Capital and Revenue Expenditure – CA Foundation Accounts Study Material

Capital and Revenue Expenditure – CA Foundation Accounts Study Material is designed strictly as per the latest syllabus and exam pattern.

Capital and Revenue Expenditure – CA Foundation Accounts Study Material

Question 1.
Capital Expenditure
Answer:
Capital Expenditure:

  • Any amount spent by actual payment or for which a liability is incurred is known as an expenditure.
  • Capital Expenditure is that expenditure which results in the acquisition of an asset (tangible or intangible) which can be later sold and converted into cash or which results in an increase in the earning capacity of the business or which affords some other advantage to the firm.
  • In a nutshell, if the benefits of an expenditure are expected to accrue for a long time, the expenditure is capital expenditure.
  • Obvious examples of capital expenditure are land, building, machinery, patents, etc.
  • All these things stay with the business and can be used over and over again.
  • Expenditure which does not result in increase in capacity or in reduction of day-to-day expenses is not capital expenditure, unless there is a tangible asset to show for it.
  • All amounts spent upto the point an asset is ready for use should be treated as capital expenditure.
  • Examples are: Fees paid to a lawyer for drawing up the purchase deed of land, overhauling expenses of second-hand machinery, interest paid on loans raised to acquire the assets but only for the period before the asset is ready for use.
  • Any expenditure incurred to bring such asset into usable condition for the 1st time is also a capital expenditure like installation expenses etc.
  • Additional expenditure on such assets in future will be capitalised only if it result into significant improvement over and above its originally assessed performance.

Question 2.
Revenue Expenditure
Answer:
Revenue Expenditure:

  • An item of expenditure whose benefit expires within the year or expenditure which merely seeks to maintain the business or keep assets in good working conditions is revenue expenditure.
  • Examples are: Salaries and Wages, power used to drive machinery, electricity used to light the factory or offices, etc.
  • Such expenditure does not increase the efficiency of the firm, nor does it result in any acquisition of fixed asset.
  • Diminution in the value of assets due to wear and tear or passage of time is revenue expense.
  • For instance, a piece of machinery is bought in the beginning of the year for ₹ 10,000. At the end of the year its value to the business may only be ₹ 9,000. This diminution in value ₹ 1,000 is a revenue loss.
  • Stocks of materials bought will be an asset unless, consumed, to the extent the materials are used up, they will be revenue expenditure.
  • Capital expenditure are shown in the Balance Sheet as assets whereas revenue expenditures are debited to P&L a/c.

Capital and Revenue Expenditure – CA Foundation Accounts Study Material

Question 3.
Deferred Revenue Expenditure & Prepaid Expenses
Answer:
Deferred Revenue Expenditure & Prepaid Expenses:
→ The Guidance Note on ‘Terms used in Financial Statement’, issued by the Institute of Chartered Accountants of India, defines “deferred revenue expenditure as those expenditure for which payment has been made or a liability incurred but which is carried forward on the presumption that it will be of benefit over a subsequent period or periods.”

→ In short, it refers to that expenditure that is, for the time being, deferred from being charged against income.

→ So long as deferred revenue expenditure is not written off, this is shown on the assets side of the balance sheet under the head “Miscellaneous Expenditure.”

→ Deferred revenue expenditure should be revenue expenditure by nature in the first instance, for example, advertisement. But its matching with revenue may be deferred considering the benefit to be accrued in future.

→ A thin line of difference exists between deferred revenue expenses and prepaid expenses.

→ The benefits available from prepaid expenses can be precisely estimated but that is not so in case of deferred revenue expenses.

→ Heavy advertising to launch a new product is a deferred expenses since the benefit from it will be available over the next three to five years but one cannot say precisely how long.

→ On the other hand, insurance premium paid, say, for the year ending 30th June, 2006, when the accounting year ends on 31st March, 2006 will be an example of prepaid expense to the extent of premium relating to three months’ period i.e. from 1st April, 2006 to 30th June, 2006.

→ Thus the insurance protection will be available precisely for three months after close of the year and the amount of the premium to be carried forward can be calculated exactly.

As per Accounting Standard 26 only those expenditures should be deferred which are expected to give future benefits. While solving problem, student should defer an expense item only if specifically so required by the question.

Question 3.
Capital Receipts and Revenue Receipts
Answer:
Capital Receipts and Revenue Receipts:

  • Receipts which are obtained in the course of normal trading operations are revenue receipts (e.g. sale of goods, interest income etc.).
  • On the other hand, receipts which are not revenue in nature are capital receipts (e.g. sale of fixed assets, secured or unsecured loans, owners’ contribution etc.).
  • Subscriptions by shareholders towards share capital of a company or for purchasing its debentures are considered by the company as capital receipts.
  • By the same criterion, contributions by partners or proprietors to capital of their business are capital receipts.
  • Sale value of fixed assets is also a capital receipts since these are distinguishable from revenue receipts, e.g., those from sale of merchandise, rent on property, interest on investment, professional fee for services rendered, etc.
  • It will be evident that capital receipts emanate out of a fund already held or arise on conversion of an asset, whereas revenue receipts flow from personal exertion, use of a capital asset or from sale or transfer of floating assets like goods.
  • Revenue and capital receipts are recognized on accrual basis as soon as the right of receipt is established.
  • Revenue receipts are credited to the Profit and loss account.
  • On the other hand, capital receipts are not directly credited to Profit and loss account.
  • For example, when a fixed asset is sold, the entire capital receipts is not credited to Profit and Loss Account. Profit or loss on sale of fixed assets is calculated and recorded in Profit and Loss Account.

