NCERT Textbook - Financial Statements - I | Accountancy Class 11 - Commerce PDF Download

 Page 1


Financial Statements - I 8
Learning Objectives After studying this chapter, 
you will be able to :
•	 state 	 the	 nature	 of	 the	
financial 	 statements;
•	 identify 	 the 	 various	
stakeholders and their 
information 	 requi re-	
ments;
•	 di s t i ngui s h 	 be t w e en	
the 	 capital 	 and 	 reve -
nue expenditure and 
receipts;
•	 explain 	 the	 concept 	 of	
trading 	 and	 profit 	 and	
loss account and its 
preparation;
•	 State 	 the 	 nature 	 of	
gross	 profit, 	 net	 profit 	
and 	operating	 profit;
•	 descr i be 	 the	 concept 	 of	
balance sheet and its 
preparation;
•	 explain 	 grouping 	 and	
marshalling 	 of 	 assets 	
and 	liabilities;
•	 prepare 	 	 profi t 	 and 	 loss	
account and balance 
sh eet 	 of 	 a 	 sole 	 prop -
rietor	 	 y 	firm; 	 and
•	 make 	 an 	 opening	
entry.
Y
ou have learnt that financial accounting is a  
well-defined sequential activity which begins 
with Journal (Journalising), Ledger (Posting), 
and preparation of Trial Balance (Balancing and 
Summarisation at the first stage).  In the present 
chapter, we will take up the next step, namely,  
preparation of financial statements, and discuss 
the types of information requirements of various 
stakeholders, the distinction between capital and 
revenue items and its importance and the nature 
of financial statements and the preparation thereof.
8.1 Stakeholders and their 
 Information Requirements
Recall from chapter I (Financial Accounting Part I) 
that the objective of business is to communicate 
the meaningful information to various stakeholders 
in the business so that they can make informed 
decisions. A stakeholder is any person associated 
with the business. The stakes of various stakeholders 
can be monetary or non-monetary. The stakes can 
be active or passive; or can be direct or indirect. The 
owner and persons advancing loan to the business 
would have monetary stake. The government, 
consumer or a researcher will have non-monetary 
stake in the business. The stakeholders are also 
called users who are normally classified as internal 
and external depending upon whether they are inside 
the business or outside the business. All users 
have different objectives for joining business and 
Ch-8.indd   277 9/13/2022   2:49:08 PM
2024-25
Page 2


Financial Statements - I 8
Learning Objectives After studying this chapter, 
you will be able to :
•	 state 	 the	 nature	 of	 the	
financial 	 statements;
•	 identify 	 the 	 various	
stakeholders and their 
information 	 requi re-	
ments;
•	 di s t i ngui s h 	 be t w e en	
the 	 capital 	 and 	 reve -
nue expenditure and 
receipts;
•	 explain 	 the	 concept 	 of	
trading 	 and	 profit 	 and	
loss account and its 
preparation;
•	 State 	 the 	 nature 	 of	
gross	 profit, 	 net	 profit 	
and 	operating	 profit;
•	 descr i be 	 the	 concept 	 of	
balance sheet and its 
preparation;
•	 explain 	 grouping 	 and	
marshalling 	 of 	 assets 	
and 	liabilities;
•	 prepare 	 	 profi t 	 and 	 loss	
account and balance 
sh eet 	 of 	 a 	 sole 	 prop -
rietor	 	 y 	firm; 	 and
•	 make 	 an 	 opening	
entry.
Y
ou have learnt that financial accounting is a  
well-defined sequential activity which begins 
with Journal (Journalising), Ledger (Posting), 
and preparation of Trial Balance (Balancing and 
Summarisation at the first stage).  In the present 
chapter, we will take up the next step, namely,  
preparation of financial statements, and discuss 
the types of information requirements of various 
stakeholders, the distinction between capital and 
revenue items and its importance and the nature 
of financial statements and the preparation thereof.
