Revenue Account and Capital Account Explanation
In the world of commerce, the two words ‘capital’ and ‘revenue’ are among the fundamental concepts. These concepts form the basis of the economy of a nation.
From observing our country's financial position, it is important to draw certain conclusions regarding revenue collections and the corresponding expenditure as it determines the country's financial health.
Before we dive deep into such an analysis, it is important to understand the concepts of ‘capital’ and ‘revenue.'
Capital refers to the liquid assets (generally in the form of cash) that are procured by a company to be used for its expenses. This is a general idea of capital, but if we expand its definition under financial economics, the capital that is held by a company is also known as its capital assets.
Revenue, on the other hand, refers to the income that is generated by a company/business in the form of discounts or deductions for the goods returned. Revenue comprises the overall income of a business or the gross income where business operations costs have not been considered. The deduction of costs from revenue shall reveal the net income of a business.
So, now that we know the meaning of capital and revenue, the next question here is, how do these affect the economy of a nation? The answer to this lies under the notion of Revenue Account and Capital Account.
The revenue account and capital account were established to understand the national income and expenditure better. Let's get to know about them in detail.
What is a Revenue Account?
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As revenue includes the income earned by a business, a revenue account is essentially an account that contains the receipts of this income. Such an account includes the income from the operations in hand.
Let us consider the government like a business. Now, just like a common business, the government also generates income by carrying out various operations. In this case, these operations include
Revenue from Tax: Tax revenues from taxes on imports and productions that can be both the direct revenue and indirect revenue.
Direct Tax Revenue: Such revenue is generated when the government receives income tax and corporate tax.
Indirect Tax Revenue: Such revenue is generated through service tax, excise duties, and custom export and import duties.
Revenue from Sources Other than Tax: While tax revenue makes the major portion of income for the government, other sources such as profits from public sector industries, interests of investments, dividends, and certain penalties or fees are known as non-tax revenue.
Did You know?
Corporate gains are taxed twice. A corporation's profits are taxed two times- first as corporate tax and second as a tax on dividends.
A revenue account keeps a record of all such revenues collected by the government and represents the nation's gross income.
What is a Capital Account?
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The second type of account associated with the government is the Capital account. As the name suggests, a capital account holds the record of the capital assets and liabilities related to the government. It includes payments and capital receipts of the government.
So, what could be the assets and liabilities of the government? To put it simply, they are similar to any other business. The capital of a business is the money or liquid assets it generates throughout its operation. So, for the government, this asset is generated from
Capital generated from Public loans or Market loans
T-Bills or Treasury Bills that refer to the finances borrowed from banks
Other loans that are sanctioned by foreign government or institutions outside the country
Capital may also be generated from withdrawing or deduction of public sector/unit investments.
As every business face liability as debt, the government also has certain liabilities in the form of pension payments, government bills or bonds, or the payment of goods and services that the government has acquired but has not paid for yet.
Both the government assets as well as liabilities are accounted for in the Capital account. This account keeps a record of the nation's total assets and liabilities during a single financial year and the net change in both of them. The account balance of a capital account decides whether a country is an apparent exporter or importer of capital.
Terminologies Related to Capital Account
Voucher: It refers to any written documentation in favor of the entries reported in account books and helps in indicating the accuracy of the transaction’s accounting.
Financial Accounting: it is a particular type of accounting that considers a method of summarising, documenting, and reporting the transactions that arise due to business operations.
Tender: itis an offer formulated to perform some task or to provide goods at a certain fixed price.
Escalator Clause or Escalation Clause: these clauses refer to the provisions made by the company that allows for an automatic increase in the wages or prices of their employees or products.
Financial Structure: it refers to the way in which the firm’s assets are actually financed.
Coopetition: it refers to the combination of competition and cooperation between companies.
What is Capital Expense?
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A capital expense or capital expenditure refers to the government's amount of cost or a business organization for buying assets. The assets bought through capital funds are fixed assets such as machinery, equipment or property, etc.
Buying and selling assets is an integral part of running a business. It is useful in expanding the business operation to build future capital and secure financial assets for future use.
For a government, capital expense means enhancing the assets and reducing liabilities. It can do so in the form of loan repayment where the loan represents a liability, and hence by repaying the loan, the government cuts down liability.
What are the Examples of Capital Expenditure?
Capital expenditure refers to an expenditure that acquires a capital asset. The examples of capital expenditure are
Expenditure made for the acquisition of fixed assets like land, building, machinery, furniture, motor vehicle, workspace, and more comes under capital expenses.
Expenditure made for improving or extending the fixed assets, that is, furniture, machinery, and workspace, for example, increasing the seating capacity of a theatre comes under capital expenditure.
Expenditure made to bring the fixed assets to the place of their use and expenditure made on the installation of required machinery or on erection such as freight on fixed assets, wages paid for installation, and others are also counted under capital expense.
