Capital and Revenue Expenditure:

Capital Expenditure

Revenue Expenditure

Deferred Revenue Expenditure

 Capital Expenditure (CAPEX)
 Expenditure that acquires a capital asset is capital expenditure.
 Expenditure incurred for acquisition of fixed tangible assets such as land, building,
machinery, furniture, motor vehicle etc.
 Expenditure incurred for improvement or extension of fixed assets such as increasing the
seating capacity of a theatre.
 Expenditure incurred to bring the fixed assets to the place of their use and expenditure
incurred on their installation or erection such as freight on fixed assets, wages paid for
installation.
 Expenditure incurred for the purchase of intangible assets such as goodwill, patent
rights, and trademarks, copyright, etc.
 Major repairs and replacement of plant which increase the efficiency of the plant.
 Capital Expenditure (CAPEX)
 Treatment of Capital Expenditure.
 Capital expenditure is capitalised. It is written off over the estimated useful life of the
asset. For example, when machinery is purchased, Machinery Account is debited at the
price paid for it and later shown in the Balance Sheet as an asset after deducting
depreciation. Similarly, wages paid for the installation of machinery is capitalised by
debiting the Machinery Account.
 Revenue Expenditure
 If an expenditure is made for running the business or working it with a view to produce
the profits is revenue expenditure.
 Such expenditure benefits the current period only.
 It is incurred to maintain the existing earning capacity of the business.
 For example, the amount spent on purchase of stock-in-trade is of revenue nature.
Administrative expenses and selling and distribution expenses are other examples of
revenue expenditure.
 An expenditure incurred for the purpose of acquiring goods purchased for resale,
consumable items, etc. is a revenue expenditure.
 expenses on production and purchase of goods such as wages, power, freight etc. are
revenue expenditure.
 amount spent on repairs and renewals is revenue expenditure.
 Depreciation on fixed assets is revenue expenditure.
 Expenditures incurred on office and administrative and selling and distribution
departments
 Deferred Revenue Expenditure
 Deferred revenue expenditure is a revenue expenditure by nature but it is not treated as
revenue expenditure on the ground that its benefit is not fully exhausted in the
accounting period in which it is incurred.
 expenditure on launching of new products, expenditure on advertising and promotional
activities
Depreciation &
Amortization
 Introduction
 Buildings, machinery, equipment, furniture, fixtures, computers, outdoor
lighting, parking lots, cars, and trucks are examples of assets that will last
for more than one year, but will not last indefinitely. They are used in the
operations of a business, and are not intended for sale to customers.

 During each accounting period (year, quarter, month, etc.) a portion of

the cost of these assets is being used up.

 The portion being used up is reported as Depreciation Expense on the 

income statement.

 In effect depreciation is the transfer of a portion of the asset's cost from

the balance sheet to the income statement during each year of the asset's
life.
 Introduction
 Amortization is the practice of spreading an intangible asset's cost over
that asset's useful life. Intangible assets are not physical assets, per se.
Examples of intangible assets that are expensed through amortization
might include:
 Patents and trademarks
 Franchise agreements
 Proprietary processes, such as copyrights
 Cost of issuing bonds to raise capital
 Organizational costs

 Unlike depreciation, amortization is typically expensed on a straight line

basis, meaning the same amount is expensed in each period over the
asset's useful life.
 SO…

 Accounting regards assets as depreciable when they

 Are expected to be used in more than one accounting period.
 Have a finite useful life, and
 Are held for use in the production or supply of goods and
services, for rental to others, or for administrative purposes.

 Depreciation is defined as the ‘allocation of the depreciable

amount of an asset over its estimated life’.
 The calculation and reporting of depreciation is based
upon two accounting principles:

 Cost principle. This principle requires that the Depreciation Expense

reported on the income statement, and the asset amount that is
reported on the balance sheet, should be based on the historical
(original) cost of the asset.
Continue…
 Matching principle. This principle requires that the asset's cost be 
allocated to Depreciation Expense over the life of the asset. In
effect the cost of the asset is divided up with some of the cost
being reported on each of the income statements issued during the
life of the asset.