8.1 Stakeholders and their 
 Information Requirements
Recall from chapter I (Financial Accounting Part I) 
that the objective of business is to communicate 
the meaningful information to various stakeholders 
in the business so that they can make informed 
decisions. A stakeholder is any person associated 
with the business. The stakes of various stakeholders 
can be monetary or non-monetary. The stakes can 
be active or passive; or can be direct or indirect. The 
owner and persons advancing loan to the business 
would have monetary stake. The government, 
consumer or a researcher will have non-monetary 
stake in the business. The stakeholders are also 
called users who are normally classified as internal 
and external depending upon whether they are inside 
the business or outside the business. All users 
have different objectives for joining business and 
Ch-8.indd   277 9/13/2022   2:49:08 PM
2024-25
278 Accountancy
consequently different types of information requirements from it. In nutshell, 
the various users have diverse financial information requirements from the 
business.
For example we have classified the following into the category of internal 
and external users specifying their objectives and consequent information 
requirements.
Name	 Internal/	 Object ive 	for	participating	 Accounting 	 Information	 requirements
 External in business
 users
Current Internal  To make investment in the Likes to know extent of profit in the  
owners  business and wealth grow. last accounting period, current 
   position of the assets/liabilities of the 
   business.
Manager Internal For a career. They essenti- Accounting information in the form 
  ally  act  as  the  agent of of financial statements is like their 
  owners (their employers). report card and they are interested 
   in information about both profits 
and     financial position.
Government External Its role is regulatory and Its concerns are that the rights of all 
  tries to lay down the rules stakeholders are protected. Since the 
  in the best public interest. government levies taxes on the 
   business, they are interested in 
   information about profitability in 
   particular besides lot of other 
   information.
Prospective External He is expecting to make He is interested in information about 
owner  investments in the business past profits and financial position as 
  with a view to make his indicative of likely future performance.
  investment and wealth grow. 
Bank External Bank is interested in safety Bank is interested in adequacy of 
  of the principal as well as  profit s only as an assurance of the 
  the periodic return return of principal and interest back 
  (interest). in time. Bank is equally concerned 
   about the form in which the assets 
   are held by the business. When more 
   assets are held in cash or near cash 
   form, the aspect is knnown as 
   liquidity.
Fig. 8.1 : Analysis 	 of 	various	 users	 of	 accounting	information
Ch-8.indd   278 9/13/2022   2:49:09 PM
2024-25
Page 3


Financial Statements - I 8
Learning Objectives After studying this chapter, 
you will be able to :
•	 state 	 the	 nature	 of	 the	
financial 	 statements;
•	 identify 	 the 	 various	
stakeholders and their 
information 	 requi re-	
ments;
•	 di s t i ngui s h 	 be t w e en	
the 	 capital 	 and 	 reve -
nue expenditure and 
receipts;
•	 explain 	 the	 concept 	 of	
trading 	 and	 profit 	 and	
loss account and its 
preparation;
•	 State 	 the 	 nature 	 of	
gross	 profit, 	 net	 profit 	
and 	operating	 profit;
•	 descr i be 	 the	 concept 	 of	
balance sheet and its 
preparation;
•	 explain 	 grouping 	 and	
marshalling 	 of 	 assets 	
and 	liabilities;
•	 prepare 	 	 profi t 	 and 	 loss	
account and balance 
sh eet 	 of 	 a 	 sole 	 prop -
rietor	 	 y 	firm; 	 and
•	 make 	 an 	 opening	
entry.
Y
ou have learnt that financial accounting is a  
well-defined sequential activity which begins 
with Journal (Journalising), Ledger (Posting), 
and preparation of Trial Balance (Balancing and 
Summarisation at the first stage).  In the present 
chapter, we will take up the next step, namely,  
preparation of financial statements, and discuss 
the types of information requirements of various 
stakeholders, the distinction between capital and 
revenue items and its importance and the nature 
of financial statements and the preparation thereof.
