Revenue Recognition & Management Revenue v/s Capital (Receipts & Expenditure)

1. Financial Accounting
Revenue Recognition & Management
Revenue v/s Capital
(Receipts & Expenditure)

2. Introduction
When a business entity spends money (or purchase on credit) to acquire goods or services, a
decision needs to be made as to the purpose and nature of the expenditure. The questions raised to
decide the classification are:-
 What did I pay for?
 Is the expense incurred has some value or benefits to my business over the long run? (e.g.
more than one year)
 Is the expenses I paid for something that the business has already enjoyed or used in the
past? (e.g. electricity, phone, water & etc.)
 Is it for something that the business intends to resell later?
 Is it for packing of the goods meant to be sold later?
In accounting, the classification of the expenditure into either capital expenditure or revenue
expenditure is required. Wrong classification of the expenditure may have a great impact on the
financial position (balance sheet) and the financial performance/results (profit & loss or income
statement) of the business entity.
Capital Expenditure
Capital expenditure refers to the expenditure made by business entities to acquire assets (usually
non-current or fixed assets) that are expected to give the business entities future economic benefits
(by way of using the assets in the business to generate revenue or income). Capital expenditure is
recorded as asset and therefore would appear on the balance sheet of the business entities.
A capital expenditure is an amount spent to acquire or improve a long-term asset such as equipment
or buildings. Capital expenditure occurs when a business gets a long term advantage due to that
expenditure. It includes costs incurred on the acquisition of a fixed asset and any subsequent
expenditure that increases the earning capacity of an existing fixed asset. These expenditures do not
occur in the regular day to day transactions of the business. Usually the cost is recorded in an
account classified as Property, Plant and Equipment.
Common examples:
 Purchase of furniture, office building etc.
 Purchase of additional furniture or machinery
 Expenditure incurred in connection with the purchase of a fixed asset i.e. costs incurred in
bringing the fixed asset into its present location and condition. For example, carriage paid on
machinery purchased.
 Expenditure incurred, during the early years, on development of mines and land for
plantation till they become operational
 Cost of experiments which ultimately result in acquisition of patents. However the cost of
experiments which are not successful is treated as deferred revenue expenditure which is
written-off within two to three years.
 Purchase of patent right, copy rights etc.
 Legal charges incurred in connection with acquiring or defending suits for protecting fixed
assets, rights, etc.
 Interest on Loan paid during initial period (before commencement of production)

3. Revenue Expenditure
Revenue expenditure refers to those expenses incurred to acquire goods or services that are
essential in terms of the daily operations of the businesses. However, the benefits that revenue
expenditure gives to the business entities are of a shorter term in nature and usually in the day to
day operations and DO NOT provide future economic benefits, i.e. the benefits are consumed over a
short period of time (usually one year is the period that is used as the measurement). Hence
revenue expenditure is an amount that is expensed immediately — thereby being matched with
revenues of the current accounting period. Expenditure which is not for increasing the value of fixed
assets, but for running the business on a day to day basis, is known as revenue expenditure. Routine
repairs are revenue expenditures because they are charged directly to an account such as Repairs
and Maintenance Expense. Even significant repairs that do not extend the life of the asset or do not
improve the asset or enhance the earning capacity of the assets (the repairs merely return the asset
back to its previous condition) are revenue expenditures.
Common examples
 Expenses incurred in day-to-day conduct of the business – wages, salaries, rent, postage,
repairs, insurance, electricity etc.
 Expenditure to buy goods for re-sale or raw material for manufacturing
 Expenditure incurred for routine maintenance of fixed assets
 Depreciation of Fixed Assets
 Interest on loan for running the business. But any interest on Loan paid during initial period
(before the production commences) is treated as capital expenditure.
 Legal charges paid during regular course of business to defend a suit for damages or for
collecting money from debtors.
Difference between Capital and Revenue Expenditure
The following are the points of distinction between capital expenditure and revenue expenditure.
Capital Expenditure Revenue Expenditure
Expenses to acquire assets usually non-current or
fixed assets
Expenses in the day-to-day running of the
business
It is recorded on the asset side of the balance
sheet
It is recorded on the debit of the Profit & Loss
Account or Income Statement
Gives a long term advantage to the business –
usually more than a year
Gives a short term advantage to the business –
less than a year
Provided future economic benefits, by way of
using the assets in the business to generate
revenue or income
Do not provide future economic benefits.
Benefits only in the short run
If a Capital Expenditure is wrongly classified as
Revenue Expenditure it would result in an under-
statement of the profit
If a Revenue Expenditure is wrongly classified as
Capital Expenditure it would result in an over-
statement of the profit and under-valuation of
an asset

