The Van That Was Treated as Revenue
Maya runs a small delivery business as a sole trader. On 1 March her trial balance showed motor vehicles at cost $18,000 with accumulated depreciation $7,200. On 1 April she bought a second-hand van for $9,600 cash. Her bookkeeper recorded this as a debit to Motor Expenses because the van was second-hand and 'not really a new asset'. Maya depreciates motor vehicles at 20% per year on the reducing balance, charging a full year in the year of purchase and none in the year of disposal.
At the year end, 31 March, the trial balance totals still agreed after the bookkeeper's entry, and Maya's profit was calculated as $21,400. She is pleased, but her bank balance has fallen by more than the profit figure and she cannot explain why.
1. Explain, using figures, why the trial balance still agreed despite the bookkeeper's error, and calculate the corrected profit for the year.
Read the worked answer
A trial balance only proves that total debits equal total credits. Recording the van as Motor Expenses debited $9,600 and credited Cash $9,600 - both entries were made, so the totals still agree. The error is one of principle (an asset treated as an expense), which a trial balance cannot detect.
Correction:
- Remove the expense: profit increases by $9,600.
- Add depreciation on the new van: $9,600 × 20% = $1,920 expense.
- Net effect on profit: +$9,600 − $1,920 = +$7,680.
Corrected profit = $21,400 + $7,680 = $29,080.
The bank fell because $9,600 left the business as a capital purchase, not because the business traded badly. Profit of $21,400 overstated expenses and understated the asset base.
2. State the corrected amounts for motor vehicles at cost, accumulated depreciation, and the depreciation charge to appear in the year-end statement of financial position and income statement.
Read the worked answer
Motor vehicles at cost: $18,000 + $9,600 = $27,600.
Depreciation charge for the year:
- Old vehicles: ($18,000 − $7,200) × 20% = $10,800 × 20% = $2,160
- New van: $9,600 × 20% = $1,920
- Total = $4,080
Accumulated depreciation at 31 March: $7,200 + $4,080 = $11,280.
Carrying amount: $27,600 − $11,280 = $16,320.
Note the policy assumption: a full year's charge on the van bought on 1 April is consistent with Maya's stated policy, even though it was held for the whole year here - the point being tested is that the policy must be applied consistently to the reclassified asset.
3. Identify the accounting principle that was breached and explain one control Maya could introduce to prevent a recurrence.
Read the worked answer
The business entity / capital vs revenue distinction was breached: the van is a non-current asset providing benefit over several years, so its cost should be capitalised and matched to the periods benefiting (accruals/matching). Treating it as revenue expenditure distorted both profit and the statement of financial position.
A suitable control: require any single payment above a set threshold (e.g. $500) to be authorised by Maya and supported by an invoice describing the nature of the purchase, with the bookkeeper classifying it against a fixed asset register. A fixed asset register, reconciled to the nominal ledger, would have flagged that the van was missing from the asset records.