8.1 Stakeholders and their 
 Information Requirements
Recall from chapter I (Financial Accounting Part I) 
that the objective of business is to communicate 
the meaningful information to various stakeholders 
in the business so that they can make informed 
decisions. A stakeholder is any person associated 
with the business. The stakes of various stakeholders 
can be monetary or non-monetary. The stakes can 
be active or passive; or can be direct or indirect. The 
owner and persons advancing loan to the business 
would have monetary stake. The government, 
consumer or a researcher will have non-monetary 
stake in the business. The stakeholders are also 
called users who are normally classified as internal 
and external depending upon whether they are inside 
the business or outside the business. All users 
have different objectives for joining business and 
Ch-8.indd   277 9/13/2022   2:49:08 PM
2024-25
278 Accountancy
consequently different types of information requirements from it. In nutshell, 
the various users have diverse financial information requirements from the 
business.
For example we have classified the following into the category of internal 
and external users specifying their objectives and consequent information 
requirements.
Name	 Internal/	 Object ive 	for	participating	 Accounting 	 Information	 requirements
 External in business
 users
Current Internal  To make investment in the Likes to know extent of profit in the  
owners  business and wealth grow. last accounting period, current 
   position of the assets/liabilities of the 
   business.
Manager Internal For a career. They essenti- Accounting information in the form 
  ally  act  as  the  agent of of financial statements is like their 
  owners (their employers). report card and they are interested 
   in information about both profits 
and     financial position.
Government External Its role is regulatory and Its concerns are that the rights of all 
  tries to lay down the rules stakeholders are protected. Since the 
  in the best public interest. government levies taxes on the 
   business, they are interested in 
   information about profitability in 
   particular besides lot of other 
   information.
Prospective External He is expecting to make He is interested in information about 
owner  investments in the business past profits and financial position as 
  with a view to make his indicative of likely future performance.
  investment and wealth grow. 
Bank External Bank is interested in safety Bank is interested in adequacy of 
  of the principal as well as  profit s only as an assurance of the 
  the periodic return return of principal and interest back 
  (interest). in time. Bank is equally concerned 
   about the form in which the assets 
   are held by the business. When more 
   assets are held in cash or near cash 
   form, the aspect is knnown as 
   liquidity.
Fig. 8.1 : Analysis 	 of 	various	 users	 of	 accounting	information
Ch-8.indd   278 9/13/2022   2:49:09 PM
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279 Financial Statements - I
Box 1
Accounting Process (up to Trial balance) :
1. Identify the transactions, which that are recorded.
2. Record transactions in journal. Only those transactions are recorded which are 
measured in money terms. The system followed for recording is called double entry 
system whereby two aspects (debit and credit) of every transaction are recorded. 
Repeated transactions of same nature are recorded in subsidiary books, also called 
special journals. Instead of recording all transactions in journal, they are recorded 
in subsidiary books and the  journal proper. For example, the business would record 
all credit sales in sales book and all credit purchases in purchases book. The other 
examples of subsidiary books are return inwards book, return outwards book. An 
other important special book is cash book, in which all cash and bank transactions 
are recorded. The entries, which are not recorded in any of these books, are recorded 
in a residual journal called 	 journal 	 proper.
3. The entries appearing in the above books are posted in the respective accounts in the ledger.
4. The accounts are balanced and listed in a statement called trial balance. If the 
total amounts of debit and credit balances agree, accounts are taken as free from 
arithmetical errors. 
5. The trial balance forms the basis for making the financial statements, i.e. trading 
and profit and loss account and balance sheet.
8.2 Distinction between Capital and Revenue
A very important distinction in accounting is between capital and revenue 
items. The distinction has important implications for making of the trading and 
profit and loss account and balance sheet. The revenue items form part of  the 
trading and profit and loss account, the capital items help in the preparation 
of a balance sheet.
