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A manufacturing company receives an invoice on 29 February 2002 for work done on one of its machines. $25,500 of the cost is actually for a machine upgrade which will improve its efficiency.
The accounts department do not notice and charge the whole amount to maintenance costs. Machinery is depreciated at 25% per annum on a straight line basis, with a proportional charge in the years of acquisition and disposal.
By what amount with the profit for the year to 30 June 2002 be understated?
$23,375
$25,500
$27,625
$19,125I got the right answer which is 23,375 but what I don’t get is why depreciation is being deducted from the amount ??
Firstly consider at time of upgrade cost should have been capitalised not charged as expense. This would increase Machinery by $25500. As a result depreciation would have to be charged on this amount for the four remaining months of the year and this would result in extra depreciation being charged in profit and loss. Depreciation-
$25500 X 0.25=$6375
4/12 X $6375 = $2125$25500 – $2125 = $23375
Hope this helps.
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