Capital and Revenue Items

Learning Objectives:

1. Define explain and give examples capital and revenue expenditures, receipts, payments, profits and losses.
2. What is the difference between capital and revenue expenditures?
3. What are the exceptions to the general rule of capital and revenue expenditures?
4. Difference between capital and revenue expenditures affects the fundamental principle of correct accounting. Proper adjustments are necessary before preparation of the final accounts. All items of capital and expenditure will find place in the balance sheet whereas all items of revenue expenditure will be included in the profit and loss account. If any incorrect adjustment or allocation is made between these expenditures, this will falsify  the final results as disclosed by the revenue account or the balance sheet.

Capital Expenditures:
Learning Objectives:

1. Define and explain capital expenditures

Expenditure means the amount spent. Any expenditure incurred for the following purposes is capital expenditure:

1. For acquiring fixed assets such as land, building, plant and machinery, furniture and fitting and motor vehicles. These assets should not be acquired with a view to resell them at a profit but to retain in the business. The cost of fixed asset would include all expenditure up to the asset becomes ready for use.
2. For making improvement and extensions to the fixed asset e.g., additions to buildings.
3. For increasing the earning capacity of a business or for reducing the cost of manufacture, administration or distribution in a business e.g., expenditure incurred in removing the business to a central locality or compensation paid to retrenched employee.
4. For raising capital monies for the business such as brokerage paid for arranging loans, discount on issue of shares and debentures, underwriting commission etc.

All capital expenditures represent either an asset or liability and are shown in the balance sheet.
List of Capital Expenditures - (Examples of Capital Expenditures):
The following is a list of the usual items of capital expenditures:

• Cost of goodwill.
• Cost of freehold land and building and the legal charges incurred in this connection.
• Cost of lease.
• Cost of machineries, plants, tools, fixtures, etc.
• Cost of trade marks, patents, copy rights, designs, etc.
• Cost of car, lorry etc.
• Cost of installation of lights and fans.
• Cost of any other assets acquired by way of equipment.
• Erection cost of plant and machinery.
• Cost of addition to existing assets.
• Structural improvements and alteration in the existing assets.
• Expenses for developments in case of mines and plantations.
• Expenses for administration incurred during construction and equipment of any industrial enterprise.
• Expenses incurred in experimenting which finally result in the acquisition of a patent or other rights.

Revenue Expenditures:
Learning Objectives:

1. Define and explain revenue expenditures

Definition and Explanation:
Expenditures will be treated as revenue expenditures if it is incurred for the following purposes:

1. Expenditure for purchasing floating assets i.e., assets meant for resale at a profit or for being converted into saleable goods, such as the cost of goods, raw materials and stores.
2. Expenditures incurred by maintaining assets in proper working order e.g., repairs to plant and machinery, building furniture and fittings etc.
3. Expenditures incurred for meeting day to day expenses of carrying on a business e.g., salaries, rent, rates, taxes, stationery, postage etc.

All revenue expenditures have to be deducted from the income earned by the firm. That is to say, all revenue items will be taken to the profit and loss account.

List of Revenue Expenditures - (Examples of Revenue Expenditures):
The following is a list of the usual items of revenue expenditures:

• Expenses incurred for the ordinary administration and carrying on the business.
• Expenses for repairs, renewals and replacement of permanent assets.
• Cost of goods for resale.
• Cost of raw materials and stores acquired for consumption in course of manufacturing.
• Wages paid for manufacture of products for sales.
• Expenses for the manufacture and distribution of the finished goods.
• Loss from wear and tear and obsolescence of assets.
• Depreciation of lease.
• Interest on loans borrowed for business.
• Loss from sale of fixed assets.
• Fees for renewal of patent rights, etc.
• Up-keep and maintenance of motor car and van.
• Maintenance of fan and lights.
• Book value of assets discarded or totally damaged or destroyed by fire or other reasons.

Difference Between Capital and Revenue Expenditures:

Learning Objectives:

1. What is the difference between capital and revenue expenditures.

Following is the difference between capital and revenue expenditures.

