Financial
Transactions can be sub-divided into two special categories: Capital Transactions
and Revenue Transactions. Revenue
Tranactions are those finacial transactions which take place on a day to day
basis as part of the general running of the business. For
example: the payment of rent and/or rates, insurance, wages, petrol for a business
van, interest on a loan, the purchase of goods for resale (stock). Revenue
transactions affect the calculation of profit/loss in the Trading and Profit and
Loss Account. Example: A
business pays rent by cheque. DEBIT
Rent (an expense) CREDIT
Bank (an asset) The expense
of rent is then deducted from revenues when calculating profit/loss at the end
of an accounting period. Capital
Transactions are those financial transactions which do not take place every
day and relate not to the day to day running of a business, but ensuring that
it has the fixed assets it needs to be able to operate. For
example: the purchase of a motor vehicle, fixtures, fittings, premises indeed
any fixed asset). Capital
transactions do not affect profit/loss in the Trading and Profit and Loss Account
in that what is paid for is not treated as an expense. Instead they affect the
Balance Sheet (what is purchased is recorded as a fixed asset). Example A
business buys a moor vehicle on credit. DEBIT
Motor Vehicle (asset) CREDIT
Creditor (liability) There
will eventually be an expense passed through to the \profit and Loss Account on
an annual basis therefater - it is called Depreciation. LINK
NEEDED HERE There will eventually
be an expense passed through to the Profit and Loss Account on an annual basis
therefater - it is called Depreciation. When
can confusion arise? It
is possible to treat what would otherwise be Revenue Transactions as Capital Transaction
if they are incurred along with a Capital Transaction i.e. the purchase of a fixed
asset. Example 1 A
business purchases a motor vehicle (£20,000) and in addition to the purchase
price pays for the road tax (£200), insurance for the first year (£1,000)
and a full tank of petrol (£50). All of these expenses are necessary before
the vehicle (or fixed asset) can be put on the road. The
purchase of the motor vehicle is clearly a Capital Transaction but the other exenses
at any other time would clearly be Revenue Tranactions. But because they occur
together, the revenue transactions may be 'capitalised' (in other words treated
as capital transactions). The
double entry transaction would be as follows: DEBIT
Motor Vehicle £21,250 (being £20,000 + £200 + £1,000 +
£50) CREDIT Bank/Cash
£21,250 This larger
amount would then be depreciated on an annual basis thereafter, rather than the
slightly smaller £20,000. Profit
in the year of purchase will therefore be larger than it would otherwise be because
expenses of £1,250 (£200 + £1,000 + £50) are not being
treated as expenses in the year of purchase - they are instead to be depreciated
over the next few years. Example
2 A business purchases
a machine (£12,000) and in addition to the purchase price pays installation
fees (£500). This expense is necessary before the machine (or fixed asset)
can be used. The purchase
of the machine is clearly a Capital Transaction but the other expense could be
treated as a Revenue Tranaction. But because they occur together, the revenue
transaction may be 'capitalised' (in other words treated as a capital transaction). The
double entry transaction would be as follows: DEBIT
Machinery £12,500 (being £12,000 + £500) CREDIT
Bank/Cash £12,500 This
larger amount would then be depreciated on an annual basis thereafter, rather
than the slightly smaller £12,000. Profit
in the year of purchase will therefore be larger than it would otherwise be because
an expense of £500 is not being treated as an expense in the year of purchase
- it is instead to be depreciated over the next few years.
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