The distinction between capital and revenue is crucial in accounting. Incorrect classification directly affects the profit/loss and balance sheet figures.
Capital Expenditure is incurred to acquire or improve a long-term asset. It provides benefit over multiple accounting periods. Examples: purchase of machinery, building, patent, or additions that increase the asset's earning capacity.
Revenue Expenditure is incurred for day-to-day operations and benefits only the current period. Examples: salaries, rent, repairs, electricity, and cost of goods sold.
Capital Receipts are non-recurring receipts that either reduce an asset or increase a liability. Examples: sale of fixed asset, capital introduced by owner, loan received.
Revenue Receipts arise from normal business operations and are recurring in nature. Examples: sales revenue, commission earned, rent received, interest received.
Deferred Revenue Expenditure is revenue expenditure that provides benefit over multiple periods but is not an asset. It is written off over 3-5 years. Example: heavy advertisement expenditure for launching a new product.
Key rules for classification: 1. Amount spent to acquire an asset → Capital 2. Amount spent to maintain an asset in working condition → Revenue 3. Amount spent to increase earning capacity of an existing asset → Capital 4. Amount spent on day-to-day running of business → Revenue
Exam tip: ICAI tests this through a list of 8-10 items asking you to classify each as capital or revenue. Always give reasoning alongside your classification for full marks.