The concept of Capital and Revenue is very important in order to determine the accounting process correctly for a particular period of time. At the end of the accounting year, it is very necessary to bifurcate the transactions between capital and revenue for the recognition of the assets of the business.
Accounting is the process of identifying, recording, classifying, summarizing, interpreting, and communicating financial information relating to an organization to the interested users for judgment and decision-making. In this segment, some basic terms are discussed that can be helpful in understanding advanced accounting.
The transactions which have long-term effects on the business are known as capital transactions. Basically, by this, we understand that the effect of these transactions can be extended to a period of more than one year.
What are Business Transactions?
Transaction refers to a financial agreement or an economic event that various parties enter into and the details of the transaction are recorded in the books of accounts. Basically, it is an agreement between two parties that involves the transfer or exchange of goods or services. It is termed as ‘Business Transaction’ or ‘Financial Transaction’.
Example: Purchase of goods, receipt of money from the debtors, payment to a creditor, purchase or sale of fixed assets, payment of interest, payment of dividend, etc.
Characteristics of a Business Transaction
It is associated with money or money that is worth goods or services.
It occurs when the transfer or exchange of goods and services takes place.
It brings about a shift in the financial position of an organization (i.e., the assets and the liabilities of the organization).
It makes an impact on the accounting equation of a business firm.
It has two sides --- Receiving which is called Debit and Giving which is called Credit of the benefit.
The total assets of a business must be equal to the total liabilities and capital of the firm after each transaction.
The nature of each transaction must be verified very accurately since it determines the financial status of a business unit.
Classification of Business Transaction
A transaction can be of four types: Cash transaction and Credit transaction, External Transaction and Internal Transaction
When the amount is received or paid immediately on entering into an agreement then it is a cash transaction.
When an agreement is done between two parties wherein one party promises to pay at a later date then it is a credit transaction.
When a transaction takes place between the business entity and the second party then it is called an external transaction.
Example: XYZ firm sold goods to Mr A.
In this transaction, any second party is not involved.
Example: Depreciation charged on machinery
What are Revenue and Capital Transactions?
When a transaction arises due to day-to-day business activities and the transaction affects only one accounting period or a transaction whose benefits are received within one year then it is called a revenue transaction.
Revenue transactions can be of the following two types.
It is the expenses incurred for the normal activities of the business and whose benefit is consumed within the accounting period. There is a direct relationship between the revenue and the accounting period.
Example: Rent of the establishment, electricity, salaries, cost of goods sold, etc.
The amount that is received or receivable for normal business activities like the sale of goods or rendering services or interests of business investments. This is shown in the Profit & Loss Account in the case of profit enterprises and in the Income and Expenditure account in the case of Non-profit organizations.
Example: Sale of goods, rendering services, interest on fixed deposits or capital investments, etc.
When a transaction has a considerable effect of more than one accounting period or a transaction whose benefit is received more than one year is called a Capital transaction.
A capital transaction can be of the following two types.
It is the expense that is incurred while procuring assets or maintaining the existing assets which will increase the production capacity resulting in an increase in earning capacity. Capital expenditure is incurred to purchase tangible or intangible assets. This expenditure is shown in the Balance Sheet of the entity.
Example: Purchase of machinery to manufacture goods, computers to operate a business, money paid for goodwill, etc.
It is the amount received or receivable by selling assets and they are not revenue in nature. They are also shown in the balance sheet of the entity.
Example: Amount received or receivable from the sale of machinery, building, furniture, investment, loan, etc.
Difference between Capital and Revenue Transaction
Capital transactions consume long term benefits from the transactions whereas revenue transactions consume short term benefits from the transactions.
The capital transaction has an irregular recurrence of transactions whereas revenue transaction has a regular recurrence of transactions.
Rules to Determine Capital Expenditure
Any type of expenditure that increases the earning capacity of that business is also considered as capital expenditure. Any expenditure which incurs on the improvement in the present condition of fixed assets to bring it back in a good working condition is considered as capital expenditure.
Those expenditures which are made for the purchase of fixed assets with the purpose of resale will not be considered as capital expenditure.
Rules to Determine Revenue Expenditure
Expenditures that are incurred on the goods and services and consumable items.
Expenditure that is incurred in maintaining the fixed assets like repairing and renewing is the revenue expenditure.
Expenditures incurred on the day to day activities of the business entities are a revenue
Expenditure. The benefits from revenue expenditures last for a period of one year only.
Important Accounting Terms
Capital is the amount invested by the proprietor in the business in the case of proprietorship or by partners in the case of the partnership business. It may be in the form of cash or in the form of assets.
When a profit is earned by selling an asset of a business at a higher cost than the original cost then it is termed as capital profit. The profit earned from the sale of assets is credited to the profit & loss account as an unusual item of income. If the profit is earned on the sale of shares, then the profit earned from capital is credited to the Capital Reserve.
The loss that is incurred on the sale of business assets or while raising more funds for the business, is called a capital loss. It is shown as fictitious assets in the balance sheet.
Revenue is the cash inflow or receivables arising in the course of business activities of an enterprise from the sale of goods or from rendering services or interests earned from the usage of business resources by others, dividends on business investments, etc.
Note: Revenue is different from income.
When a profit is earned in the ordinary course of business operations then it is termed as revenue profit. The profit earned from revenue appears in the Profit & Loss Account. Revenue profit and revenue income are the same.
Example: Profit made from the sale of goods, income received from letting out business property, dividends received on investments, etc.
The loss that is incurred from the day-to-day operations of a business like the sale of goods, theft, bad debts, etc., is termed as revenue loss. It appears in the profit & loss account of the year in which it arises.
Deferred Revenue Expenditure
Some revenue expenses are the expenses, the benefit of which may be accrued in more than one financial year is termed deferred revenue expenditure. Every accounting year, a part of this expenditure is written off even though it is revenue in nature. It appears in the balance sheet till it is written off completely.
Example: Advertising expenses for branding, professional fees, discounts on shares and debentures, etc.