Why is distinction between capital and revenue important?give examples to show how wrong classification can affect the ascertainment of profit
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The expense in a business is categorised as either Capital or Revenue.
The categorisation is made on the basis of:
1 - Whether the amount spent is material or not. Material expenses are classified as Capital Expense
2 - The frequency of expenditure. If the expenditure is frequent, it is categorised as revenue expenditure.
3- The economic useful life of the reward obtained from the expenditure. Expenditure providing returns for longer periods are classified as Capital Expenditure.
Wrong categorization can lead to incorrect value for expenses, net profit and the value of the assets.
For example if and expenditure on a vehicle is incorrectly categorised as revenue rather than expense, the expenses would be overstated and the profit understated while the assets will also be understated.
The categorisation is made on the basis of:
1 - Whether the amount spent is material or not. Material expenses are classified as Capital Expense
2 - The frequency of expenditure. If the expenditure is frequent, it is categorised as revenue expenditure.
3- The economic useful life of the reward obtained from the expenditure. Expenditure providing returns for longer periods are classified as Capital Expenditure.
Wrong categorization can lead to incorrect value for expenses, net profit and the value of the assets.
For example if and expenditure on a vehicle is incorrectly categorised as revenue rather than expense, the expenses would be overstated and the profit understated while the assets will also be understated.
phoenixsekhar:
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