Capital and Revenue Transactions
The distinction
Capital expenditure is incurred to acquire or improve a fixed asset and yields benefit over more than one accounting period: the purchase price of machinery, carriage on it, installation wages, legal costs of acquiring land, and extensions that increase earning capacity. It is shown in the balance sheet. Revenue expenditure is incurred in the ordinary course to run the business and is consumed within the period: rent, salaries, wages, power, repairs, insurance, stationery. It is charged to the trading or profit and loss account.
Capital receipts arise from the sale of fixed assets, the issue of shares or the raising of loans, and are not income. Revenue receipts arise from sales and other ordinary operations.
Deferred revenue expenditure is revenue in nature but unusually heavy, so it is written off over several years: heavy advertising to launch a product, preliminary expenses, discount on issue of shares, and research and development.
Worked example
A firm bought a machine for ₹4,00,000, paid ₹15,000 freight, ₹25,000 erection wages and ₹6,000 annual insurance. Freight and erection wages are necessary to bring the asset into working condition, so they are capitalised and machinery appears at ₹4,40,000. The insurance premium covers one year of running, so it is revenue expenditure debited to the profit and loss account.
Traps
Showing installation wages as ordinary wages in the trading account; treating a repair that extends an asset's life as revenue; treating a loan received as income; charging a heavy launch advertisement wholly in one year when it is deferred revenue expenditure; confusing capital receipts with capital expenditure.