Capital Expenditures		Revenue Expenditures
1	Its effect is long term i.e., it is not exhausted within the current account year. Its benefit is enjoyed in future year or years also. In a word, its effect is reduces gradually.	1	Its effect is temporary, i.e., it is exhausted within the current accounting year.
2	An asset is acquired or the value of an asset is increased as a result result of this expenditure.	2	Neither an asset is acquired nor the value of an asset is increased.
3	It does not occur again and again - it is non-recurring and irregular.	3	It occurs repeatedly - It is recurring and regular.
4	Generally, it has physical existence i.e., it can be seen with eyes.	4	It has no physical existence, i.e., it cannot be seen with eyes.
5	This expenditure improves the position of the concern	5	This expenditure helps to maintain the concern
6	A portion of this expenditure is shown in the trading and profit and loss account or income and expenditure account as depreciation.	6	The whole amount of this expenditure is shown in trading and profit and loss account or income and expense account. But deferred revenue expenditures and prepaid expenses are not shown.
7	It appears in balance sheet until its benefit is fully exhausted.	7	It does not appear in balance sheet. Deferred revenue expenditure, outstanding expenditure, outstanding expenses and prepaid expenses, however, temporarily shown in the balance sheet.
8	It does not reduce the revenue of the concern. Purchase of fixed assets does not effect revenue.	8	It reduces revenue. Payment of salaries to employees decreases revenue.

Capital and Revenue Receipts, Payments, Profits and Losses:

Learning Objectives:

1. Define and explain and give examples of capital and revenue receipts and payments?
2. Define and explain and give examples of capital and revenue profits and losses?

1.Capitalized and Revenue Receipts

1. Capital and Revenue Payments
2. Capital and Revenue Profits
3. Capital and Revenue Losses

Capitalized and Revenue Receipts:

Receipts refer to the actual amounts of cash received. They can be either of capital nature or revenue nature.

Capital receipts include the following:

1. Capital brought in by the proprietor at the commencement and any additions made subsequently.
2. Money borrowed from partners, bankers, private individuals etc.
3. Money received by the sale of fixed assets.
4. Money received on account of capital profit.

Revenue receipts include the following:

1. Money received by the sale of floating assets - by sale of goods.
2. Money received on account of some revenue profit.

Capital and Revenue Payments:

Definition and Explanation:

Capital payment is an amount paid on account of some capital expenditure and a revenue payment is an amount actually paid on account of some revenue expenditure. Expenditure is the full amount incurred whether paid or not, whilst payments refer to the amount actually paid.

Example:

If a building is purchased for $20,000 from X and $10,000 is paid in cash and the remaining sum to be paid after six months; $20,000 is capital expenditure, but $10,000 is only capital payment. Similarly if goods are purchased from X for 30,000 and $15,000 is paid in cash; $30,000 is revenue expenditure but only $15,000 is revenue payment.

Capital and Revenue Profits:

Definition and Explanation:

Capital profit means a profit made on the sale of a fixed asset or profit earned on raising monies for the business. For example a building purchased for $20,000 is sold for $25,000 the profit $5,000 thus made is a capital profit.

Revenue profit on the other hand is a profit made by the business e.g., profit on the sale of goods, income from investments, commission earned etc.

Whenever, capital profit is made it should either be transferred to the capital account of the proprietor or credited to capital reserve account which would appear as a liability on the balance sheet. But capital profits should in no case be transferred to profit and loss account because it is non-trading profit. Revenue profits on the other hand should be transferred to profit and loss account because they arise out of regular trading operation.

Capital and Revenue Losses:

Definition and Explanation:

Capital loss means a loss made on the sale of a fixed asset or a loss incurred in connection with the raising of money for business. Capital loss may be shown as an asset in the balance sheet. But as this asset is a fictitious nature, it would would advisable to write off it.

Revenue loss, on the other hand, is the loss incurred in trading operations such as loss on the sale of goods. Revenue losses are charged to profit and loss account of the year in which they occur.

More About Capital and Revenue Expenditures:

Capitalized or Deferred Revenue Expenditures:

Where a certain revenue expenditure incurred is of such a nature that its benefit is likely to be spread over a certain number of years, or where it is of non-recurring and special nature and large in amount, in such circumstances, instead of debiting the entire amount to the profit and loss account of the year in which it has been incurred, it may be spread over a number of years, a proportionate amount being charged to each year's profit and loss account. The remaining portion of the expenditure is carried forward and is known as capital expenditure or or deferred revenue expenditure and is shown as an asset in the balance sheet. Item such as preliminary expenses, cost of issue of debentures are examples that may be classified under this head.