 By assigning a portion of the asset's cost to various income

statements, the accountant is matching a portion of the asset's cost
with each period in which the asset is used.
 Characteristics
 Depreciation is a non-cash expense.
 Expired cost of an asset is called depreciation
 Depreciation is the process of allocating to expense, the cost of a
plant asset over its useful (service) life in a rational and systemic
manner
 Such cost allocation is designed to properly match expenses with
revenues.
 Depreciation affects the balance sheet through accumulated
depreciation, which is reported as a deduction from plant assets
 It effects the income statement through depreciation expense
Factors in computing depreciation

 Cost—Plant assets are recorded at cost, in accordance with the

cost principle

 Salvage value—an estimate of the asset’s value at the end of its

useful life

 Useful life—an estimate of the expected productive life, also

called service life, of the asset. The useful life of an asset is an
estimate of how long the asset will be used (as opposed to how
long the asset will last).
 Useful life example..
 For example, a graphic artist might purchase a computer in 2018
and expects to replace it in 2020 with a more advanced computer.
Hence the graphic artist's computer will have an
estimated useful life of 2 years.

 An accountant purchasing a similar computer in 2018 expects to use

it until 2022. The accountant will use an estimated useful life of 4
years when computing depreciation.

 Both the graphic artist and the accountant are correct—the graphic
artist in using 2 years and the accountant in using 4 years—even if
the computers will be in working order for many years after their
useful lives end.
 Non-Depreciable Asset
 Freehold Land
 Ithas an indefinite useful life, and it retains its value
indefinitely.
 Depreciation Methods
 Straight Line Method
 Reducing Balance Method/Diminishing Balance Method
 Production Output Method/Units of Production Method
 Straight Line Method
 Depreciation is computed by dividing the depreciable amount of
the asset by the expected number of accounting periods of its
useful life.
 Under the straight-line method, an equal amount of depreciation
expense is recorded each year of the asset.

Depreciation = Cost of Asset – Estimated Residual Value

Estimated Useful Economic Life
Example
Cost of asset 10,00,000
Residual/scrap/salvage value 50,000
Estimated useful life 10 years
Annual charge for depreciation
= 10,00,000-50,000
10
= 9,50,000
10
= 95,000
Reducing Balance Method / Diminishing
Balance Method
 Under this method the asset is depreciated at fixed
percentage calculated on the book value of the asset which is
diminished year after year on account of depreciation.

 This method associates the high amount of depreciation

expenses in the initial years and low amount in the later
years. The yearly rate of depreciation is calculated as under:
Annual Depreciation = Net Book Value x Depreciation Rate

= (Cost – Accumulated Depreciation) x Depreciation Rate

On 1st April, 2012, Shri Ram purchased a machinery
costing Rs.40,000 and spent Rs.5,000 on its erection.
The estimated effective life of the machinery is 10 years
with a scrap valued of Rs.5,000.
Calculate the Depreciation on the Straight Line Method
and show the Machinery Account of first three years.
Accounting year ends on 31st March every year.
Example
Schedule II to the Companies Act,
2013
 Schedule II of the Companies Act, 2013, is indicative in nature as it indicates instead
of specifying the rates of depreciation for various assets, and specifies that
depreciation should be provided on the basis of useful life of an asset.

 It prescribes useful life of an asset for the purpose of calculating depreciation. The
useful life of an asset shall not be ordinarily different from the life specified in Part
C* of Schedule II.

 Company may adopt useful life separate from that specified in Part C provided it
makes a proper disclosure in financial statements and provides justification
supported with technical advice.

 It specifies that the residual value of an asset shall not exceed 5% of its original
cost. Company can adopt a residual value different from the limit specified above if
it makes proper disclosure and provides justification supported by a technical advice.
Accumulated Depreciation
 The account credited in the journal entries is sometimes not the asset
account Equipment. Instead, the credit is entered in the 
contra asset account Accumulated Depreciation.

 The use of this contra account will allow the asset Equipment to continue
to report the equipment's cost, while also reporting in the account
Accumulated Depreciation the amount that has been charged to
Depreciation Expense since the asset was acquired.

 The accumulated depreciation is shown in the liability side of the balance

sheet in the final accounts.

