Effects of Incorrect Treatment of Expenditure & Income (Cambridge International AS Accounting)

Effects of incorrect treatment of expenditure

Spec point — the effect on profit/loss and asset value of the incorrect treatment of capital and revenue expenditure

What are the effects of treating capital expenditure as revenue expenditure?

• Incorrectly treating capital expenditure as revenue expenditure will affect the financial statements

• It will incorrectly appear as an expense on the statement of profit or loss

  • The expenses will therefore be overstated
  • This means the profit for the year will be understated

• It will not appear as a non-current asset on the statement of financial position

  • The non-current assets will therefore be understated
  • The capital will be understated because of the understated profit

What are the effects of treating revenue expenditure as capital expenditure?

• Incorrectly treating revenue expenditure as capital expenditure will affect the financial statements

• It will not appear on the statement of profit or loss

  • The expenses will therefore be understated
  • This means the profit for the year will be overstated

• It will incorrectly appear on the statement of financial position

  • The non-current assets will therefore be overstated
  • The capital will be overstated because of the overstated profit

How do I treat low-valued non-current assets?

• Some non-current assets have a small cost to the business

  • Calculators
  • Staplers
  • Waste bins

• The accounting principle of materiality means that a business should treat these items as expenses rather than non-current assets

  • These will appear on the income
  • These will not appear as non-current assets on the statement of financial position

Worked Example Ajax paid $2 000 for installation costs of new equipment. He treated this as revenue expenditure.

Describe what effects this will have on the financial statements. Ignore any depreciation costs.

Answer:

The $2 000 has been incorrectly posted to the statement of profit or loss as an expense. Therefore, the expenses are overstated by $2 000 which means the profit is understated by $2 000.

The $2 000 has been omitted from the statement of financial position. Therefore, the non-current assets are understated by $2 000. The capital is also understated by $2 000 because the profit has been understated.

Effects of incorrect treatment of income

Spec point — the effect on profit/loss and asset value of the incorrect treatment of capital and revenue expenditure

What are the effects of treating capital income as revenue income?

• Incorrectly treating capital income as revenue income will affect the financial statements

• Their full value will incorrectly appear as income on the statement of profit or loss

  • The income will therefore be overstated
  • This means the profit for the year will be overstated

What are the effects of treating revenue income as capital income?

• Incorrectly treating revenue income as capital income will affect the financial statements

• They will not appear on the statement of profit or loss

  • The income will therefore be understated
  • This means the profit for the year will be understated

Worked Example Makkari’s draft statement of profit or loss for the year ended 29 February 2024 stated a profit of $45 700. Makkari took out a bank loan for $10 000 on 5 January 2024. However, this was incorrectly treated as a revenue receipt.

Calculate the correct profit for the year ended 29 February 2024.

Answer:

The money received from the bank loan was incorrectly included as an income on the statement of profit or loss. This is a capital receipt and therefore it should not appear on the statement of profit or loss. The income on the statement of profit or loss needs to be reduced by $10 000.

Final answer: The profit for the year ended 29 February 2024 is $35 700