Computer, Whitewash and Family Goods: Capital or Revenue?
Shri Mohan runs a stationery shop in Jhansi and closes his books on 31 March. His accountant has computed a net profit of ₹1,85,000 for 2024-25, and Mohan wants the figure verified before he files his return. In April 2024 he bought a computerised billing machine for ₹48,000 and paid ₹1,200 freight and ₹800 for installation; the whole ₹50,000 was debited to 'Repairs'. In February he spent ₹6,500 on whitewashing the shop before a festival, also debited to Repairs. He took goods costing ₹4,500 (selling price ₹6,000) for his daughter's school project and passed no entry. In March he received ₹9,000 from a customer as advance for notebooks to be supplied in May and credited Sales. He also paid ₹2,000 in March as the annual subscription to a trade association for the year beginning 1 April 2025 and charged it to the current year. No depreciation has been recorded on the machine, though the firm's policy is 15% p.a. on cost with a full-year charge in the year of purchase.
1. Pass the correcting journal entries for each item, with narration, and state whether the item is capital or revenue expenditure and why.
Read the worked answer
1. Billing machine.
Machinery (Computer) A/c Dr 50,000 - To Repairs A/c 50,000.
Freight and installation are costs of bringing the asset to its working condition, so they form part of cost; the whole ₹50,000 is capital expenditure. Debiting Repairs understated profit and created no asset.
2. Whitewashing. No entry. It restores the shop to its normal condition and gives no enduring benefit beyond the year, so it is revenue expenditure; the original treatment stands.
3. Goods for personal use.
Drawings A/c Dr 4,500 - To Purchases A/c 4,500.
Goods taken by the proprietor are drawings at cost. If recorded at selling price (Drawings Dr 6,000 - To Sales 6,000), the unrealised margin of ₹1,500 would inflate profit.
4. Advance received.
Sales A/c Dr 9,000 - To Advance from Customers A/c 9,000.
No sale has occurred; the obligation to supply goods in May makes it a liability, not income.
5. Subscription.
Prepaid Subscription A/c Dr 2,000 - To Subscription (Trade Association) A/c 2,000.
The benefit relates to 2025-26, so the expense belongs to the next year.
6. Depreciation.
Depreciation A/c Dr 7,500 - To Machinery A/c 7,500 (₹50,000 × 15%).
2. Compute the corrected net profit. Show the effect of each adjustment and identify any item that leaves profit unchanged.
Read the worked answer
| Item | Effect on profit (₹) |
|---|---|
| Reported profit | 1,85,000 |
| Add: capital expenditure wrongly written off to Repairs | +50,000 |
| Less: depreciation on machine (15% of 50,000) | −7,500 |
| Less: advance credited to Sales | −9,000 |
| Add: subscription belonging to next year | +2,000 |
| Whitewashing (correctly revenue) | Nil |
| Goods withdrawn, recorded at cost | Nil |
| Corrected profit | 2,20,500 |
Note: if the goods had been recorded at selling price, profit would rise by ₹1,500, but the drawings would then include an unrealised profit, so the cost basis is preferred. Depreciation is charged for the full year because the machine was used throughout 2024-25; if the firm's policy were pro-rata from the month of use and the machine had been bought later than April, the charge would change.
3. Mohan argues that since both the machine purchase and the customer advance involve cash, the two errors cancel out and the profit is roughly right. Evaluate this reasoning.
Read the worked answer
They do not cancel. The two errors are of different types and reverse over different periods.
- The machine error is capital versus revenue: it removes ₹50,000 from this year's expenses but substitutes depreciation of ₹7,500 a year for many years. This year's profit is understated by ₹42,500, and the balance sheet omits an asset of ₹42,500 (cost less one year's depreciation). The reversal is spread over the asset's life.
- The advance is revenue versus liability: ₹9,000 is shifted from this year to next year, when the notebooks are supplied. The reversal happens entirely in 2025-26.
- The subscription error shifts ₹2,000 in the opposite direction, into next year.
Net effect this year is an understatement of only ₹35,500 (50,000 − 7,500 − 9,000 + 2,000), not zero. The fact that cash moved is irrelevant: profit is measured on accrual and matching, not on cash receipts and payments. Presenting a cash-based argument would misstate both the profit and the balance sheet, and would mislead anyone comparing the two years.