Question

Explain what would be the effect of incorrectly capitalising expenses, on the profits and total assets of a business?

Answer 1

In case of expense are capitalized – Effect on profit.

1. In that period, expense are reduced. It means our income is increased, so profit will increase by such amount. (Amount which is capitalized.)
2. If the profit is increased, it leads to excess outflow of cash in form of tax.

In case of expense are capitalized – Effect on assets of the company.

1. The value of asset will increase by such amount. (Which is capitalized instead of expensing it.)
2. In case of depreciable asset we can avail depreciation deduction over a period of time.

Due to this effect our financial statement will not be true and fair, as we are violating the rules of account.