Effect of Errors on Net Profit

Correction of Errors

Skill: Apply

Stimulus

Question

(a) For each error, explain whether it caused net profit to be overstated or understated, or had no effect, and give the reason.

(b) Based on your analysis, prepare a statement of corrected net profit for Cahaya Murni Electrical Enterprise.

Thinking steps

1. Error 1: A repair is a revenue expense but was capitalised (debited to an asset). Expenses were understated, so profit was overstated by RM1,200. The correction deducts RM1,200 from profit.
2. Error 2: Discount received is other income that was omitted. Income was understated, so profit was understated by RM150. The correction adds RM150 to profit.
3. Error 3: Sales were under-recorded by RM720 - RM270 = RM450. Sales revenue was understated, so profit was understated by RM450. The correction adds RM450 to profit.
4. Error 4: Carriage inwards and carriage outwards are both expenses. It is only a misclassification: total expenses are unchanged, so there is no effect on net profit (though cost of sales and operating expenses must be reclassified).
5. Combine the effects: RM15,600 - RM1,200 + RM150 + RM450 = RM15,000. This is the corrected net profit.

Model answer

(a) Error 1 (profit OVERSTATED): the RM1,200 repair was capitalised as an asset, so expenses were understated. Error 2 (profit UNDERSTATED): discount received RM150 (income) was omitted. Error 3 (profit UNDERSTATED): sales were under-recorded by RM450 (RM720 - RM270). Error 4 (NO EFFECT on net profit): carriage inwards and carriage outwards are both expenses; only a reclassification is needed.

(b) Statement of corrected net profit:

Net profit as reported ...... RM15,600

Less: Lorry repair expense (E1) ...... (RM1,200)

Add: Discount received omitted (E2) ...... RM150

Add: Sales under-recorded (E3) ...... RM450

Error 4 ...... no effect

Corrected net profit ...... RM15,000