss account.

 Capital And Revenue Losses: 

Capital losses are those losses which occur at selling fixed assets or raising share capital. For e.g., if investments having an original cost of rs.20,000 are sold for rs.16,000, there will be a capital loss of rs.4,000. Similarly when the shares of the face value of rs.100 are issued for rs.90, the amount of discount i.e. Rs.10 per share will be a capital loss. Capital losses should not be debited to profit and loss account but may be shown on the asset side of balance sheet. As and when capital profits arise, losses are met against them. Revenue losses are those losses which arise during the normal course of business i.e. In trading operations such as losses on

the sale of goods. Such losses are debited to profit and loss account.

Illustrations

Illustration 1:

 

State which of the following expenditures are capital in nature and which are revenue in nature:

ՖՖ   Freight and cartage on the new machine rs.150; erection charges Rs.200.

 

ՖՖ   A sum of rs.10,000 on painting the new factory.

 

ՖՖ   Fixtures of the book value of rs.1,500 was sold off at rs.600 and new fixtures of the value of rs.1,000 were acquired, cartage on purchase rs.50.

 

ՖՖ   Rs.1,000 spent on repairs before using a second hand car purchased recently.

 

Solution:

 ՖՖ   Capital expenditure to be debited to machinery account.

 

ՖՖ   Painting charges of new or old factory are maintenance charges and be charged to revenue. However, if felt proper, painting charges of new factory may be treated as deferred revenue expenditure. However, some say painting of new factory is capital expenditure.

 

ՖՖ   Loss of rs.900 on the sale of fixtures be treated as revenue expense but the cost of new fixture rs.1,000 together with cartage rs.50 be debited to fixture account as these are capital expenditure.

ՖՖ   Rs.1,000 being expense to bring the asset in usable condition is a capital expenditure.

Illustration 2:

ՖՖ   The sum of rs.30,000 has been spent on a machine as follows:

 

ՖՖ   Rs.20,000 for additions to increase the output; rs.12,000 for repairs necessitated by negligence and rs.8,000 for replacement of worn-out parts.

 

ՖՖ   The sum of rs.17,200 was spent on dismantling, removing and reinstalling in order to remove their works to more suitable premises. Classify these expenses into capital and revenue.

Solution: 

ՖՖ   Rs.20,000 spent on additions is to be capitalized but rs.12,000 and rs.8,000 spent on repairs and replacement of worn-out parts respectively are to be charged to revenue.

 

ՖՖ   Rs.17,200 spent for removing to a more suitable premises is to be charged to revenue as it does not increase efficiency and income. It, may, however be treated as deferred revenue at the most.

 

Summary

Final accounts are prepared from the balances appearing in the trial balance. All accounts appearing in the trial balance are taken to either trading and profit and loss account or balance sheet. All revenue expenditures and receipts are taken to trading and profit and loss account and all capital expenditures and receipts are taken to balance sheet. It is therefore necessary to realise the importance of distinction between capital and revenue items.

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