Capital and Revenue Expenditure – CA Foundation Accounts Study Material

True or False

Question 1.
Lease premium will be treated as revenue expenditure.
Answer:
False: Lease premium is a capital expenditure.

Question 2.
Amount received by the issue of debentures is a capital receipt.
Answer:
True: Money received by way of issue of shares or debentures by a company is a capital receipt.

Question 3.
Capital expenditure is done to restore the efficiency of an asset.
Answer:
False: Capital expenditure is done to improve the efficiency of an asset.

Question 4.
Revenue loss is not the same thing as Revenue expenditure.
Answer:
True: Revenue expenditure is incurred to receive a benefit during a cur¬rent year. Revenue loss occurs in the normal course of business and provides no benefit.

Question 5.
Any expenditure which increases the value of fixed assets is termed as capital expenditure.
Answer:
True: Expenditure that is done in connection with the acquisition of fixed assets or which leads to the increment in the value of fixed assets are classified under capital expenditure.

Question 6.
Preliminary expenses are classified under deferred revenue expenditure.
Answer:
True: Preliminary expenses are treated as deferred revenue expenditure as these can be written off over a maximum of 4-5 years. Though according to AS 26, Preliminary expenses spent in the incorporation of a company should be written off in the year it is incurred.

Question 7.
Wages paid to workers for erecting machines will be treated as revenue expenditure.
Answer:
False: Expenditure done in connection with the erection of machines is an example of capital expenditure.

Capital and Revenue Expenditure – CA Foundation Accounts Study Material

Question 8.
Any heavy expenditure of revenue nature the benefit of which will be availed over a numbers of years can be classified as capital expenditure.
Answer:
False: The expenditure of this kind will be termed as Deferred revenue expenditure.

Question 9.
Capital receipts are either shown as an increase in liabilities or as a reduc-tion in the value of assets.
Answer:
True: Capital receipts are shown in the balance sheet as an increase in liabilities or as reduction in the value of assets.

Question 10.
Money spent to reduce working expenses is treated as capital expenditure.
Answer:
True: Any expenditure that reduces the working expenses will be treated as capital expenditure.

Question 11.
Interest paid on purchase of an asset in all cases, will be treated as capital expenditure.
Answer:
False: Such expenditure is classified under the head of capital expenditure if it is paid during the production/construction period. The expenditure will be treated as revenue after the asset is put to use.

Question 12.
Amount spent on experimenting which did not result in success will be treated as capital loss.
Answer:
False: It will be considered as a deferred revenue expenditure so that the burden of loss is shifted over a number of years.

Question 13.
A building of book value ₹ 45,000 got demolished and a new building having a book value ₹ 17,00,000 was constructed. Thus, ₹ 45,000 is a revenue loss and ₹ 17,00,000 is a capital receipt.
Answer:
False: ₹ 45,000 is a revenue loss but ₹ 17,00,000 is a capital expenditure.

Question 14.
Repairs amount spent on second hand machine, purchased recently, before using it will be treated as capital expenditure.
Answer:
True: Overhaul expenses (repairs) incurred to put a second hand machine in [ useable condition to derive its benefit for future periods is a capital expenditure.

Question 15.
₹ 10 lakhs were spent on the construction of a mess hall for the welfare i of the employees, ₹ 6 lakhs were received from the Government as a grant. In this case ₹ 4 lakhs will be treated as capital expenditure and ₹ 6 lakhs as capital receipt.
Answer:
False: ₹ 10,00,000 will be treated as capital expenditure since it is spent on the construction of the mess hall, though the amount has been received as a grant.

Question 16.
Amount spent in connection with the issue of capital should be considered as a capital expenditure, but legal expenses spent in connection with the issue of capital shall be considered as revenue expenditure.
Answer:
False: Legal expenses incurred on the issue of capital will be treated as capital expenditure.

Question 17.
Expenses in connection with obtaining a license for running the Cinema Hall is Revenue Expenditure.
Answer:
False: The Cinema Hall could not be started without license. Expenditure incurred to obtain the license is pre-operative expense which is to be capitalized. Such expenses are not revenue and amortized over a period of time.

Capital and Revenue Expenditure – CA Foundation Accounts Study Material

Question 18.
Overhauling expenses for the engine of motor car to get better fuel efficiency is revenue expenditure.
Answer:
False: Overhauling expenses incurred for the engine of a motor car to derive better fuel efficiency will reduce the running cost, so this is a capital expenditure.

Question 19.
Amount spent for the construction of temporary huts, which were necessary for construction of the Cinema House and were demolished when the Cinema House was ready, is capital expenditure.
Answer:
True: Amount spent for the construction or acquisition of a capital asset (here, Cinema house), in whatever form, will be treated as Capital Expenditure.

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