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CA Intermediate · Auditing and Ethics · Audit of Items of Financial Statements

While auditing Bharat Engineering Ltd, the auditor finds that the company has capitalised Rs 40 lakh of repair and maintenance costs that merely restore an existing machine to its original working condition without increasing its future benefits. Which audit conclusion is correct?

The Rs 40 lakh is revenue expenditure because it only restores the machine's original condition and brings no additional future benefit. Capitalising it overstates fixed assets and profit, so the auditor should ask for correction. Extra depreciation or a note alone would not cure the misstatement.

  1. AAccept capitalisation because the amount is large and the machine is used in production
  2. BTreat the amount as a revenue expenditure that is wrongly capitalised, so the fixed assets and profit are overstatedCorrect
  3. CTreat it as capital expenditure and ask for higher depreciation only
  4. DDisclose it only in the notes without any adjustment to the books

Explanation

Expenditure that only maintains the existing standard of performance is a revenue expense, not an addition to the asset's capacity or life. Capitalising it overstates property, plant and equipment and profit for the year. Merely increasing depreciation or giving a note does not correct the misclassification.

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