Personal Expenses Misclassified as Business Costs

Steps:

• Personal expenses paid from business account reduce cash (asset), correctly lowering net assets.
• Including them in profit or loss overstates expenses, understating profit for the year.
• For a sole trader, profit flows into capital, but the error replaces drawings (which reduce capital directly) with an expense deduction.
• Thus, capital ends up correctly stated, as the net reduction matches actual cash outflow.

Why C is correct:

• Profit is understated due to overstated expenses (per accrual accounting rules), but capital is unaffected because the asset reduction balances the error in equity.

Why the others are wrong:

• A: Profit is affected (understated), not no effect.
• B: Profit is understated, not no effect.
• D: Capital has no net effect, not understated.

Final answer: C