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.
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.
It is associated with money or money that is worth of 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.
A transaction can be of two types: Cash transaction and Credit 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.
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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 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.
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 earned on the sale of shares, then the profit earned from capital is credited to 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 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 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 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.
The following are the rules for determining capital expenditure.
When expenditure is incurred for the purpose of purchasing long-term assets for use in business activities and not meant for resale, it is treated as capital expenditure. It should be useful for more than one accounting period.
Example: Purchasing of furniture for daily operations.
When expenditure is incurred for maintenance of machinery or putting an old asset into working condition, then it is recognized as capital expenditure. The expenses made towards maintenance are added to the cost of the asset.
Expenses incurred for increasing the production capacity is also recognized as capital expenditure.
Expenses made for the investment of a business is capital expenditure.
Rules for Determining Revenue Expenditure
Any expenditure that is not done for the long term is revenue expenditure. Following are the rules for determining revenue expenditure:
Expenditure incurred for the daily conduct of business and the benefits of which affects only the current accounting period is recognized as revenue expenditure.
Wages of the workers, interest on loan taken, rent, purchase of office stationery, electricity, and daily miscellaneous expenses are revenue expenditures.
Expenditure on consumable goods, resale of goods and services rendered either in original or improved working conditions is revenue expenditure.
Expenses incurred for the maintenance of fixed assets can be recognized as revenue expenditures like repairs, renewals, and depreciation.
Some revenue expenses are the expenses, the benefit of which may be accrued in more than one financial year is termed as 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.
Q1. What are the Differences Between Capital Receipt and Revenue Receipt?
Ans. The differences between capital receipt and revenue receipt are:
It is the amount received from the sale of assets, shares, and debentures.
It is the amount received from the sale of goods and services.
Capital receipts are non-recurring.
Revenue receipts are regular and recurring.
Capital receipts affect the financial position of the business.
Revenue receipts are sales of merchandise, discounts, and commission that affect the operations of the business.
Capital receipts appear on the liabilities side of the balance sheet.
Revenue receipts appear on the credit side of the trading and profit & loss account.
A capital receipt is received in exchange for the source of income.
The revenue receipt is in replacement of the source of income.
Capital receipt either decreases the value of an asset or increases the value of the liability.
Revenue receipt neither increases nor decreases the value of asset or liability.
Q2. What Do You Understand by Capital Gain and Revenue Gain?
Ans. Capital gain is the profit earned by selling a business asset at a higher cost than the original cost whereas revenue gain is the profit earned from normal routine operations of the business.
Q3. Define Capital Transaction and Revenue Transaction.
Ans. A transaction that occurs, the benefit of which is received for more than one year is called a Capital transaction. When a transaction arises due to day-to-day business activities whose benefits are received within one year then it is called a revenue transaction.
Q4. What Do You Mean by Capital Loss and Revenue Loss?
Ans. A capital loss is a loss incurred on the sale of business assets and revenue loss is the loss incurred on daily business operations like theft, damage of goods due to fire, etc.