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Hello Sir,
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 OverstatedHere the profit was really overstated but in the same time it will overstate the the non-current assets which will have an effect on ROCE so here the model answer has ignored the
effect on capital employed.Thanks
Answer
15. D
Capitalising the repair expense will result in overstated profits. Overstated profits
will overstate EPS and ROCE.Hi,
The answer is correct as the proportionate reduction on the profit it far more than that on the capital employed. If we use numbers then it might help to see it more clearly.
If we assume that the profit is 10 and the capital employed is 100, then the ROCE is 10%
Now let’s assume that the incorrectly capitalised repairs were 1. The profit will now be 9 (10 – 1) and the capital employed 101 (100 + 1), giving a ROCE if 8.9%.
The ROCE was therefore previously overstated.
Thanks
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