8.2.1 Expenditure
Whenever payment and/or incurrence of an outlay are made for a purpose 
other than the settlement of an existing liability, it is called expenditure. The 
expenditures are incurred with a viewpoint they would give benefits to the 
business. The benefit of an expenditure may extend up to one accounting 
year or more than one year. If the benefit of expenditure extends up to one 
accounting period, it is termed as revenue 	 expenditure. Normally, they are 
incurred for the day-to-day conduct of the business. An example can be 
payment of salaries, rent, etc. The salaries paid in the current period will not 
benefit the business in the next accounting period, as the workers have put 
in their efforts in the current accounting period. They will have to be paid the 
salaries in the next accounting period as well if they are made to work. If the 
benefit of expenditure extends more than one accounting period, it is termed  
Ch-8.indd   279 9/13/2022   2:49:09 PM
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Page 4


Financial Statements - I 8
Learning Objectives After studying this chapter, 
you will be able to :
•	 state 	 the	 nature	 of	 the	
financial 	 statements;
•	 identify 	 the 	 various	
stakeholders and their 
information 	 requi re-	
ments;
•	 di s t i ngui s h 	 be t w e en	
the 	 capital 	 and 	 reve -
nue expenditure and 
receipts;
•	 explain 	 the	 concept 	 of	
trading 	 and	 profit 	 and	
loss account and its 
preparation;
•	 State 	 the 	 nature 	 of	
gross	 profit, 	 net	 profit 	
and 	operating	 profit;
•	 descr i be 	 the	 concept 	 of	
balance sheet and its 
preparation;
•	 explain 	 grouping 	 and	
marshalling 	 of 	 assets 	
and 	liabilities;
•	 prepare 	 	 profi t 	 and 	 loss	
account and balance 
sh eet 	 of 	 a 	 sole 	 prop -
rietor	 	 y 	firm; 	 and
•	 make 	 an 	 opening	
entry.
Y
ou have learnt that financial accounting is a  
well-defined sequential activity which begins 
with Journal (Journalising), Ledger (Posting), 
and preparation of Trial Balance (Balancing and 
Summarisation at the first stage).  In the present 
chapter, we will take up the next step, namely,  
preparation of financial statements, and discuss 
the types of information requirements of various 
stakeholders, the distinction between capital and 
revenue items and its importance and the nature 
of financial statements and the preparation thereof.
8.1 Stakeholders and their 
 Information Requirements
Recall from chapter I (Financial Accounting Part I) 
that the objective of business is to communicate 
the meaningful information to various stakeholders 
in the business so that they can make informed 
decisions. A stakeholder is any person associated 
with the business. The stakes of various stakeholders 
can be monetary or non-monetary. The stakes can 
be active or passive; or can be direct or indirect. The 
owner and persons advancing loan to the business 
would have monetary stake. The government, 
consumer or a researcher will have non-monetary 
stake in the business. The stakeholders are also 
called users who are normally classified as internal 
and external depending upon whether they are inside 
the business or outside the business. All users 
have different objectives for joining business and 
Ch-8.indd   277 9/13/2022   2:49:08 PM
2024-25
278 Accountancy
consequently different types of information requirements from it. In nutshell, 
the various users have diverse financial information requirements from the 
business.
For example we have classified the following into the category of internal 
and external users specifying their objectives and consequent information 
requirements.
Name	 Internal/	 Object ive 	for	participating	 Accounting 	 Information	 requirements
 External in business
 users
Current Internal  To make investment in the Likes to know extent of profit in the  
owners  business and wealth grow. last accounting period, current 
   position of the assets/liabilities of the 
   business.
Manager Internal For a career. They essenti- Accounting information in the form 
  ally  act  as  the  agent of of financial statements is like their 
  owners (their employers). report card and they are interested 
   in information about both profits 
and     financial position.
Government External Its role is regulatory and Its concerns are that the rights of all 
  tries to lay down the rules stakeholders are protected. Since the 
  in the best public interest. government levies taxes on the 
   business, they are interested in 
   information about profitability in 
   particular besides lot of other 
   information.