Exceptions to General rules:

There are certain expenses which are usually of a revenue in nature but under certain circumstances they become capital expenditures. The following are the examples of expenses which are usually revenue but under certain circumstances become capital.

Legal Charges:

These are, as a rule, revenue charges, but legal charges incurred in connection with the purchase of a fixed asset are capital expenditures as they form an additional cost of the asset acquired.

Wages:

Wages are ordinary a revenue expenditure. But in a manufacturing business where the firm's own men are employed in making of fixed asset, the wages paid for such purpose would be capitalized. For example if the firm's own men are employed in making extension to the factory building or in erection of plant or manufacturing tools for own requirements. the wages and salaries paid to the persons are not revenue but capital expenditures.

Brokerage and Stamp Duty:

Normally these are revenue expenditures, but brokerage paid on acquisition of a property and stamp duty involved thereon can be capitalized.

Freight and Carriage:

This is revenue charge, but freight and carriage paid on newly acquired plant or fixed assets are capital expenditures.

Advertising:

Ordinarily amount expended on advertising is revenue charge but the cost of special advertising undertaken for the purpose of introducing a new line of goods may be capitalized.

Development Expense:

In concern like collieries, mines, tea, rubber etc., all expenses incurred during the period of development are treated as capital.

Preliminary Expenses:

These are the expenses incurred in connection with the formation of a public company. These expenses although are revenue in nature but are allowed to be capitalized and can be shown as an asset in the balance sheet.

Single Entry System/Accounts From Incomplete Records:

Learning Objectives:

1. Define and explain single entry system.
2. What are the limitations of single entry system.
3. How profit is calculated under single entry system of accounting.

Definition and Explanation of Single Entry System:

Learning Objectives:

1. Define and explain single entry system of bookkeeping.
2. What are limitations of single entry system of accounting

It is difficult to define single entry system because, in fact, there exists no system like single entry system. Broadly speaking, it is a defective double entry system. Any system that falls short of complete double entry method is called single entry system. Under this method, sometimes both the aspects of transactions are recorded, sometimes only one aspect is recorded or sometime no aspects of transactions is recorded in the books. As a general rule under the single entry practice only the personal aspects of the transactions are recorded and the nominal and real aspects are omitted altogether. As the name implies, the single entry system does not take into account the double affect of every transaction. The ledger contains only the personal accounts of debtors and creditors, all impersonal accounts such as purchases, sales, wages, carriage, rent etc., are not recorded. Thus the system does not consider the two fold aspect of every transaction. In short single entry system may be called a mix of double entry, single entry and no entry.

Single entry system may be defined as a system which does not strictly conform to the double entry system of bookkeeping. Under this system what is found in practice is an intermixture of single entry, double entry and no entry.

Defects/Limitations/Disadvantages of Single Entry System:

The limitations or defects or disadvantages of single entry system may be summed up as follows:

1. Under this system only partial and incomplete record is maintained because two fold aspects of transactions are generally ignored.
2. As the two fold aspects of every transaction are not recorded, a trial balance cannot be drawn up to test the arithmetical accuracy of the records.
3. A nominal accounts are not maintained, a profit and loss account cannot be prepared for want of information regarding the various income and expenditures.
4. As no real accounts are maintained the preparation of balance sheet is not possible.

Defects/Limitations/Disadvantages of Single Entry System of Accounting:

Learning Objectives:

1.What are the limitations or disadvantages of single entry system of bookkeeping.

The limitations or defects or disadvantages of single entry system may be summed up as follows:

1. Under this system only partial and incomplete record is maintained because two fold aspects of transactions are generally ignored.
2. As the two fold aspects of every transaction are not recorded, a trial balance cannot be drawn up to test the arithmetical accuracy of the records.
3. A nominal accounts are not maintained, a profit and loss account cannot be prepared for want of information regarding the various income and expenditures.
4. As no real accounts are maintained the preparation of balance sheet is not possible.

Statement of Affairs:

Learning Objectives:

1. Define and explain statement of affairs.
2. What is the purpose of preparing a statement of affairs?
3. Prepare the format of statement of affairs.