 And the fixed asset is shown at its cost through out the life of the fixed
assets.
Deferred Tax Assets & Liabilities
 In some cases there is a difference between the amount of expenses or incomes that are
considered in books of accounts and the expenses or incomes that are
allowed/disallowed as per Income Tax.
 A very common example of this is depreciation. For companies, depreciation rates to be
considered in books of accounts are defined in companies act but while calculating
Income Tax the depreciation will be allowed only as per rates given in Income Tax Act.
Therefore, there is difference between income as per books and taxable income as per
IT Act.
 There is a difference between income as per books and taxable income as per IT Act. So,
only income tax related to income as per books is shown as expense in books of account
and the rest amount is shown as DTA or DTL.
 If the income as per books is more than taxable income then it means that we have paid
less tax as per book’s income and we have to pay more tax in future and thus recorded
as Deferred Tax Liability (DTL).
 Similarly if income as per books is less than taxable income then it means we have to
paid more tax and has to pay less tax in future. So it will be a Deferred Tax Asset (DTA).
 Capital receipts are the receipts which are not obtained in course of normal business
activities of the enterprise. The examples of capital receipts are :

 capital contributed by the owner(s),

 secured or unsecured loans taken,
 receipts from sale of fixed assets and non-current investments.

 Revenue receipts are the receipts which are obtained in course of normal business
activities. They include proceeds from sale of goods, fee received from the services
rendered in the ordinary course of business, receipts.
Income as per the books of accounts of a company:

Revenue 50,00,000
Expenses as per books10,00,000
Taxable income 40,00,000
Tax @ 30% 12,00,000

Income as per Income tax authorities:

Revenue 50,00,000
Expenses allowable as per IT authorities 8,00,000
Taxable income 42,00,000
Tax @ 30% 12,60,000

In the given situation, excess tax paid today due to the difference among the income
computed as per books of the company and the income computed by the income tax
authorities is 12,60,000 – 12,00,000 = 60,000.

This amount i.e. 60,000 will be termed as deferred tax asset (DTA). It will be adjusted in the
books of accounts during one or more subsequent year(s).
Capital and Revenue Receipts
Capital and Revenue Profits
 Capital profits:
 Capital profit is the net income that results from the transfer of any capital asset or
from the issue of share capital.
 As these profits do not accrue due to normal day to day business operations, they are
generally less frequent and non-recurring in nature
 Capital profits are primarily linked with two types of transactions –
 Transfer/sale of capital assets:
 Entities typically own several capital assets, these can be tangible such as land and
buildings, plant and machinery and office equipment or intangible such as software,
licenses and trademarks etc.
 Issue of share capital:
 When an entity issues its share capital, it may do so at a premium; which qualifies as a
capital profit.

 Capital profits are reported as special reserves under ‘reserves and surplus’ on the
liability side of the balance sheet.
 Revenue Profit:
 Revenue profit is the net income that results from the business operations of an entity.
Revenue profits include profits from the sale of goods and/or services, net income
earned from leasing out activities, commission business etc.
 This amount is transferred to the general reserves or profit and loss account on the
liabilities side of the balance sheet.
Reserve & Provision
 Reserve refers to a sum or percentage of profit that a company retains or keeps aside at
the end of a financial year towards meeting future contingencies that may occur.
 There are two types of reserves in an organization

 Capital Reserve
 Revenue Reserve

 A capital reserve is created from the capital profits and is not available for distribution
to shareholders in the form of dividends.

 Revenue reserve is created from the profits earned from the core operations of a
company or organisation. Revenue reserve is also known as Retained earnings. It can be
used for paying dividend to shareholders, expanding the business, etc.
 Provision refers to an amount that is kept aside from a company’s profit in order to
cover probable expenses arising in future.

 Provisions should not be regarded as savings as these are created to meet expenses for
an anticipated liability in future.

 It appears in the income statement in the form of expenses and is recorded as a current
liability in the balance sheet.
Contingent Liabilities & Assets
 A contingent liability is a potential liability that may or may not occur, depending on the
result of an uncertain future event. The relevance of a contingent liability depends on
the probability of the contingency becoming an actual liability, its timing, and the
accuracy with which the amount associated with it can be estimated.
 A contingent liability is recorded in the accounting records if the contingency is probable
and the related amount can be estimated with a reasonable level of accuracy. The most
common example of a contingent liability are outstanding lawsuits, and government
probes.
 A contingent asset is a potential economic benefit that is dependent on future events
out of a company’s control. Not knowing for certain whether these gains will
materialize, or being able to determine their precise economic value, means these
assets cannot be recorded on the balance sheet. However, they can be reported in the
accompanying notes of financial statements, provided that certain conditions are met. A
contingent asset is also known as a potential asset.
 Examples are lawsuits, warranties, anticipated mergers & acquisitions.