Impact of Errors on Profit & Financial Position | Accounting for GCSE/IGCSE - Year 11 PDF Download

Impact of Errors on Profit

Which accounts affect gross profit?

• Understanding how an account's balance impacts gross profit is crucial:
  • An account might contribute to increasing gross profit.
  • Conversely, it could lead to a decrease in gross profit.
  • Some accounts may have no impact on gross profit.
• Keep in mind these essential formulas:
  • Gross profit = net revenue - cost of sales
  • Net revenue = sales - sales returns
  • Cost of sales = opening inventory + net purchases - closing inventory
  • Net purchases = purchases + carriage inwards - purchases returns - goods for own use
• Any factor that raises net revenue will consequently boost gross profit.
• Conversely, anything that escalates the cost of sales will inevitably reduce gross profit.
• This concept can be succinctly summarized in the following table:
  

How do errors affect the gross profit?

• Certain errors can lead to either an overstatement or understatement of gross profit.
• Gross profit will be inflated if:
  • An account that typically boosts gross profit has been recorded with an exaggerated balance.
  • Alternatively, an account that normally reduces gross profit has been recorded with an insufficient balance.
• Conversely, gross profit will be underestimated if:
  • An account that typically enhances gross profit has been recorded with a deficient balance.
  • Conversely, an account that usually diminishes gross profit has been recorded with an excessive balance.
• Evaluate the collective impact of all errors on gross profit:
  • Some errors might offset each other's effects, resulting in no net impact on gross profit.

How do corrections of errors affect the gross profit?

• You may be tasked with rectifying errors and determining the adjusted gross profit.
• Analyze which debit and credit entries are necessary to rectify the errors.
• For accounts impacting gross profit:
  • Debit entries will reduce gross profit.
  • Credit entries will augment gross profit.
• Keep in mind that certain accounts have no bearing on gross profit.

Which accounts affect profit for the year?

• Understanding whether an account balance influences the profit for the year is crucial, and similar methods used for assessing gross profit can be applied.
• Recall the formula: Profit for the year = gross profit + other incomes - other expenses
• Factors that elevate gross profit or other incomes will consequently raise the profit for the year.
• This concept can be succinctly summarized in the following table:
  
• If an account impacts the profit for the year:
  • Debit entries lead to a decrease in profit.
  • Credit entries result in an increase in profit.

Impact of Errors on a Statement of Financial Position

How do errors affect the statement of financial position?

• Some errors can impact the reported values of:
  • Assets
  • Liabilities
  • Capital
• The capital account becomes overstated if:
  • Profit for the year is exaggerated.
  • Drawings account is inaccurately recorded.
• Conversely, the capital account becomes understated if:
  • Profit for the year is underestimated.
  • Drawings account is incorrectly overstated.
• Certain errors may neutralize each other's effects, thus leaving the statement of financial position unaffected.
  • For instance, if a $100 payment from a trade receivable is omitted from the ledger accounts:
    • Trade receivables would be overstated by $100.
    • The bank would be understated by $100.
  • However, the total value of assets remains unaffected by this error.

How does the correction of errors affect capital?

• Capital rises under the following circumstances:
  • An increase in the profit for the year.
  • A decrease in the balance of the drawings account.
• Determining the corrected balance for capital closely resembles determining the corrected profit for the year, but it's essential to pay attention to transactions involving drawings.