Definition and Explanation:

Correct final accounts of a business can be prepared in the records are maintained under the double entry system . How every where the record is incomplete, and it is not all possible to complete it by double entry, in such cases the final accounts can be only approximately prepared by means of a statement of affairs. In appearance the statement of affairs is similar to a balance sheet. For this purpose, two comparative statement of affairs are prepared - one at the commencement of the year and other at the end of the year. The excess of the assets over the liabilities as shown by the statement will represent the capital of the firm. If capital at the end shows an increase as compared to the amount of capital at the start the difference will represent profit and if the capital at the end is less than the capital at the beginning the difference will be loss. In this calculation, however, two more factors should be taken into account.

1. Where fresh capital has been introduced into the business during the account period, the closing capital may be taken to have been increased to that extent. To arrive at the true profit or loss, therefore, the amount of fresh capital introduced is deducted from the closing assets as determined under such circumstances.
2. Where drawings have been made by the proprietor during the accounting period, such drawings reduce the amount of capital at the close. In order to calculate net profit, it is necessary, therefore, that amount withdrawal should be added to the capital at the close before deducting from it the capital at the beginning.

Formula:

Formula for determining the net profit is put as follows:

(Capital at the end + Drawings - Additional capital introduced) - Capital in the beginning

Example:

Rashid and Co. keeps his book on single entry system. his position on 1st January, 19991 was as follows:

Cash in hand $200, cash at bank $3000; stock in trade $20,000; sundry debtors $8,500; furniture $1,800; machinery $15,000; sundry creditors $22,000.

On 31st December, 1991 the financial position was as follows:

Cash in hand $300; cash at bank $2,000; machinery $27,000; furniture $1,500; sundry debtors $14,000 stock in trade $19,000 sundry creditors $29,000.

During the year Rashid introduced a new capital of $5,000 and withdrew for his personal expenditure $9,000.

From the above figures, prepare a statement showing the profit or loss made by him during 1991.

Solution:

Rashid & Co.
Statement of Affairs as at 1st January, 1991.

Liabilities	$	Assets	$
Sundry creditors Capital (balancing figure*)	22,000 26,500	Cash in hand Cash at bank Sundry debtors Stock in trade Furniture Machinery	200 3,000 8,500 20,000 1,800 15,000
	48,500		48,500

* 48,500 - 22,000

Rashid & Co.
Statement of Affairs as at 1st January, 1991.

Liabilities	$	Assets	$
Sundry creditors Capital (balancing figure*)	29,000 34,800	Cash in hand Cash at bank Sundry debtors Stock in trade Furniture Machinery	300 2,000 14,000 19,000 1,500 27,000
	63,800		63,800

* 63,800 - 29,000

Statement of Profit for the year ending 31st December, 1991.

Capital 31st December, 1991	34,800
Add drawings during the year	9,000
	43,800
Less capital introduced during the year	5,000
	38,800
Less capital as at 1st January, 1991	26,500
Net profit during the year	12,300

 Difference Between Statement of Affairs and Balance Sheet:

Learning Objectives:

1.What is the difference between statement of affairs and balance sheet?

As real or property accounts are not maintained and also because a capital account does not exist under the single entry system, a balance sheet cannot be prepares in the same way as is done under the double entry system. However, in order to have an idea about the financial position on a particular date information concerning the available assets and liabilities is gathered and a statement is prepared setting in it assets and liabilities on the date; this statement is called a statement of affairs. The assets and liabilities are set out in the form of a balance sheet. The excess of assets over liabilities is shown as capital.

Balance sheet and statement of affairs may be distinguished as follows:

Statement of Affairs		Balance Sheet
(1)	It is a statement of assets and liabilities (including capital) prepared under the single entry system	(1)	It is statement of assets and liabilities (including capital) prepared under the double entry system.
(2)	It is prepared partly from a trader's books, partly from other sources of information and sometimes from memory	(2)	It is prepared with data available from the books of accounts only.
(3)	It is compiled from an incomplete books and information, the accuracy of which cannot be relied upon	(3)	It is prepared from a set of books kept according to the double entry system, the arithmetical accuracy of which can be proved.