Prospective External He is expecting to make He is interested in information about 
owner  investments in the business past profits and financial position as 
  with a view to make his indicative of likely future performance.
  investment and wealth grow. 
Bank External Bank is interested in safety Bank is interested in adequacy of 
  of the principal as well as  profit s only as an assurance of the 
  the periodic return return of principal and interest back 
  (interest). in time. Bank is equally concerned 
   about the form in which the assets 
   are held by the business. When more 
   assets are held in cash or near cash 
   form, the aspect is knnown as 
   liquidity.
Fig. 8.1 : Analysis 	 of 	various	 users	 of	 accounting	information
Ch-8.indd   278 9/13/2022   2:49:09 PM
2024-25
279 Financial Statements - I
Box 1
Accounting Process (up to Trial balance) :
1. Identify the transactions, which that are recorded.
2. Record transactions in journal. Only those transactions are recorded which are 
measured in money terms. The system followed for recording is called double entry 
system whereby two aspects (debit and credit) of every transaction are recorded. 
Repeated transactions of same nature are recorded in subsidiary books, also called 
special journals. Instead of recording all transactions in journal, they are recorded 
in subsidiary books and the  journal proper. For example, the business would record 
all credit sales in sales book and all credit purchases in purchases book. The other 
examples of subsidiary books are return inwards book, return outwards book. An 
other important special book is cash book, in which all cash and bank transactions 
are recorded. The entries, which are not recorded in any of these books, are recorded 
in a residual journal called 	 journal 	 proper.
3. The entries appearing in the above books are posted in the respective accounts in the ledger.
4. The accounts are balanced and listed in a statement called trial balance. If the 
total amounts of debit and credit balances agree, accounts are taken as free from 
arithmetical errors. 
5. The trial balance forms the basis for making the financial statements, i.e. trading 
and profit and loss account and balance sheet.
8.2 Distinction between Capital and Revenue
A very important distinction in accounting is between capital and revenue 
items. The distinction has important implications for making of the trading and 
profit and loss account and balance sheet. The revenue items form part of  the 
trading and profit and loss account, the capital items help in the preparation 
of a balance sheet.
8.2.1 Expenditure
Whenever payment and/or incurrence of an outlay are made for a purpose 
other than the settlement of an existing liability, it is called expenditure. The 
expenditures are incurred with a viewpoint they would give benefits to the 
business. The benefit of an expenditure may extend up to one accounting 
year or more than one year. If the benefit of expenditure extends up to one 
accounting period, it is termed as revenue 	 expenditure. Normally, they are 
incurred for the day-to-day conduct of the business. An example can be 
payment of salaries, rent, etc. The salaries paid in the current period will not 
benefit the business in the next accounting period, as the workers have put 
in their efforts in the current accounting period. They will have to be paid the 
salaries in the next accounting period as well if they are made to work. If the 
benefit of expenditure extends more than one accounting period, it is termed  
Ch-8.indd   279 9/13/2022   2:49:09 PM
2024-25
280 Accountancy
as capital expenditure. An example can be payment to acquire furniture for use 
in the business. Furniture acquired in the current accounting period will give 
benefits for many accounting periods to come. The usual examples of capital 
expenditure can be payment to acquire fixed assets and/or to make additions/
extensions in the fixed assets.
Following points of distinction between capital expenditure and revenue 
expenditure are worth noting :
 (a) Capital expenditure increases earning capacity of business whereas 
revenue expenditure is incurred to maintain the earning capacity.
 (b) Capital expenditure is incurred to acquire fixed assets for operation of 
business whereas revenue expenditure is incurred on day-to-day conduct 
of business. 
 (c) Revenue ex penditure is generally recurring expenditure and capital 
expendi ture is non-recurring by nature.
 (d) Capital expenditure benefits more than one accounting year whereas 
revenue expenditure normally benefits one accounting year.
 (e) Capital expenditure (subject to depreciation) is re corded in balance sheet 
whereas revenue expenditure (subject to adjustment for outstanding and 
prepaid amount) is transferred to trading and profit and loss account.