Expenditure invested for the purchase of intangible assets such as goodwill, patent rights, trademarks, copyright, and more are also a part of capital expense.
Expenditure made for reconditioning or renovation of old fixed assets such as money spent on repairing or overhealing of secondhand machinery comes under capital expense.
Money spent on major repairs and replacement of plants that increase the efficiency of the plant is also counted in capital expense.
The cost paid for shifting a plant from one place to another place is also a part of capital expenditure.
What is Revenue Expense?
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An idea that goes hand-in-hand with the capital expense is Revenue expense or revenue expenditure. Revenue expenditure includes the costs incurred by a business that works as current expenses, i.e., these costs are not incurred as a means of asset creation or removal of liabilities.
The government's revenue expenses are made in the form of payment of salaries and wages, grants, advertising, rent or costs of sold goods, etc.
While the concepts of capital expense and revenue expense may seem similar at first glance, there is a significant difference between the two.
Difference between Capital Expense and Revenue Expense
FAQs on Revenue vs. Capital Accounts Explained
1. What is the primary difference between a revenue account and a capital account?
The primary difference lies in their time horizon and nature. A revenue account records transactions related to the daily operations of a business that occur within a single accounting period, such as sales, rent paid, and salaries. In contrast, a capital account tracks long-term financial transactions that affect the owner's equity or the company's long-term assets and liabilities, like the initial investment by owners or the purchase of machinery.
2. What are some typical examples of capital expenditure and revenue expenditure?
These two categories represent different types of business spending.
- Capital Expenditure: These are long-term investments meant to generate value over multiple years. Examples include purchasing land and buildings, acquiring new machinery, buying office furniture, or spending a large sum on upgrading an existing asset to increase its capacity.
- Revenue Expenditure: These are short-term, operational costs required for the day-to-day running of the business. Examples include paying employee salaries, rent for the office, utility bills, costs of goods sold, and marketing expenses. You can explore this further in our detailed guide on the Difference Between Capital Expenditure and Revenue Expenditure.
3. How does misclassifying a capital expenditure as a revenue expenditure impact a company's financial statements?
Misclassifying a capital expenditure (an asset) as a revenue expenditure (an expense) has significant negative impacts on financial reporting.
- It understates the company's net profit for the current period because expenses on the Profit & Loss Account are artificially inflated.
- It understates the value of the company's assets on the Balance Sheet, as the item was not capitalised.
- This can mislead investors and stakeholders about the company's true profitability and financial health. This violates a core principle detailed in the Theory Base of Accounting.
4. Why is the distinction between capital and revenue items considered fundamental in accounting?
This distinction is fundamental for ensuring the "true and fair" presentation of financial statements. It correctly matches costs with the periods they benefit (the matching principle). Segregating them allows a business to accurately calculate its operational profit for a specific period (from revenue items) and assess its long-term financial position and investment scale (from capital items). Without this, a company cannot reliably measure its performance or value.
5. What is the difference between a capital receipt and a revenue receipt?
The difference is based on whether the receipt is part of normal business operations and its frequency.
- A revenue receipt is income generated from the main, recurring activities of the business, such as cash from the sale of goods, fees for services rendered, or interest earned.
- A capital receipt is a non-recurring inflow of cash that either creates a liability (like a bank loan) or reduces the value of a fixed asset (like selling old machinery). Money received from issuing shares is another prime example of a capital receipt.
6. In which financial statements are capital and revenue items recorded?
They are recorded in different statements to reflect their distinct nature.
- Revenue items (both incomes and expenditures) are recorded in the Trading and Profit & Loss Account (also known as the Income Statement) to determine the net profit or loss for the accounting period.
- Capital items (like long-term assets, liabilities, and owner's capital) are recorded in the Balance Sheet, which provides a snapshot of the company's financial position at a specific point in time. Our notes on Financial Statements of a Company explain this structure in detail.
7. What is deferred revenue expenditure and how is it different from capital expenditure?
Deferred revenue expenditure is a unique type of expense where a large, one-time payment is made, but its benefits are expected to extend over several years (typically 3-5). A massive advertising campaign for a new product launch is a classic example.
Key Difference: While it provides long-term benefits like a capital expenditure, it does not create a physical or tangible asset. Unlike capital expenditure which is shown as a fixed asset, the unwritten-off portion of deferred revenue expenditure is shown on the asset side of the Balance Sheet until it is fully charged to the P&L account over subsequent years.
8. How does a government's capital budget differ from its revenue budget?
A government budget has two main components that serve different purposes:
- The Revenue Budget deals with the government's revenue receipts (like taxes) and the revenue expenditure incurred on day-to-day functioning (like salaries, subsidies, and interest payments). These items do not impact the government's asset or liability status.
- The Capital Budget includes capital receipts (like borrowings and disinvestment) and capital expenditure (like building roads, hospitals, and airports). These transactions lead to a change in the government's assets or liabilities. This is a key topic in the Government Budget and The Economy chapter.