Conversion into Double Entry System:

Learning Objectives:

1. Define and explain conversion method.
2. How trading and profit and loss account and balance sheet is prepared under conversion method.
3. Conversion of books from single entry system to double entry system is possible either with retrospective (i.e., on and from a date before the date of conversion arrangements) or with a prospective effect (i.e., on and from the date on which arrangements are made for conversion).

Conversion with Prospective Effect:

If the conversion is to be made with prospective effect a statement of assets and liabilities of a trader on a given date must be prepared. Care should be taken to see that the opening cash and bank balances and also the amount of debtors and creditors appearing in the statement, tally respectively with the opening balances of the cash book and the totals of debit and credit balances,  extracted from the personal accounts of the ledger. An opening journal entry is to be made taking the items of assets and liabilities of the statement of affairs thus prepared and after opening the necessary ledger accounts the above journal entry is to be posted. All subsequent transactions are to be passed through different books of original entry such as cash book, purchase book, sales book, etc., and posted into ledger according to the principles of double entry.

Conversion With Retrospective Effect:

For example a trader whose accounting period begins on 1-1-1991 and the books have been maintained under single entry till 30-04-1991. It is decided to convert the books into double entry system with effect from 1-1-1991. This is a case of retrospective conversion. The recourse of the interim period i.e., from 1-1-1991 to 30-04-1991 are to be adjusted before the double entry system is adopted.

Assuming that a statement of affairs at the commencement of accounting period (31-12-1990) is available and single entry records consists of cash book and personal ledger, the process of conversion proceeds as follows:

1. Find out the total credit purchases and total credit sales. These can be obtained from the bought and sales ledger respectively.
2. A journal entry should be passed to incorporate the balances appearing in the statement of affairs. Items should be posted in the respective accounts in the ledger.
3. The cash book should be scrutinized and post the items of receipts and payments appearing in it in the appropriate accounts in the ledger.
4. Cash sales and cash purchases can also be found out from the cash book. The figures should be posted to the sales and purchases account respectively.
5. Post the credit sales and purchases in the ledger.
6. Personal ledger should be scrutinized. Pick up the items for which no corresponding double entry has been effected. These items mostly consist of discount allowed to customers, or discount received, returns inwards, allowances, transfers, bad debts, etc. These items should be posted in the ledger. It is now possible to prepare a trial balance followed by a trading and profit and loss account and balance sheet.

Abridged Conversion:

There is a way to obtain final results by short cut method. When a summary of cash and other transactions are given; information regarding assets and liabilities in the beginning and at the end of the year is available, the final accounts can be drawn. In such a case, the missing items which may be any of the following are to be found out from the given data:-

1. Capital
2. Credit purchase
3. credit sales
4. Bills receivable
5. Bills payable
6. Sundry debtors
7. Cash in hand and at bank
8. Stock in the beginning

Any of these items when unknown may be found out preparing a total debtors account and a total creditors account.

Total Debtors Account

To (1) Opening balance To (2) Credit sales To (3) B/R dishonoured  - if any		By (4) Cash received from debtors By (5) B/R Received By (6) Returns inwards By (7) Discount allowed By (8) Bad debts By (9) Closing Balance

Total Debtors Account

By (4) Cash paid to creditors  By (5) B/p granted By (6) Returns outwards By (7) Discount received By (8) Closing Balance		To (1) Opening balance To (2) Credit purchases To (3) B/p dishonoured  - if any

Capital:

If capital is unknown prepare the statement of affairs. The difference of assets and liabilities will represent the capital.

Credit Purchases:

If credit purchases are unknown it can be ascertained from the total creditors account. Add item No. 4, 5, 6, 7, 8 and subtract from the result  item No. 1 and 3. It can also be calculated in the following way:

Acceptance given to creditors	xxxxx
Cash paid to creditors	xxxxx
Discount allowed by customers	xxxxx
Returns outwards	xxxxx
Creditors at the close of the year	xxxxx
Less creditors at the beginning	xxxxx
Credit purchases for the year	xxxxx

Credit Sales:

If credit sales are unknown, it can be ascertain from the total debtors account. Add No. 4, 5, 6, 7, 8, 9 and subtract from the result item No. 1 and 3. It can be calculated in the following form:

