Evaluating a Comparison-Method Profit Calculation

Incomplete Records

Skill: Evaluate

Stimulus

Question

(a) Calculate the opening and closing capital of Kedai Basikal Laju.

(b) Determine the CORRECT net profit figure by showing the full Comparison-Method computation.

(c) Evaluate Ali's and Bala's calculations: whose is correct, and what error did the other make? Explain why the treatment of additional capital and drawings is justified.

(d) Based on your evaluation, give one written recommendation to Encik Rashid about the figure he should submit to the bank, and justify your recommendation.

Thinking steps

1. Compute opening capital = total assets - total liabilities at 1 Jan 2024 = (12,000+8,000+3,000+2,000) - 4,000 = 25,000 - 4,000 = RM21,000.
2. Compute closing capital at 31 Dec 2024 = (12,000+10,000+5,000+6,000) - 3,000 = 33,000 - 3,000 = RM30,000.
3. Recall the Comparison-Method formula: Net profit = Closing capital - Opening capital + Drawings - Additional capital.
4. Understand the logic: drawings reduce capital but are not an expense, so they are added back; additional capital raises closing capital but is not earned from operations, so it must be deducted so it is not mistaken for profit.
5. Compute the correct profit = 30,000 - 21,000 + 7,000 - 5,000 = RM11,000. Compare: Bala (RM11,000) is correct; Ali (RM21,000) added the additional capital (+5,000) when it should be subtracted, a RM10,000 difference.
6. Make an evidence-based decision: RM11,000 is the figure to submit because it reflects the true operating performance; Ali's figure falsely inflates profit and could mislead the bank and the owner.

Model answer

(a) Opening capital = (Fittings 12,000 + Inventory 8,000 + Debtors 3,000 + Cash 2,000) - Creditors 4,000 = 25,000 - 4,000 = RM21,000. Closing capital = (12,000 + 10,000 + 5,000 + 6,000) - 3,000 = 33,000 - 3,000 = RM30,000.

(b) Net profit = Closing capital - Opening capital + Drawings - Additional capital = 30,000 - 21,000 + 7,000 - 5,000 = RM11,000.

(c) Bala's calculation (RM11,000) is CORRECT. Ali's error: he ADDED the additional capital of RM5,000 when it should have been SUBTRACTED, overstating his profit by RM10,000 (adding +5,000 versus subtracting -5,000 = a 10,000 difference). Justification of the treatment: Drawings are added back because they reduce closing capital yet are not a business expense but the owner's personal withdrawal; if not added back, profit would be understated. Additional capital is deducted because it raises closing capital without arising from business activity; if not deducted, the owner's personal cash injection would be wrongly counted as profit earned by the business.

(d) Recommendation: Encik Rashid should submit the net profit of RM11,000 to the bank. Justification: this figure reflects the true operating performance of the business under the correct Comparison-Method formula. Submitting Ali's figure (RM21,000) would give false, inflated financial information to the bank; this could damage the owner's credibility, risk a loan he cannot repay, and breach the principle of transparent information.