Entities receive various cash inflows at different stages of their business. From loans taken or share capital proceeds received at the time of setting up business to product sales revenue to supplementary income such as rental or interest income. All these receipts must be appropriately classified, measured and recorded in the books of accounts. Appropriate accounting for these receipts can be done if they are correctly classified into capital based and revenue based inflows. This is of utmost importance as it impacts the entities profitability as well as financial position.
This article looks at meaning of and differences between these two classifications of receipts – capital receipts and revenue receipts.
Definitions and meanings
Capital receipts are monetary inflows which are non-recurring in nature and result in creation of a financial liability or reduction of an asset. These receipts are not generated from normal sales and purchases related commercial activities of the business and are thus also non-operating in nature. To qualify as a capital receipt, it must either create a liability or reduce an asset.
Examples of receipts that create a liability:
Examples of receipts that reduce balance of an asset:
Selling off of a fixed asset or receiving insurance claim against a scrapped fixed asset, receipt of settlement towards loans given, receipt of government grant against cost of asset all result in reduction of assets and thus qualify as capital receipts.
Example journal entry to record a capital receipt (obtaining a loan):
Bank a/c…..XXXXX [Dr]
Loan taken a/c…..XXXXX [Cr]
(Being loan obtained for office expansion)
As capital receipts impact balances affecting the balance sheet, they do not have an immediate or direct impact on profitability. They may, however, have an indirect impact on profitability. For example, capital receipt of a loan taken will impact the liabilities side of the balance sheet first. It will, however, eventually result in interest being paid which will reduce profitability.
Capital receipts are typically one-off transactions and do not generally take place on a very regular basis.
Revenue receipts are monetary inflows that are generated through the routine operational activities of a business entity. Such receipts are thus recurring in nature as they are likely to take occur very frequently, often even daily. Examples include sale of goods and/or services, rental income, interest income from savings account, commission income and cash back received from suppliers.
Example journal entry to record a revenue receipt (sale of goods):
Bank a/c…..10,000 [Dr]
Sales a/c…..10,000 [Cr]
(Being sale of goods recorded)
As can be seen, revenue receipts have an immediate and direct impact on the profitability of the business. Whether they impact gross or net profit would depend on the nature of the receipt.
Difference between capital and revenue receipts:
The nine key points of difference between capital and revenue receipts are listed below:
- Capital receipts are non-operating inflows that have the effect of increasing liabilities or decreasing assets of a business.
- Revenue receipts are operating inflows that are generated through routing business activities and have a direct impact on profitability of the business.
- Capital receipts are less frequent and non-recurring in nature. For example, a business may take a loan only on occasion when they require funds.
- Revenue receipts on the other hand are frequent and recurring in nature. For example, revenue from sale of products may occur daily for a business.
- Capital receipts generate from non-operating sources which mainly include financing or investing activities of the business.
- Revenue receipts mainly generate from operating activities of a business.
- Capital receipts are credited to a balance sheet account and, thus, result in reduction of an asset, addition to an existing or creation of a new liability in the books of accounts.
- Revenue receipts are credited to the trading or profit and loss account as they result in recording of a profit or an income.
5. Impact on profitability
- Capital receipts do not have an immediate or direct impact on profitability. They, however, often have a long-term indirect impact on profitability.
- Revenue receipts have an immediate and direct impact on the profitability of the business.
6. Core purpose
- The core purpose of generating capital receipts is the long-term funding. These can include taking loans for business expansion or sale of existing assets to generate funds for the purchase of new assets etc.
- The core purpose of generating revenue receipts is to have working capital to keep the business operations functioning.
- Capital receipts being one-time or non-recurring in nature are generally of higher amounts. This is especially the case as they used for funding long-term high value projects.
- Revenue receipts generally occur in large volumes but at relatively lower individual values than capital receipts.
8. Distribution to shareholders
- As capital receipts are not credited to the profit and loss account, they are not available for distribution to shareholders.
- Revenue receipts being operating in nature are credited to profit and loss account and form part of the profits that are available for distribution to shareholders.
- Examples of capital receipts include borrowings, sale of fixed assets and proceeds from issue of shares etc.
- Examples of revenue receipts include sale of products or services, rental income, interest on savings and investments and commission income etc.
Conclusion – capital vs revenue receipts:
While capital and revenue receipts have different purposes and are accounted for differently, they both are equally important for efficient functioning of a business. For example, an entity that receives funds from loans but are not able to generate sufficient inflows from their operating activities will not be sustainable. At the same time, an entity that has reasonable inflows from operations but is unable to generate large scale fund inflows may not be able to grow and expand its operations. This makes it important for a business to be able to generate both capital and revenue receipts.