Acceptance received from debtors	xxxxx
Cash received from debtors	xxxxx
Discount allowed to debtors	xxxxx
Returns inwards	xxxxx
Debtors at the close of the year	xxxxx
Less debtors at the beginning	xxxxx
Credit sales for the year	xxxxx

Bills Receivable:

I bill receivable are unknown the same may be ascertained from the total debtors account. The formula is:

Item Nos. [(1) + (2) + (3)] - [(4) + (6) + (7) + (8) + (9)]

It may also be ascertained in the following form:

Bills receivable in hand on 1-1-19	xxxxx
Acceptance received during the year	xxxxx
Less bills dishonoured	xxxxx
Less bills honored	xxxxx
Bills receivable on 31st December	xxxxx

Bills Payable:

If bills payable are unknown the same may be ascertained from total creditors account:

Item Nos. [(1) + (2) + (3)] - [(4) + (6) + (7) + (8)]

It may also be calculated in the following form

Bills payable in hand on 1-1-19	xxxxx
Acceptance given during the year	xxxxx
Less acceptance honored	xxxxx
Bills bills payable on 31st December	xxxxx

Sundry Debtors:

If opening balance of sundry debtors are unknown we can calculate it by the following method:

Item Nos.  [(4) + (5) + (6) + (7) + (8) + (9)] - [(3) + (2)]

If closing balance of debtors is unknown:

Item Nos. [(1) + (2) + (3)] - [(4) + (5) + (6) + (7) + (8)]

Sundry Creditors:

If opening balance of sundry Creditors are unknown we can calculate it by the following method:

Item Nos.  [(4) + (5) + (6) + (7) + (8)] - [(2) + (3)]

If closing balance of Creditors is unknown:

Item Nos. [(1) + (2) + (3)] - [(4)+ (5) + (6) + (7)]

Cash in Hand and at Bank:

Prepare the cash book and balance it.

Opening Stock:

Sometime opening stock is unknown, if it is unknown it can be calculated from sales. In such a case from sales fin out the cost price of the goods sold. Add in the cost of goods sold the closing stock. Subtract from the result purchases during the year.

Example:

A trader started business on 1st January, 1991 with a capital of $50,000. He kept only a cash book and a personal ledger. An analysis of the cash book for the year 1991 gave the following figures:

Receipt from debtors $1,40,000; cash sales $42,000; payment to creditors $1,00,000; expenses paid $22,000; personal drawings $10,000; cash purchases $36,000.

On 31st December, 1991 the stock in hand was valued at $20,000 and the debtors and creditors were $1,20,000 and $ 1,10,000 respectively.

You are required to prepare a profit and loss account for the year ended 31st December, 1991 and a balance sheet as on that date, after making a reserve of $2,000 fro bad and doubtful debts.

Solution:

Calculation of credit purchases:

Cash paid to creditors	1,00,000
Add creditors on 31-12-1991	1,10,000
Credit purchases	2,10,000

Total purchases = Credit purchases + Cash purchases
Total purchases = 2,10,000 + 36,000 = 2,46,000

Calculation of Credit Sales:

Cash received from debtors	1,40,000
Add debtors on 31-12-1991	1,20,000
Credit purchases	2,60,000

Total sales = Credit sales + Cash sales
Total purchases = 2,60,000 + 42,000 = 3,02,000

Trading and Profit and Loss Account
For the year ended 31st December, 1991

To Purchases To Gross profit c/d	2,46,000 76,000	By sales By stock 31-12-91	3,02,000 20,000
	3,22,000		3,22,000
To Expenses To Reserve for bad debts To Net profit	22,000 2,000 52,000	By Gross profit b/d	76,000
	76,000
			76,000

Balance Sheet as on 31st December, 1991

Liabilities		$	Assets		$
Sundry creditors Capital:      Less drawings	50,000 52,000 ------- 1,02,000 10,000 -------	1,10,000 92,000 -------- 2,02,000 ======	Cash in hand Sundry debtors Less reserve Stock	1,20,000 2,000 ------	64,000 1,18,000 20,000 -------- 2,02,000 ======

Note: For cash in hand and at the end of the year prepare cash book [Receipts: 50,000+1,40,000+42,000] - [Payments: 1,00,000 + 22,000 + 10,000 + 36,000] and find out the balance.