Capital and Revenue Items in Accounting (6 Types)
The proper allocation of capital items and revenue items are important for the fundamental principles of correct accounting. It is not easy to give a correct rule to allocate capital items and revenue items. In order to understand them, one should know the correct principles governing the allocation between capital and revenue.
The following are the types of capital and revenue items in accounting:
(A) Capital Receipts:
Capital Receipts is the amount received in the form of additional Capital (by issuing shares) loans or by the sale proceeds of any fixed assets. Capital Receipts are shown in Balance Sheet.
(B) Revenue Receipts:
Revenue Receipts are the amount received in the ordinary course of a business. It is the incomes earned from selling merchandise, or in the form of discount, commission, interest, transfer fees etc. Income received by selling waste paper, packing cases etc. is also a revenue receipt. Revenue Receipts are shown in the Profit and Loss Account.
(C) Capital Profit:
Capital profits are earned as a result of selling some fixed assets or in connection with raising capital for the firm. For example a land purchased by a business for Rs 2, 00,000 is sold for Rs. 2, 50,000. Rs 50,000 are a profit of capital nature. Another example, suppose a company issues its shares of the face value of Rs 100 for Rs 110 each, i.e. issue of shares at premium, the premium on shares i.e. Rs 10 is capital profit. Such profits are (a) transferred to Capital Account or (b) transferred to Capital Reserve Account. This amount is utilised for meeting Capital losses. Capital Reserve appears in the Balance Sheet as a liability.
(D) Revenue Profits:
Revenue Profits are earned in the ordinary course of business. Revenue profits appear in the Profit and Loss Account. For example, profit from sale of goods, income from investments, discount received, Interest Earned etc.
(E) Capital Losses:
Capital losses occur when selling fixed assets or raising share capital. A building purchased for Rs 2, 00,000 is sold for Rs 1, 50,000. Rs 50,000 are a capital loss. Shares of the face value of Rs 100 issued at Rs 95, i.e. discount of Rs 5. The amount of discount is a capital loss.
Capital Loss is not shown in the Profit and Loss Account. They are shown in the asset side of Balance Sheet. When Capital Profit arises, Capital losses are gradually written off against them. If capital losses are huge, it is common to spread them over a number of years and a proportionate amount is charged to Profit and Loss Account every year.
Balance amount is shown in the Balance Sheet as an asset and it is written off in future years. If the loss is manageable, they are debited to Profit and Loss Account of the same year.
(F) Revenue Losses:
Revenue losses arise during the normal course of business. For instance, sale of goods, loss may incur. Such losses are debited in the Profit and Loss Account
Concept of Double Entry
Every transaction has two effects. For example, if someone transacts a purchase of a drink from a local store, he pays cash to the shopkeeper and in return, he gets a bottle of dink. This simple transaction has two effects from the perspective of both, the buyer as well as the seller. The buyer’s cash balance would decrease by the amount of the cost of purchase while on the other hand he will acquire a bottle of drink. Conversely, the seller will be one drink short though his cash balance would increase by the price of the drink.
Accounting attempts to record both effects of a transaction or event on the entity’s financial statements. This is the application of double entry concept. Without applying double entry concept, accounting records would only reflect a partial view of the company’s affairs. Imagine if an entity purchased a machine during a year, but the accounting records do not show whether the machine was purchased for cash or on credit. Perhaps the machine was bought in exchange of another machine. Such information can only be gained from accounting records if both effects of a transaction are accounted for.
Traditionally, the two effects of an accounting entry are known as Debit (Dr) and Credit (Cr). Accounting system is based on the principal that for every Debit entry, there will always be an equal Credit entry. This is known as the Duality Principal.
Debit entries are ones that account for the following effects:
- Increase in assets
- Increase in expense
- Decrease in liability
- Decrease in equity
- Decrease in income
Credit entries are ones that account for the following effects:
- Decrease in assets
- Decrease in expense
- Increase in liability
- Increase in equity
- Increase in income
Double Entry is recorded in a manner that the Accounting Equation is always in balance.
Assets – Liabilities = Capital
Any increase in expense (Dr) will be offset by a decrease in assets (Cr) or increase in liability or equity (Cr) and vice-versa. Hence, the accounting equation will still be in equilibrium.
Purchase of machine by cash
Debit Machine Increase in Asset
Credit Cash Decrease in Asset
2. Payment of utility bills
Debit Utility Expense Increase in Expense
Credit Cash Decrease in Asset
3. Interest received on bank deposit account
Debit Cash Increase in Asset
Credit Finance Income Increase in Income
4. Receipt of bank loan principal
Debit Cash Increase in Asset
Credit Bank Loan Increase in Liability
5. Issue of ordinary shares for cash
Debit Cash Increase in Asset
Credit Share Capital Increase in Equity
What are debits and credits?
Debit and Credit are the respective sides of an account.
Debit refers to the left side of an account.
Credit refers to the right side of an account.
Explanation
In accounting, every account or statement (e.g. Accounting ledgers, trials balance, profit and losd account, balance sheet) has 2 sides known as debit and credit.
According to the dual aspect principle, each accounting entry is recorded in 2 equal debit and credit portions. In other words, the total amount that will be recorded in the left side (debit) of accounting ledgers will always equal to the total amount recorded on the right side (credit).
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