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CA Intermediate · Advanced Accounting · Framework for Preparation and Presentation of Financial Statements

Mehta & Co. purchased machinery on 1 April for ₹10,00,000 and expects to use it for 5 years with nil residual value. Under the accrual basis, the company's accountant debits the full ₹10,00,000 to the Statement of Profit and Loss in the year of purchase. Which statement best describes the effect on the first year's profit, compared with straight-line depreciation for a full year?

Profit is understated by ₹8,00,000. Under accrual accounting the machine is an asset whose cost is spread over five years, giving ₹2,00,000 depreciation a year. Expensing the full ₹10,00,000 charges ₹8,00,000 too much, so profit for the first year is lower than it should be.

  1. AProfit is understated by ₹8,00,000Correct
  2. BProfit is overstated by ₹8,00,000
  3. CProfit is understated by ₹2,00,000
  4. DProfit is overstated by ₹10,00,000

Explanation

Correct treatment is capitalising and charging depreciation of 10,00,000/5 = ₹2,00,000. The accountant charged ₹10,00,000, so the expense is excess by ₹8,00,000 and profit is understated by that amount. Overstatement options reverse the direction.

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