Question

Why is distinction between capital and revenue important?Give examples to show how wrong classification can affect the ascertainment of profit.

Answer 1

Capital is the total liabilities owned by a company after we subtract the total assets, capital is also known as net assets of a company. Whereas revenue is the income the company generates by providing goods and services to consumers including the returns, discounts and defected products.The reason why is it important to separate both of these categories and how the wrong classification can affect the ascertainment of profit is to avoid over and understatement of fixed assets in the Balance Sheet. Avoid over and understatement of net profit as a result of wrong charges, for example, adding the revenue in the capital section will altogether increase the price or cost of the machinery owned by a company. In order to understand the true worth of the goods owned by the company and sold by the company.