Question

Question 1 Mr. Kenny is an accountant at AF Textile, and he plays squash with Mr. Zuni, the CEO of AF Textile. The CEO wanted to decrease net income with the objective to pay lesser tax. Mr. Kenny was eager to get into Mr. Zuni’s elite social circle; he boasted to Mr. Zuni that he knew some accounting tricks that could decrease company income by simply disclosing company’s capital expenditure as their revenue expenditure. At the end of the year, Mr. Kenny changed the debits from “capital expenditures” to “revenue expenditure” on several transactions. Later, Mr. Zuni achieved his objective of paying lesser tax, and the manipulations were never discovered.

Required: • Differentiate between Capital Expenditure and Revenue Expenditure. • How did the change in journal entries affect the net income and net assets of the company at year-end?

Answer 1

Net income -

Capitalizing costs and depreciating them over time will show a smoother pattern of reported incomes. Expensing firms have higher variability in reported income. In terms of profitability, in the early years, a company that capitalizes costs will have a higher profitability than it would have had if it expensed them. In later years, the company that expenses costs will have a higher profitability than it would have had if it capitalized them.

Assets reported on the balance sheet -

A company that capitalizes its costs will display higher total assets