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Hello Sir,
In the following question for the wrong capitalisation of repair and maintenance expenses
the answer is overstated EPS and overstated ROCE ,but the point is in case of of ROCE if we look to the profit it was realy increased but with regard to capital employed it was also increased .So the there is almost an equal increament in profit as well as capital employed .So why the answer should be overstated ROCE .Can you clarify please Sir,
Thanks
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Q
15.Delivery Co, a logistics company, carries out the regular repair and
maintenance of its vehicles. Given the absence of a qualified accountant in the
previous month, all the repairs were capitalised.
What will be the impact of this error on earnings per share (EPS) and return on
capital employed (ROCE)?
EPS ROCE
A) Understated Overstated
B) Overstated Understated
C) Understated Understated
D) Overstated OverstatedAnswer
15. D
Capitalising the repair expense will result in overstated profits. Overstated profits
will overstate EPS and ROCEHi,
It is probably best illustrated using numbers. Remember that ROCE is PBIT divided by capital employed. So, imagine if the ROCE is currently 10%, based upon PBIT of 10 and capital employed of 100 for example (i.e. 10/100 x 100% = 10%).
If the repairs of say 1 were incorrectly capitalised then the PBIT would now be 9 (10 less 1) and the capital employed 99 (100 less 1). If we plug the new numbers into the ROCE equation then we have ROCE of 9.1% (i.e. 9/99 x 100% = 9.1%).
As the previous ROCE was higher than what it now is then it was previously overstated before we corrected the error.
Thanks
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