Question

Part C

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. (4 marks)

How did the change in journal entries affect the net income and net assets of the company at year-end?                                 (3 marks)

Answer 1

Capital expenditure	Revenue expenditure
It is an expenditure incurred towards fixed assets which would be used for a period of more than one years.	It is an expenditure incurred in the day to day running of the business.
2. The size of the transaction is very large and hence, it is depreciated from the books of accounts over the useful life of the corresponding asset.	2. The size of the transaction is comparatively lower than a capital expenditure and is deducted from the books of accounts for the corresponding period
3. It affeccts both the statement of profit and loss in the form of depreciation and the statement of financial position in the form of an asset.	3. It affects only the statement of profit or loss as an expenditure.

4. it is non recurring in nature.

4. It is recurring in nature.

B. By changing a capital expenditure into a revenue expenditure, the net income in the statement of profit or loss is decreased and also the net assets value in the statemnt of financial position has decreased. All the assets owned by AF textiles have to be appropriately shown in the statement of financial position, in the absence of which it would show that the books of accounts do not potray a true and fair view.

In reality, only the depreciation pertaining to the capital expenditure had to be reduced from the statement of profit of loss instead of the entire capital expenditure incurred which would have dramatically reduced the net profit. Even though this has lead to AF Textile paying a lower amount of tax but the shareholders will not be happy with the company's results there by affecting the overall value of the company.