Question

It's a accounting question Please answer me.
 
John is running a small business under the name of JohnBros. He has recently hired Jack as a junior accountant to maintain the books of accounts of his business. Owing to little knowledge in accounting, jack could not perform well and following errors have been found in his work. You are required to give your opinions/answers as required in all the following cases regarding the given errors.
a.        There was an error in the valuation of closing stock of the previous year. In the previous year, the closing stock was valued more by Rs. 5,000. What will be its effect on current year’s profit? (Just mention whether the current year’s profit will be overstated, understated or remains unaffected).
b.        Amount of Rs. 1,000 was paid as rent to harry , but it was wrongly debited to a debtor Ihsan’s account. What will be the effect of this error on arithmetical accuracy of trial balance? (Just mention whether the arithmetical accuracy of trial balance will be overstated, understated or remains unaffected).
c.        A revenue expenditure of Rs. 2,000 is treated as a capital expenditure in the books of accounts. What will be the effect of this error on Net profit? (Just mention whether the profit will be overstated, understated or remains unaffected).
d.        What will be the correct amount of profit if the profit before the correction of above errors is Rs. 40,000?

Answer 1

1)The answer is.. Current year's profit will be overstated by 5000..if the Closing stock is overvalued by 5000...

Now Lets go by an example.... for example take... opening stock as 10000 closing stock is 40000..

then the profit will be 40000-10000=30000

so..if the Closing stock is overvalued by 5000(in the previous year).what will be the result..its simple..

45000-10000=35000..

What is the original(correct) profit=30000(current year)

what is the profit after jack's mistake=35000(wrong current year's profit)

..so profit will be overstated by 5000(35000-5000)..

2) it remains unaffected... because.

amount was paid to harry for rent..

Journal Entry will be...

Rent a/c Dr 1000

To cash a/c 1000

(being rent paid to harry)

but wrong entry made by jack is

Inshan a/c Dr 1000

To cash a/c 1000

(being cash paid to Debtor)

all assets and expenses come under debit side of the trail balance..

rent is an expense ,cash,inshan are assets..so all of them will come under debit side of the trail balance only...
so 1000 in first case...and also 1000 in the second case(wrong entry) will not affect the balance know!..

But there will affect on profit.. profit will be overstated by 1000... because here revenue expenditure is treated as capital expenditure..(point three below)

3) The profit will be overstated by 2000 ... because..
the expenses will be understated..which leads to the overstatement of the Profit as well as overstatement of the asset(capital asset on which expenditure is capitalised)

eg.. take income 5000 and Rent(revenue expenditure example) paid 2000 is recorded as Furniture bought 2000..

if rent is correctly recorded..

then income - expenses= 5000-2000 = 3000 is the profit...

Now if rent is not recorded properly by jack

Rent(revenue expenditure example) paid 2000 is recorded as Furniture bought 2000..

then income - expenses= 5000 - 0 =5000..
(furniture is an asset.cost incurred on it is not deducted from income to arrive at profit)

And also furniture is overstated by 2000.

as u can see.. correct profit = 3000

Profit due to jacks mistake= 5000

.. overstated profit = 5000-3000 =2000..

4) profit before the correction = 40000...

in the first case.. profit is wrongly overstated by 5000..so we should deduct it..

In the second case..the profit is overstated by 1000.s o we should deduct it..

in the third case.. profit is overstated by 2000..so we should deduct it...

so corrected profit will be

40000 - 5000 -1000- 2000=32000. is the answer (correct profit)