Sometimes, it becomes difficult to classify the expenditure into revenue or 
capital category. In normal usage, the advertising expenditure is termed as 
revenue expenditure. The heavy expenditure incurred on advertising is likely to 
benefit the business firm for more than one accounting period. Such revenue 
expenditures, which are likely to give benefit for more than one accounting 
period, are termed as deferred	revenue	expenditure.
It must be understood that expenditure is a wider term and includes 
expenses. Expenditure is any outlay made/incurred by the business firm. The 
part of the expenditure, which is perceived to have been used or consumed in 
the current year, is termed as expense of the current year.
Revenue expenditure is treated as an expense for the current year and 
is shown in trading and profit and loss account. For example, salary paid 
by the business firm is treated as an expense of the current year. Capital 
expenditures are charged to income statement and are spread over to more 
than one accounting period. Hence, furniture of ` 50,000 if expected to be used 
for 5 years will be treated as expense @ ` 10,000 per year. The name given for 
the expense is depreciation. The treatment of deferred revenue expenditure is 
same as of capital expenditure. They are also written-off over their expected 
period of benefit.
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Page 5


Financial Statements - I 8
Learning Objectives After studying this chapter, 
you will be able to :
•	 state 	 the	 nature	 of	 the	
financial 	 statements;
•	 identify 	 the 	 various	
stakeholders and their 
information 	 requi re-	
ments;
•	 di s t i ngui s h 	 be t w e en	
the 	 capital 	 and 	 reve -
nue expenditure and 
receipts;
•	 explain 	 the	 concept 	 of	
trading 	 and	 profit 	 and	
loss account and its 
preparation;
•	 State 	 the 	 nature 	 of	
gross	 profit, 	 net	 profit 	
and 	operating	 profit;
•	 descr i be 	 the	 concept 	 of	
balance sheet and its 
preparation;
•	 explain 	 grouping 	 and	
marshalling 	 of 	 assets 	
and 	liabilities;
•	 prepare 	 	 profi t 	 and 	 loss	
account and balance 
sh eet 	 of 	 a 	 sole 	 prop -
rietor	 	 y 	firm; 	 and
•	 make 	 an 	 opening	
entry.
Y
ou have learnt that financial accounting is a  
well-defined sequential activity which begins 
with Journal (Journalising), Ledger (Posting), 
and preparation of Trial Balance (Balancing and 
Summarisation at the first stage).  In the present 
chapter, we will take up the next step, namely,  
preparation of financial statements, and discuss 
the types of information requirements of various 
stakeholders, the distinction between capital and 
revenue items and its importance and the nature 
of financial statements and the preparation thereof.
8.1 Stakeholders and their 
 Information Requirements
Recall from chapter I (Financial Accounting Part I) 
that the objective of business is to communicate 
the meaningful information to various stakeholders 
in the business so that they can make informed 
decisions. A stakeholder is any person associated 
with the business. The stakes of various stakeholders 
can be monetary or non-monetary. The stakes can 
be active or passive; or can be direct or indirect. The 
owner and persons advancing loan to the business 
would have monetary stake. The government, 
consumer or a researcher will have non-monetary 
stake in the business. The stakeholders are also 
called users who are normally classified as internal 
and external depending upon whether they are inside 
the business or outside the business. All users 
have different objectives for joining business and 
Ch-8.indd   277 9/13/2022   2:49:08 PM
2024-25
278 Accountancy
consequently different types of information requirements from it. In nutshell, 
the various users have diverse financial information requirements from the 
business.
For example we have classified the following into the category of internal 
and external users specifying their objectives and consequent information 
requirements.
Name	 Internal/	 Object ive 	for	participating	 Accounting 	 Information	 requirements
 External in business
 users
Current Internal  To make investment in the Likes to know extent of profit in the  
owners  business and wealth grow. last accounting period, current 
   position of the assets/liabilities of the 
   business.
