CAPITAL AND REVENUE LOSSES :

Revenue losses are the losses which arise during the normal course of business whereas capital losses are those which occur when selling fixed assets or raising share capital. If a building purchased for Rs.5,00,000 is sold for Rs.4,50,000, there will be capital loss of Rs.50,000. Similarly, when shares of the face value of Rs.101 are issued at Rs. 9 i.e. at a discount of Rs.1, the amount of discount will be a capital loss.

Treatment of capital losses is not different from that of capital profits. Just as capital profits are not shown in the profit and loss account, similarly capital losses are not shown in the profit and loss account. They are shown in the balance sheet on the assets side. As and when capital profits arise, capital losses are gradually written off against them. If however, capital losses are huge, the common practice is to spread them over a number of years and charge a part thereof to profit and loss account of each such year. But if they are negligible, they are debited to profit and loss account of the year in which they occur.

Illustration :
State which of the following expenditures are capital, revenue, deferred revenue expenditures and capital loss:
(i) Cost of overhauling and painting a second-hand truck newly purchased.

(ii) Cost of making more exits in a cinema hall under order of the Government.

(iii) Rs.25,000 were spent on air conditioning the office of the General Manager.

(iv) An old machine which stood in the books at Rs.15,000 was sold for Rs.13,000.

(v) Rs.2,000 were paid as municipal tax in connection with a building which was purchased last year for Rs.2,00,000.

(vi) Rs.30,000 were spent on heavy advertising in connection with the introduction of a new product.

(vii)Rs.500 was paid out in connection with carriage on goods purchased.

(viii) A temporary room constructed for Rs 25,000 for storing raw material for the construction of a big building.

(ix) Rs.5,00,000 was spent on putting up a gallery in a theatre hall.

(x) Freight and cartage amounting to Rs4,000 were paid on purchase of a new plant and a sum of Rs.2,000 was spent as erection charges of that plant.

Solution:

(i) When a second hand machine is purchased, the entire expenditure incurred in the beginning to make it fit for working is treated as capital expenditure. The value of the machine is increased by the amount spent. Therefore, the cost of overhauling and painting the truck will be treated as capital expenditure.

(ii) Making more exits in a cinema hall does not increase the capacity of the hall and therefore, it should be treated as revenue expenditure.

(iii) The sum of Rs.25,000 spent on air conditioning the office of General Manager is capital expenditure because it represents a fixed asset. Moreover, the effect of air conditioning will be available for several years to come, and it can possibly be disposed of, if desired, at a future date, when it will fetch some amount.

(iv) The old machine costing Rs.15,000 was sold for Rs.13,000 only, and the loss o fRs.2,000 is clearly a
capital loss.

(v) Rs.2,000 paid by way of municipal tax on a building purchased is an item of revenue nature. It is an expenditure of routine nature, which was necessary for using the building.

(vi) Since the benefit of Rs.30,000 spent on advertising will occur for several years, it is of capital nature. It may be treated as a deferred revenue expenditure and be written off against the profit and loss account of a number of years.

(vii) The expenditure of Rs.500 incurred on carriage on goods purchased is of revenue nature because the goods are meant for resale.

(viii)Rs.25,000 spent on construction of temporary room should be treated as capital expenditure because it was necessary for the construction of the main building. The cost of the room will be added to the cost of the building.

(ix) When a new gallery is put up, it will increase the number of seats (capacity) of the hall. Therefore, this
cost of Rs.5,00,000 should be treated as a capital expenditure.

(x) The expenditure incurred by way of freight and cartage amounting to Rs.4,000 and the erection charges of Rs.2,000 are both of capital nature. The former has been incurred in connection with the receipt of  capital asset while the latter has been incurred for erecting it so that it may be used for business purposes.

Illustration :
State whether the following expenses are capital, revenue or deferred revenue expenditure:

(i) A Ltd. spent Rs.2,00,000 for overhauling the machinery which improved the capacity utilization and saved running expenditure by Rs.15,000 p.a.

(ii) M/s Capital Properties, property dealers, purchased ten flats @ Rs.7,00,000 each.

(iii) A firm incurred Rs.10,000 to retain the title of a land purchased for business in litigation with third party.

(iv) Compensation paid to undesirable employees.

(v) M/s Durga & Co. spent Rs.2,50,000 for organizing an Inter-school Cricket Tournament in Delhi. This was held for advertising their new school bag and certain books and stationery which they wanted to market.

(vi) Rs.12,000 paid to Mahanagar Telephone Nigam Ltd. for installing a telephone in the office.

(vii) Damages paid on account of breach of contract to supply certain goods.

(viii)Rs.25,000 has accrued during the year on term loan obtained and utilized for the construction of factory building and purchase of machinery, however, the production did not commence till the last date of the year.

(ix) Imported goods worth Rs.1,75,000 confiscated by customs authorities for non-disclosure of material facts.

(x)Rs.20,000 spent for the trial run of newly installed machinery.

Solution:

(i) Expenses for overhauling the machinery increased capacity utilization which contributes to increase the revenue generating capacity. Also, saving in revenue expenditure for more than one accounting period will accrue from this overhauling which will increase future profits. Hence, this expense is capital in nature.

(ii) Purchase of flats in the ordinary course of business by property dealers is revenue expenditure as flats are stock in trade for it.

(iii) Legal expenses incurred to retain the title of land are expenses for maintaining the asset. The expenses will not generate any revenue in future directly. Hence, it is revenue in nature.

(iv) Compensation paid to retrench undesirable employees is expected to increase revenue earning capacity of the business because such undesirable employees would either waste resources or time with adverse effect on profit. The expenditure is capital in nature.

(v) The purpose of expenses incurred for organizing the Inter-School Cricket Tournament is to advertise for some new products. This advertisement has some enduring effect so far as the marketability of the new products is concerned. The expense may be treated as deferred revenue expenditure.

(vi) The money deposited with Mahanagar Telephone Nigam Ltd. for acquiring a telephone connection is treated as an asset; hence it is a capital expenditure.

(vii) Damages paid on account of the breach of contract to supply certain goods are treated as revenue expenditure incurred in the ordinary course of the business.

(viii) Interest accrued on term loan obtained and utilized for the construction of factory building and purchase of machinery should be treated as capital expenditure since commercial production did not start till the last date of the accounting year.

(ix) The confiscation of imported goods by the customs authorities is a loss arisen on account of negligence and is of abnormal nature. It is appropriate to write it off to profit and loss account over a period of 2 to 5 years treating it as a deferred revenue expenditure.

(x) Expenses incurred for trial-run of newly installed machinery is capital expenditure in nature.