In accounting it is important to distinguish between capital receipts and revenue receipts transactions as their treatment in the financial statements of a business differs.
It should be noted that in this context the word receipts refers to a transaction which is to be recognized on an accruals basis, when the right of receipt is established, and not solely when cash is actually received.
Capital receipts either increase a liability, for example, the receipts from a new loan create the liability to repay the loan, or decrease an asset, for example the disposal of a property creates a capital receipt but reduces the value of the property asset to zero.
Capital Receipts Examples
Capital receipts are normally accounting transactions relating to one of the following types.
- Sale of debt instruments (e.g. bonds, debentures or bank loans)
- Sale of shares in the business (e.g. common or preferred stock)
- Sale of non-current assets (e.g property, plant and equipment)
Example 1: Capital Receipts from the Sale of Debt Instruments
A business agrees a loan with a bank for 40,000 and the following journal entry is made.
The transaction is recorded on the balance sheet. The receipt of cash into the bank account has created a corresponding liability (the loan must be repaid to the lender), and is therefore a capital receipt.
Example 2: Capital Receipts from the Issue of Shares
A business issues new shares at par to an investor in return for cash of 30,000. The transaction is recorded as follows.
The receipt from the issue of new shares is a capital receipt as it creates a ‘liability’ to shareholders in the amount of 30,000: this is credited to the common stock account in the balance sheet.
Example 3: Capital Receipts from the Sale of a Non-current Asset
A business disposes of a property originally costing 100,000 for the amount of 120,000, making a gain on disposal of 20,000. The journal entry to record the capital receipt is as follows.
|Gain on disposal||20,000|
The disposal proceeds of 120,000 is a capital receipt as it decreases a non-current asset.
*Note that the gain on disposal of 20,000 is referred to as capital income not a capital receipt.
Revenue receipts are receipts generated by the operating activities of the business in the normal course of business. Revenue receipts are short term and tend to be recurring in nature.
Revenue receipts do not increase a liability, and do not decrease an asset the credit entry in relation to the transaction is to the income statement and not to the balance sheet. For example, the receipts from the sale of goods in the normal course of trade create a credit entry to revenue in the income statement.
Revenue Receipts Examples
Revenue receipts are normally accounting transactions relating to one of the following types.
- Normal trading operations e.g. sale of goods and services
- Other income e.g dividends, rental income, interest receipts etc.
Example 1: Revenue Receipts from the Sale of Professional Services
A business provides professional services to a customer and invoices them for the amount of 5,000. Assuming the customer is allowed credit terms, then the journal to record the entry is as follows.
The transaction results from the normal trading operations of the business and neither increased a liability or decreased an asset, and is therefore classified as a revenue receipt. The credit entry is to the revenue account in the income statement.
Example 2: Revenue Receipts of Interest Income
A business receives interest income of 800 on its cash deposits, the following journal entry is made to record the amount.
Again the transaction results from the normal trading operations of the business and neither increased a liability or decreased an asset, and is therefore classified as a revenue receipt. The credit entry is to the interest income account in the income statement.
In summary, a capital receipt is normally a non-recurring transaction which either increases a liability or decreases an asset, and is dealt with on the balance sheet of the business. A revenue receipt is normally a recurring transaction which does not increase a liability and does not decrease an asset, and is dealt with on the income statement.