4. Capital Receipt
Capital receipts consist of additional payments made to the business either by owner or shareholder
of the business; or from sale of fixed assets of the business.
If a receipt is related to fixed asset, the receipts are considered as capital receipts. Fixed asset is
giving the long-term benefit to the proprietor. It has long life for example land and buildings, plant
and machinery etc.
The following are the best examples of capital receipts.
 Insurance claim received as compensation for the damaged asset.
 Conversion of capital asset into business asset. The difference between the market value
and cost price is taken as capital receipt.
 Shares issued at a premium
 Any other income received apart from the regular business is deemed as capital receipt.
Revenue Receipt
Revenue receipts are categorised as any receipt in the normal running or day-to-day transactions of
the business. Sales receipts of the business are revenue receipts.
Revenue receipt is related with the current or circulating assets, it is derived from the sale of the
circulating asset. It is the main purpose of the business.
The following are the example of revenue receipts:
 income arising through buying yarn and selling the same in the form of cloth
 Incomes such as interest earned, commission received, rent received etc.
Difference between Capital and Revenue Receipt (Income)
Capital Receipt Revenue Receipt
Capital receipt is the amount received from the
sale of assets, shares and debentures.
Revenue receipt is the amount received from the
sale of goods and services.
Capital receipt is of non-recurring nature. Revenue receipt is of recurring nature.
Main items of capital receipt are capital and
loan, which affect financial position of the
business.
Main items of revenue receipt are sale of
merchandise, discount and commission received,
which affect operating results of the business.
Capital receipt is shown on the liabilities side of
the balance sheet.
Revenue receipt is shown on the credit side of
the trading and profit and loss accounts.
Capital receipts are not available for distribution
as profits.
Revenue receipts are available for distribution as
profits only after deducting revenue expenses.
A business can survive without any capital
receipt in an accounting period.
But revenue receipts are necessary for the
survival of a business.

5. Deferred Revenue Expenditure
Sometimes, certain expenditure which is normally treated as revenue may be unusually heavy. Its
benefit will be reaped over a number of accounting years. Hence these expenses are incurred in an
accounting period and they do not create any assets but their benefit is spread in more than one
accounting period.
A few examples of deferred revenue expenditure and their treatment in final accounts are as
explained below:
 When a new firm enters into market, it undertakes special advertising campaign on which it
spends heavy amount. The benefit of this expenditure will certainly come in some future
years. Hence it will not be justified to charge this expenditure only in the profit and loss
account of the year in which it is incurred. This expenditure must be spread over the period
over which the benefit is likely to lose. Suppose this expenditure will cover 3 years. Hence
1/3 of the expenditure must be charged to each year Profit and Loss Account.
 Sometimes even a big loss, arising from an accident or other unforeseen circumstances, may
be spread over 3 or 4 years instead of being charged off wholly against the revenues of the
year in which the loss is actually suffered. The loss of building because of an earthquake may
be treated in this manner. This type of loss is treated as revenue expenditure. It may be
noted here that the amount which has not been charged off to the profit and loss account is
shown in the balance sheet as a sort of asset.
 Expenditure incurred on formation of a new company (preliminary expenses)
 Brokerage charges, underwriting commission, etc. paid in connection with issue of shares /
debentures
 Cost of shifting the plant and machinery to a new site which may involve dismantling,
removing and re-erection of the plant and machinery.
 The cost of experiments which are not successful is treated as deferred revenue expenditure
which is written-off within two to three years.
Deferred Revenue Income
Deferred income (also known as deferred revenue, unearned revenue, or unearned income) is,
in accrual accounting, money received for goods or services which have not yet been delivered.
According to the revenue recognition principle, it is recorded as a liability until delivery is made, at
which time it is converted into revenue.
Deferred income shares characteristics with accrued expense with the difference that a liability to be
covered later are goods or services received from a counterpart, while cash is to be paid out in a
latter period, when such expense is incurred, the related expense item is recognized, and the same
amount is deducted from accrued expenses.
Examples of Deferred revenue income are:
 A company receives an annual software license fee paid out by a customer upfront on
January 1. However the company's fiscal year ends on May 31. So, the company using
accrual accounting adds only five months worth (5/12) of the fee to its revenues in profit
and loss for the fiscal year the fee was received. The rest is added to deferred
income (liability) on the balance sheet for that year.

6.  A typical example is an annual maintenance contract where the entire contract is invoiced
up front. “I received Rs. 12,000 for an annual maintenance contract, but need to recognize it
as deferred income, and then recognize Rs. 1,000 each month as the service is rendered.”
 Another classic example is annual subscription received by a magazine company in advance
from its subscribers. This needs to be recognized as deferred income on the liability side of
the Balance Sheet, and then proportionately recognized as and when the magazine is
delivered to the subscriber.

7. Source
Capital receipt is the amount received from the sale of assets, shares and debentures. Revenue
receipt is the amount received from the sale of goods and services.
Nature
Capital receipt is of non-recurring nature. Revenue receipt is of recurring nature.
Impact
Main items of capital receipt are capital and loan, which affect financial position of the business.
Main items of revenue receipt are sale of merchandise, discount and commission received, which
affect operating results of the business.
Treatment
Capital receipt is shown on the liabilities side of the balance sheet. Revenue receipt is shown on the
credit side of the trading and profit and loss accounts.
Distribution
Capital receipts are not available for distribution as profits, whereas revenue receipts are available
for distribution as profits only after deducting revenue expenses.
Survival
A business can survive without any capital receipt in an accounting period. But revenue receipts are
necessary for the survival of a business.