Goodwill Valuation : Correcting Profit impact due to errors in Capital and Revenue Expenditure treatment
What We'll Learn Today:
✅ What are Capital and Revenue Expenditures?
✅ Common accounting mistakes
✅ How to calculate profit impact
✅ Step-by-step correction methods
Made Simple for Students! 🎓
Understanding the Basics
💰 Revenue Expenditure
Definition: Gives benefit up to one year. Generally these are Day-to-day running expenses of business
Examples: Rent, Salaries, Electricity, Travel Expenses
Impact: Reduces profit in the SAME year. Fully charged to profit and loss A/c in the year these are incurred
🏢 Capital Expenditure
Definition: Money spent on buying long-term assets
Examples: Buildings, Machinery, Vehicles, Computers
Impact: Charged to Profit and Loss A/c over multiple years. Reduces profit through depreciation over MANY years
What is Depreciation?
Simple Example: Buying a Bicycle 🚲
Cost: ₹12,000
Life: 4 years
Depreciation per year: ₹12,000 ÷ 4 = ₹3,000 (In case of straight line method)
Methods for Depreciation Generally Straight Line Method and Written Down Value method
How Depreciation Affects Profit Each Year:
| Year | Depreciation | Profit Reduction |
|---|---|---|
| Year 1 | ₹3,000 | ₹3,000 |
| Year 2 | ₹3,000 | ₹3,000 |
| Year 3 | ₹3,000 | ₹3,000 |
| Year 4 | ₹3,000 | ₹3,000 |
Error Type 1: Revenue Expenditure → accounted as → Capital Expenditure
The Mistake 🚗
What happened: Travel expenses of ₹15,000 were wrongly recorded as Vehicle purchase
When: FY 2021-22
Detected: 01-Apr-2024
Vehicle Life: 5 years
What Should Have Happened vs What Actually Happened:
✅ CORRECT WAY
₹15,000 travel expense
Full amount reduces profit in FY 2021-22
❌ WRONG WAY
₹15,000 as Vehicle
Only ₹3,000 depreciation reduces profit each year
⚠️ Impact Analysis:
Revenue to Capital Error Results in:
• Expenses Understated - Should have been ₹15,000 but only ₹3,000 was charged
• Profits Overstated - Profits shown higher than actual
Step-by-Step Calculation:
Depreciation per year: ₹15,000 ÷ 5 = ₹3,000
| Financial Year | Original Profit | Add Depreciation | Less Rev Exp | Corrected Profit |
|---|---|---|---|---|
| 2021-22 | ₹50,000 | +₹3,000 | -₹15,000 | ₹38,000 |
| 2022-23 | ₹60,000 | +₹3,000 | ₹0 | ₹63,000 |
| 2023-24 | ₹70,000 | +₹3,000 | ₹0 | ₹73,000 |
📝 Steps for Correcting Profit Impact Revenue → Capital Error:
Step 1: Take the profit as per question for each year
Step 2: Calculate depreciation charged in each year
Step 3: Add depreciation to profits of each year where wrongly charged
Step 4: Subtract revenue expenditure from profits of the year in which expense incurrred
Step 5: Find adjusted profits (Corrected) for each year
Error Type 2: Capital Expenditure → accounted as → Revenue Expenditure
The Mistake 🚲
What happened: Bicycle purchase of ₹12,000 was wrongly recorded as Travel expense
When: FY 2021-22
Detected: 01-Apr-2024
Bicycle Life: 4 years
What Should Have Happened vs What Actually Happened:
✅ CORRECT WAY
₹12,000 as Bicycle (Capital)
₹3,000 depreciation reduces profit each year
❌ WRONG WAY
₹12,000 as Travel expense
Full amount reduced profit in FY 2021-22 only
⚠️ Impact Analysis:
Capital to Revenue Error Results in:
• Expenses Overstated - Charged ₹12,000 but should have been only ₹3,000
• Profits Understated - Profits shown lower than actual
Step-by-Step Calculation:
Depreciation per year: ₹12,000 ÷ 4 = ₹3,000
| Financial Year | Original Profit | Less Depreciation | Add Rev Exp | Corrected Profit |
|---|---|---|---|---|
| 2021-22 | ₹50,000 | -₹3,000 | +₹12,000 | ₹59,000 |
| 2022-23 | ₹60,000 | -₹3,000 | ₹0 | ₹57,000 |
| 2023-24 | ₹70,000 | -₹3,000 | ₹0 | ₹67,000 |
📝 Steps for Correcting Profit Impact Capital → Revenue Error:
Step 1: Take the profit as per question for each year
Step 2: Calculate depreciation to be charged in each year
Step 3: Subtract depreciation from profits of each year where not charged
Step 4: Add revenue expenditure to profits of the year in which wrongly charged
Step 5: Find adjusted profits (Corrected) for each year
Summary Comparison
Error Impact Summary:
| Error Type | Expense Impact | Profit Impact | First Year Effect | Later Years Effect |
|---|---|---|---|---|
| Revenue → Capital | Expenses Understated | Profits Overstated | Profit Decreases | Profit Increases |
| Capital → Revenue | Expenses Overstated | Profits Understated | Profit Increases | Profit Decreases |
Tips to Remember
🧠 Memory Tricks:
Revenue Expenditure: Think "Right Now" - Fully affects profit immediately
Capital Expenditure: Think "Can Last" - affects profit over many years
Step-by-Step Process for Any Error:
1️⃣ Identify: What was the wrong entry?
2️⃣ Calculate: What should have been the correct entry?
3️⃣ Find Difference: Compare wrong vs correct impact each year
4️⃣ Adjust Profit: Add or subtract the difference
5️⃣ Make Corrections: Find Corrected profits for each year
🎯 Practice Questions:
Try calculating profit impact for different scenarios:
• Office rent recorded as Building purchase
• Computer purchase recorded as Electricity expense
• Salary recorded as Furniture purchase
Well Done!
🎓 You Now Know:
✅ Difference between Capital and Revenue Expenditure
✅ How depreciation works
✅ Impact of accounting errors on profits
✅ How to calculate corrections for each year
✅ Steps to correct profits due to different types of errors
🚀 Next Steps:
Practice with more examples
Always double-check your Calculations
Keep Learning & Keep Growing! 📚