Business – 5.1 Business finance – Working capital | e-Consult
5.1 Business finance – Working capital (1 questions)
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Misclassifying the delivery van as a revenue expense will:
- Profit: Reduce the current period’s profit by the full purchase price, whereas proper capitalisation would spread the cost via depreciation, resulting in a higher profit for the period.
- Asset Base: Understate total assets on the balance sheet because the van would not be recorded as a non‑current asset, leading to a lower asset total and equity.
- Financial Ratios:
- Return on Assets (ROA): Appear higher due to a lower asset base and lower profit, potentially misleading stakeholders.
- Current Ratio: May improve temporarily if the van’s cost is recorded as an expense rather than a non‑current asset, but this is a distortion.
- Debt‑to‑Equity Ratio: Could appear higher because equity is reduced by the lower profit retained earnings.
Overall, the misclassification inflates expenses, depresses profit, understates assets, and distorts performance and solvency ratios, potentially affecting investor perception and credit decisions.