Capital profits are those profits which are not earned during the regular course of business or in other words which are not trading profits. Such profits are (1) Premium received on the issue of shares or debentures, (2) The difference between the amounts received on the forfeited shares and the amount at which they are reissued, (3) Profits prior to incorporation, (4) profits earned by the redemption of the company’s own debentures at a discount in the market, (5) Profits realized on the sale of fixed assets, (6) Profits from the acquisition of another firm, and so on.
Profits arising from non-recurring transactions are called capital profits. Businesses should transfer these profits to the capital reserve account, appearing on the balance sheet’s liabilities side.
The profits earned by a business from the sale of its shares, debentures, and assets are capital profits. When the business issues the shares and debentures at a higher price than their face values, the face value’s excess or premium is capital profit. In the same way, if the business sells the assets at a higher price than their book value, the book value’s excess is capital profit.