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Q18E.

Expert-verified
Intermediate Accounting (Kieso)
Found in: Page 1312

Short Answer

Peter Henning Tool Company’s December 31 year-end financial statements contained the following errors.

December 31, 2017 December 31, 2018

Ending inventory $9,600 understated $8,100 overstated

Depreciation expense $2,300 understated —

An insurance premium of $66,000 was prepaid in 2017 covering the years 2017, 2018, and 2019. The entire amount was charged to expense in 2017.

In addition, on December 31, 2018, fully depreciated machinery was sold for $15,000 cash, but the entry was not recorded until 2019.

There were no other errors during 2017 or 2018, and no corrections have been made for any of the errors. (Ignore income tax considerations.)

Instructions

(a) Compute the total effect of the errors on 2018 net income.

(b) Compute the total effect of the errors on the amount of Henning’s working capital at December 31, 2018.

(c) Compute the total effect of the errors on the balance of Henning’s retained earnings at December 31, 2018.

The effect on net income is $24,700, the effect on working capital is $28,900, and the effect on retained earnings will be $26,600.

See the step by step solution

Step by Step Solution

Step 1: Computation of part A

Effect on 2015 net income over (under) statement

Understatement of 2017 ending Inventory

9,600

Overstatement of 2018 ending Inventory

8,100

Expensing of insurance premium in 2017

22,000

Failure to record sale of the fully depreciated machine in 2018

-15,000

The total effect of errors on net income

24,700

Step 2: Computation of part B

Effect on working capital over (under) statement

Overstatement of 2018 ending Inventory

-8,100

Expensing of insurance premium in 2017 (prepaid Insurance)

-22,000

Sale of fully depreciated machine unrecorded

-15,000

Total effect on working capital (understated)

-28,900

Step 3: Computation of part C

Effect on retained earnings over (under) statement

Overstatement of 2018 ending inventory

8,100

Understatement of depreciation expense in 2017

2,300

Expensing of insurance premium in 2017

-22,000

Failure to record sale of a fully depreciated machine in 2018

-15,000

Total effect on retained earnings (understated)

-26,600

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