Capital and Revenue Profits

While ascertaining the trading profit of a business for a particular period, a proper distinction
is to be made between capital and revenue profits. If profit arises out of an ordinary nature,
being the outcome of the ordinary function and object of the business, it is termed as ‘revenue
profit’. But, when a profit arises out of a casual and non-recurring transaction, it is termed as
capital profit. Revenue profit arises out of the sale of the merchandise that the business deals
in.
Generally, capital profits arise out of the sale of assets other than inventory at a price more than
its book value or in connection with the raising of capital or at the time of purchasing an
existing business. For example, if an asset, whose book value is Rs 5,000 on the date of sale, is
sold for Rs 6,000—Rs 1,000 will be considered as capital profit. Likewise, issue of shares at a
premium is also a capital profit. Revenue profits are distributed to the owners of the business
or transferred to General Reserve Account, being shown in the balance sheet as a retained
earning. Capital profits are generally capitalised-transferred to a capital reserve account which
can only be utilised for setting off capital losses in future. Capital profits of a small amount
(arising out of selling of one asset) is taken to the Profit and Loss Account and added with the
revenue profit-applying the concept of materiality.