Rashid's bookkeeper made the following errors when recording transactions for the year ended 31 December 2024. Error Details Amount ($) 1 Legal fees for the...
Question 1 Report
Rashid's bookkeeper made the following errors when recording transactions for the year ended 31 December 2024.
| Error | Details | Amount ($) |
|---|---|---|
| 1 | Legal fees for the purchase of new premises were charged as an expense | 5 000 |
| 2 | The purchase of new office equipment was added to the premises account | 8 000 |
| 3 | Revenue received from the sale of an old vehicle was recorded as sales revenue | 3 500 |
| 4 | Annual maintenance on the photocopier was recorded as a capital expense (added to equipment account) | 1 200 |
Draft profit for the year was $48 000.
(a) For each error, state the correct treatment and classify the item as capital expenditure, revenue expenditure, capital receipt, or revenue receipt. [8]
(b) For each error, state whether the correction will increase or decrease profit and by how much. [4]
(c) Calculate the corrected profit for the year. [4]
(d) Explain the difference between a capital receipt and a revenue receipt. [4]
Answer Details
(a) Correct treatment and classification of each error
| Error | Incorrect Treatment | Correct Treatment | Classification |
|---|---|---|---|
| 1 | Legal fees for new premises charged as an expense in the income statement | Legal fees should be added to the cost of the premises, since they are part of the cost of acquiring the non-current asset. [1] They are directly attributable to bringing the asset into use and must be capitalised. [1] | Capital expenditure |
| 2 | New office equipment added to the premises account | Office equipment should be recorded in a separate equipment account. [1] Although both are non-current assets, premises and equipment must be shown as separate asset categories in the statement of financial position. [1] | Capital expenditure (correct type, but wrong asset account) |
| 3 | Sale proceeds of old vehicle recorded as sales revenue | The proceeds from selling a non-current asset are a capital receipt. [1] They should be recorded in a disposal account, not as sales revenue in the income statement. [1] | Capital receipt |
| 4 | Annual photocopier maintenance added to the equipment account | Annual maintenance is a recurring expense that keeps the asset in working condition, not an improvement that extends its life. [1] It should be charged as an expense in the income statement. [1] | Revenue expenditure |
(b) Effect of each correction on profit
| Error | Effect on Profit | Amount ($) |
|---|---|---|
| 1 | Increase profit. The $5 000 was wrongly treated as an expense. Removing it from expenses and capitalising it increases profit. [1] | +5 000 |
| 2 | No effect on profit. This is a reclassification between two non-current asset accounts (premises to equipment). Neither account affects the income statement. [1] | 0 |
| 3 | Decrease profit. The $3 500 was incorrectly included as sales revenue. Removing it from revenue and transferring it to the disposal account reduces profit. [1] | -3 500 |
| 4 | Decrease profit. The $1 200 maintenance was wrongly capitalised. Charging it as an expense in the income statement reduces profit. [1] | -1 200 |
(c) Corrected profit calculation
| Draft profit | $48 000 | [1] |
| Add: Error 1 (legal fees reclassified as capital) | $5 000 | [1] |
| Less: Error 3 (vehicle sale removed from revenue) | ($3 500) | |
| Less: Error 4 (maintenance now charged as expense) | ($1 200) | [1] |
| Corrected profit | $48 300 | [1] |
Error 2 has no effect on profit, so it does not feature in this calculation.
(d) Difference between a capital receipt and a revenue receipt
A capital receipt is money received from the sale or disposal of a non-current asset (such as a vehicle, premises, or equipment) [1] or from the introduction of new capital by the owner. [1] It is a one-off inflow related to the long-term structure of the business, not its day-to-day trading.
A revenue receipt is income generated from the normal, recurring trading operations of the business, [1] such as sales revenue, rent received, commission earned, or interest received. [1] These are regular inflows that arise from the ordinary activities the business was set up to carry out.
Download The App On Google Playstore
Everything you need to excel in your exams
