Question

Question:

Mr. Hamid is running his small retail business under the name of Hamid Store. He has recently hired Mr. Imran as a junior accountant to maintain the books of accounts of his business. Mr. Imran has little knowledge in accounting. Recently, it has been observed that Mr. Imran wrongly treated installation charges of plant and machinery worth Rs. 500,000 as revenue expenditure under the heading of administration expenses. As a result, financial statements failed to reflect true and fair business affairs.

Required:

1. Identify the “type of error” committed by Mr. Imran.
2. What will be the effect of given error on asset side of a balance sheet? (Just mention whether the assets would be overstated, understated or remains unaffected)
3. What will be correct amount of fixed assets, if current assets and fixed assets before correcting this error were Rs. 160,000 and Rs. 940,000 respectively?
4. What will be correct amount of operating profit, if operating loss before correcting this error was Rs. 300,000?

Answer 1

1) Error Committed by Mr. Imran is "ERROR OF PRINCIPLE" . Error of Principle Means a transaction which is not in accordance with Generally accepted accounting principle( GAAP). In this case Mr. Imran has wrongly debited to revenue expenditure instead of debiting to Plant and machinery.

2) The assets side of Balance sheet is understated by Rs. 500,000/-.

3)Fixed Assets correct amount= Fixed assets before correcting the errors + installation charges

=9,40,000+5,00,000

=14,40,000

4) Correct Profit= Profit/(loss) Before correcting the error+Installation Charges

Profit= (3,00,000)+5,00,000

Profit=2,00,000