Question

During May 2020, a company spend $14,000 on ordinary maintenance of its delivery trucks. These maintenance costs should have been recorded as debits to ‘Maintenance Expense’ but the company mistakenly capitalized these costs instead. Which of the following is true?

A. Total Assets are overstated as of May 31, 2020 and May 2020 Net Income is overstated.
B. Total Assets are overstated as of May 31, 2020 and May 2020 Net Income is properly stated.
C. Total Assets are understated as of May 31, 2020 and May 2020 Net Income is understated.
D. Both Total Assets as of May 31, 2020 and May 2020 Net Income are properly stated.

Answer 1

Answer: A. Total Assets are overstated as of May 31, 2020 and May 2020 Net Income is overstated

Step-by-step explanation:

Capitalizing the costs of the maintenance means that the $14,000 was taken to the Machinery Account which is an asset when in fact it should have been taken to the Maintenance Expense account which is an expense. This will increase the Asset account for May by $14,000 when it should not have meaning that the Asset account is now Overstated.

Net Income is acquired by deducting expenses from Sales/Revenue. The $14,000 which should never have been recorded as an Asset but instead as an expense, will mean that this Expense will not be deducted from the Net Income because it is being recognized as an Asset. This will mean that the Net Income for May will be Overstated by $14,000 which was supposed to be removed from it.