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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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The following are independent errors made by a company that uses the periodic inventory system:

a. Goods in transit, purchased on credit and shipped FOB destination, $10,000, were included in purchases but not in the physical count of ending inventory.

b. Purchase of a machine for $2,000 was expensed. The machine has a 4-year life, no residual value, and straight-line depreciation is used.

c. Wages payable of $2,000 were not accrued.

d. Payment of next year’s rent, $4,000, was recorded as rent expense.

e. Allowance for doubtful accounts of $5,000 was not recorded. The company normally uses the aging method.

f. Equipment with a book value of $70,000 and a fair value of $100,000 was sold at the beginning of the year. A 2-year, non-interest-bearing note for $129,960 was received and recorded at its face value, and a gain of $59,960 was recognized. No interest revenue was recorded and 14% is a fair rate of interest.

Required:

  1. 1. Next Level Indicate the effect of each of the preceding errors on the company’s assets, liabilities, shareholders’ equity, and net income in the year in which the error occurs. State whether the error causes an overstatement (+), an understatement (−), or no effect (NE).
  2. 2. Prepare the correcting journal entry or entries required at the beginning of the year for each of the preceding errors, assuming the company discovers the error in the year after it was made. Ignore income taxes.

1.

To determine

Mention the effect of the given errors on the company’s assets, liabilities, shareholders, equity, and net income, in the year the error occurred.

Explanation

Errors: The comparability and consistency of the financial statements decreases when a company records arithmetic mistakes, or errors. Such errors do require adjustments to make the financial information more reliable, and more relevant.

Effect of the errors:

a.

Record credit purchases when the goods are in transit, but did not include in the ending inventory:

Effect:

Net IncomeAssetsLiabilitiesShareholders’ Equity
NE+

Table (1)

Justification:

RevenuesExpensesNet IncomeAssetsLiabilitiesShareholders’ Equity
 Overstated expensesUnderstated income Overstated accounts payableUnderstated retained earnings

Table (2)

b.

Expensing the cost of machine:

Effect:

Net IncomeAssetsLiabilitiesShareholders’ Equity
NE

Table (3)

Justification:

RevenuesExpensesNet IncomeAssetsLiabilitiesShareholders’ Equity
 Overstated expensesUnderstated incomeUnderstated machine value Understated retained earnings

Table (4)

c.

Failure to accrue wages:

Effect:

Net IncomeAssetsLiabilitiesShareholders’ Equity
+NE+

Table (5)

Justification:

RevenuesExpensesNet IncomeAssetsLiabilitiesShareholders’ Equity
 Understated wages expenseOverstated income Understated wages payableOverstated retained earnings

Table (6)

d...

2.

To determine

Journalize the correction of errors at the beginning of the year for the prior period errors.

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