Manager Internal For a career. They essenti- Accounting information in the form 
  ally  act  as  the  agent of of financial statements is like their 
  owners (their employers). report card and they are interested 
   in information about both profits 
and     financial position.
Government External Its role is regulatory and Its concerns are that the rights of all 
  tries to lay down the rules stakeholders are protected. Since the 
  in the best public interest. government levies taxes on the 
   business, they are interested in 
   information about profitability in 
   particular besides lot of other 
   information.
Prospective External He is expecting to make He is interested in information about 
owner  investments in the business past profits and financial position as 
  with a view to make his indicative of likely future performance.
  investment and wealth grow. 
Bank External Bank is interested in safety Bank is interested in adequacy of 
  of the principal as well as  profit s only as an assurance of the 
  the periodic return return of principal and interest back 
  (interest). in time. Bank is equally concerned 
   about the form in which the assets 
   are held by the business. When more 
   assets are held in cash or near cash 
   form, the aspect is knnown as 
   liquidity.
Fig. 8.1 : Analysis 	 of 	various	 users	 of	 accounting	information
Ch-8.indd   278 9/13/2022   2:49:09 PM
2024-25
279 Financial Statements - I
Box 1
Accounting Process (up to Trial balance) :
1. Identify the transactions, which that are recorded.
2. Record transactions in journal. Only those transactions are recorded which are 
measured in money terms. The system followed for recording is called double entry 
system whereby two aspects (debit and credit) of every transaction are recorded. 
Repeated transactions of same nature are recorded in subsidiary books, also called 
special journals. Instead of recording all transactions in journal, they are recorded 
in subsidiary books and the  journal proper. For example, the business would record 
all credit sales in sales book and all credit purchases in purchases book. The other 
examples of subsidiary books are return inwards book, return outwards book. An 
other important special book is cash book, in which all cash and bank transactions 
are recorded. The entries, which are not recorded in any of these books, are recorded 
in a residual journal called 	 journal 	 proper.
3. The entries appearing in the above books are posted in the respective accounts in the ledger.
4. The accounts are balanced and listed in a statement called trial balance. If the 
total amounts of debit and credit balances agree, accounts are taken as free from 
arithmetical errors. 
5. The trial balance forms the basis for making the financial statements, i.e. trading 
and profit and loss account and balance sheet.
8.2 Distinction between Capital and Revenue
A very important distinction in accounting is between capital and revenue 
items. The distinction has important implications for making of the trading and 
profit and loss account and balance sheet. The revenue items form part of  the 
trading and profit and loss account, the capital items help in the preparation 
of a balance sheet.
8.2.1 Expenditure
Whenever payment and/or incurrence of an outlay are made for a purpose 
other than the settlement of an existing liability, it is called expenditure. The 
expenditures are incurred with a viewpoint they would give benefits to the 
business. The benefit of an expenditure may extend up to one accounting 
year or more than one year. If the benefit of expenditure extends up to one 
accounting period, it is termed as revenue 	 expenditure. Normally, they are 
incurred for the day-to-day conduct of the business. An example can be 
payment of salaries, rent, etc. The salaries paid in the current period will not 
benefit the business in the next accounting period, as the workers have put 
in their efforts in the current accounting period. They will have to be paid the 
salaries in the next accounting period as well if they are made to work. If the 
benefit of expenditure extends more than one accounting period, it is termed  
Ch-8.indd   279 9/13/2022   2:49:09 PM
2024-25
280 Accountancy
as capital expenditure. An example can be payment to acquire furniture for use 
in the business. Furniture acquired in the current accounting period will give 
benefits for many accounting periods to come. The usual examples of capital 
expenditure can be payment to acquire fixed assets and/or to make additions/
extensions in the fixed assets.
Following points of distinction between capital expenditure and revenue 
expenditure are worth noting :
 (a) Capital expenditure increases earning capacity of business whereas 
revenue expenditure is incurred to maintain the earning capacity.
 (b) Capital expenditure is incurred to acquire fixed assets for operation of 
business whereas revenue expenditure is incurred on day-to-day conduct 
of business. 
