The proper allocation of capital items and revenue items are important for the fundamental principles of correct accounting. The wrong classification of items would lead to the wrong ascertainment of profit and also the financial position.
It therefore becomes necessary to determine correctly whether an item is of capital or of revenue nature.
The accounting transactions are primarily divided into two types :-
- Capital Transactions
- Revenue Transactions
WHAT ARE CAPITAL ITEMS ?
Capital items are those items which have long term effects on business, (normally more than one year). Examples of capital items are Fixed assets such as land, building , or intangible assets like trademark etc.
There are three main types of Capital items , i.e. –
- CAPITAL RECEIPTS :- Capital Receipts is the amount received in the form of additional Capital (by issuing shares) loans or by the sale proceeds of any fixed assets and are shown in Balance Sheet.
- CAPITAL EXPENDITURE :– Capital expenditures include large purchases of fixed assets that can be used for a longer duration. These are non recurring in nature . For example, expenditure incurred to buy machinery.
- CAPITAL PROFIT/LOSS :– The profits that are earned through capital items is called capital profit and the loss that is incurred on capital items is called capital loss. For example, profit on the sale of debentures is capital profit.
WHAT ARE REVENUE ITEMS ?
Revenue items are those items having short term effects on business, (normally less than one year). Example of revenue items are repairs, wages, salaries etc.
There are three main types of revenue items , i.e :-
- REVENUE RECEIPTS :- Revenue Receipts are the amount received in the ordinary course of a business and are shown in the profit and loss account. For example – discount, commission, interest, transfer fees etc.
- REVENUE EXPENDITURE :- When the benefit of an expenditure is likely to be available for less than a year, it is treated as revenue expenditure. These expenditures are recurring in nature . For example expenditure incurred on rent paid. Electricity bill paid etc.
- REVENUE PROFIT/LOSS :– Revenue profits are normally earned through discount received, rent received, interest received etc. Revenue losses may incur due to bad debts, theft of goods etc.
Hence, this distinction between capital and revenue nature of the items is necessary in order to find out the correct profit or loss during the year and also to ascertain the true and fair position of the business.