 (c) Revenue ex penditure is generally recurring expenditure and capital 
expendi ture is non-recurring by nature.
 (d) Capital expenditure benefits more than one accounting year whereas 
revenue expenditure normally benefits one accounting year.
 (e) Capital expenditure (subject to depreciation) is re corded in balance sheet 
whereas revenue expenditure (subject to adjustment for outstanding and 
prepaid amount) is transferred to trading and profit and loss account.
Sometimes, it becomes difficult to classify the expenditure into revenue or 
capital category. In normal usage, the advertising expenditure is termed as 
revenue expenditure. The heavy expenditure incurred on advertising is likely to 
benefit the business firm for more than one accounting period. Such revenue 
expenditures, which are likely to give benefit for more than one accounting 
period, are termed as deferred	revenue	expenditure.
It must be understood that expenditure is a wider term and includes 
expenses. Expenditure is any outlay made/incurred by the business firm. The 
part of the expenditure, which is perceived to have been used or consumed in 
the current year, is termed as expense of the current year.
Revenue expenditure is treated as an expense for the current year and 
is shown in trading and profit and loss account. For example, salary paid 
by the business firm is treated as an expense of the current year. Capital 
expenditures are charged to income statement and are spread over to more 
than one accounting period. Hence, furniture of ` 50,000 if expected to be used 
for 5 years will be treated as expense @ ` 10,000 per year. The name given for 
the expense is depreciation. The treatment of deferred revenue expenditure is 
same as of capital expenditure. They are also written-off over their expected 
period of benefit.
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281 Financial Statements - I
8.2.2 Receipts
The similar treatment is given to the receipts of the business. If the receipts 
imply an obligation to return the money, these are capital receipts. The example 
can be an additional capital brought in by the owner or a loan taken from the 
bank. Both receipts are leading to obligations, the first to the owner (called  
equity) and the other to the outsiders (called liabilities). Another example on a 
capital receipt can be the sale of a fixed asset like old machinery or furniture. 
However, if a receipt does not incur an obligation to return the money or is  
not in the form of a sale of fixed asset, it is termed as revenue receipt. The  
examples of revenue receipts sales made by the firm and interest on investment 
received by the firm.
8.2.3 Importance of Distinction between Capital and Revenue
As stated earlier, the distinction between capital and revenue items has  
important implications for the preparation of trading and profit and loss  
account and the balance sheet as all items of revenue value are to the shown 
in the trading and profit and loss account and the items of capital nature in  
the balance sheet. If any item is wrongly classified, i.e. if any item of revenue 
nature is treated as capital item or vice-versa, the ascertainment of profit or  
loss will be incorrect. For example, the revenues earned during an accounting 
period are ` 10,00,000 and the expenses shown are ` 8,00,000, the profit 
shall work out as ` 2,00,000. On scrutiny of the details, you find that a  
revenue item of ` 20,000 (an expenditure on repairs of machinery) has been 
treated as capital expenditure (added to the cost of machinery and debited to 
machinery account, not to repairs account), and hence, does not form part of 
the expenses for the period. It means the actual expenses for the period are  
` 8,20,000 and not ` 8,00,000. So, the correct profit is ` 1,80,000, not  
` 2,00,000. In other words, the profit has been over stated. Similarly, if any 
capital expenditure is wrongly shown as revenue expenditure (for example, 
purchase of furniture shown as purchases), it will result in under statement  
of profits, and also an under statement of assets. Thus, the financial statements 
will not reflect the true and fair view of the affairs of the business. Hence, it is 
necessary to identify the correct nature of each item and treat it accordingly  
in the book of accounts. It is also important from taxation point of view because 
capital profits are taxed differently from revenue profits.
8.3 Financial Statements
It has been emphasised that various users have diverse informational 
requirements. Instead of generating particular information useful for specific 
users, the business prepares a set of financial statements, which in general 
satisfies the informational needs of the users.
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