Chapter 22, Problem 16E

1.

To determine

Calculate the correct pretax income for 2015, 2016, and 2017, after including the omissions.

Explanation of Solution

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.

Calculate the correct pretax income for the years 2015, 2016, and 2017.

Details	2015	2016	2017
Reported pretax income	$20,000	$25,000	$23,000
Prepaid expenses:
Add: Expense paid in the year	500	900	1,100
Deduct: Expense incurred in the year		(500)	(900)
Accrued expenses:
Deduct: Expense incurred in the year	(800)	(700)	(950)
Add: Expense paid in the year		800	700
Revenue received in advance:
Deduct: Revenue in the year received	(300)	(400)	(1,300)
Add: Revenue in the year earned		300	400
Revenue earned but not received:
Deduct: Revenue in the year received		(600)	(1,000)
Add: Revenue in the year earned	600	1,000	1,200
Correct pretax income	$20,000	$25,800	$22,250

Table (1)

2.

To determine

Journalize the correction of errors at the end of 2017 for the prior period errors.

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Journalize the correction of errors at the end of 2017 for the prior period errors.

Prepaid expenses paid in 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Prepaid Expenses			1,100
			Expense			1,100
		(Record prepaid expenses)

Table (2)

Description:

• Prepaid Expenses is an asset account. Since prepaid expenses were recorded in 2017, asset value increased, and an increase in asset is debited.
• Expense is an equity account. Since prepaid expenses of 2016were recorded as expenses in 2017, the expenses in 2017 were overstated. The equity account is credited to decrease the overstated expense value.

Prepaid expenses incurred in 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Expense			900
			Retained Earnings			900
		(Record expenses paid and increase the retained earnings value)

Table (3)

Description:

• Expense is an equity account. Expenses decrease equity value, and a decrease in equity is debited.
• Retained Earnings is an equity account. Since prepaid expenses of 2016 were recorded as expenses in 2017, and was included in the computation of net income, the net income in 2017 was understated. The equity account is credited to increase the understated value.

Accrued expensesincurred in 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Expense			950
			Accrued Expenses			950
		(Record accrued expenses incurred)

Table (4)

Description:

• Expense is an equity account. Expenses decrease equity value, and a decrease in equity is debited.
• Accrued Expenses is a liability account. Since amount to be paid has increased, liabilities value increased, and an increase in liabilities is credited.

Accrued expenses paid in 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Retained Earnings			700
			Expense			700
		(Record accrued expenses paid)

Table (5)

Description:

• Retained Earnings is an equity account. Since accrued expenses of 2016 were recorded as expenses in 2017, the net income in 2017 was decreased, and a decrease in equity account is debited.
• Expense is an equity account. Since accrued expenses of 2016 were recorded as expenses in 2017, the expenses in 2017 were overstated. The equity account is credited to decrease the overstated expense value.

Unearned revenue received in 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Revenue			1,300
			Unearned Revenue			1,300
		(Record unearned revenue received)

Table (6)

Description:

• Revenue is an equity account. Since unearned revenue is recorded as revenue in 2017, the revenue value is overstated. The equity account is debited to decrease equity value.
• Unearned Revenue is a liability account. Since revenue received in advance in 2017 were recorded as revenue in 2017, the liability value in 2017 was understated. The liability account is credited to increase the understated liability value.

Unearned revenue earned in 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Retained Earnings			400
			Revenue			400
		(Record unearned revenue being earned)

Table (7)

Description:

• Retained Earnings is an equity account. Since unearned revenue of 2016were recorded as revenue in 2017, and was included in the computation of net income, the net income in 2017 was overstated. The equity account is debited to decrease the overstated value.
• Revenue is an equity account. Revenues increase equity value, and an increase in equity is credited.

Accrued revenue received in 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Revenue			1,000
			Retained Earnings			1,000
		(Record revenue received and increase the retained earnings value)

Table (8)

Description:

• Revenueis an equity account. Accrued revenues earned in 2016but recorded as received in 2017 would increase the revenue value of 2017. So, the equity is debited to decrease the 2017 revenue.
• Retained Earnings is an equity account. Since accrued revenue of 2016 were recorded as revenue in 2017, and was not included in the computation of net income, the net income in 2016 was understated. The equity account is credited to increase the understated value.

Accrued revenue earned in 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Accounts Receivable			1,200
			Revenue			1,200
		(Record revenue earned on account)

Table (9)

Description:

• Accounts Receivable is an asset account. Since amount to be received has increased, the assets have increase, and an increase in assets is debited.
• Revenue is an equity account. Revenues increase equity value, and an increase in equity is credited.

3.

To determine

Journalize the correction of errors at the end of 2018 for the prior period errors.

Explanation of Solution

Journalize the correction of errors at the end of 2018 for the prior period errors.

Prepaid expenses incurred in 2018:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Expense			1,100
			Retained Earnings			1,100
		(Record expenses paid and increase the retained earnings value)

Table (10)

Description:

• Expense is an equity account. Expenses decrease equity value, and a decrease in equity is debited.
• Retained Earnings is an equity account. Since prepaid expenses of 2017 were recorded as expenses in 2018, and was included in the computation of net income, the net income in 2017 was understated. The equity account is credited to increase the understated value.

Accrued expenses paid in 2018:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Retained Earnings			950
			Expense			950
		(Record accrued expenses paid)

Table (11)

Description:

• Retained Earnings is an equity account. Since accrued expenses of 2017 were recorded as expenses in 2018, the net income in 2018 was decreased, and a decrease in equity account is debited.
• Expense is an equity account. Since accrued expenses of 2017 were recorded as expenses in 2018, the expenses in 2018 were overstated. The equity account is credited to decrease the overstated expense value.

Unearned revenue earned in 2018:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Retained Earnings			1,300
			Revenue			1,300
		(Record unearned revenue being earned)

Table (12)

Description:

• Retained Earnings is an equity account. Since unearned revenue of 2017 were recorded as revenue in 2018, and was included in the computation of net income, the net income in 2017 was overstated. The equity account is debited to decrease the overstated value.
• Revenue is an equity account. Revenues increase equity value, and an increase in equity is credited.

Accrued revenue received in 2018:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Revenue			1,200
			Retained Earnings			1,200
		(Record revenue received and increase the retained earnings value)

Table (13)

Description:

• Revenue is an equity account. Accrued revenues earned in 2017 but recorded as received in 2018 would increase the revenue value of 2018. So, the equity is debited to decrease the 2018 revenue.
• Retained Earnings is an equity account. Since accrued revenue of 2017 were recorded as revenue in 2018, and was not included in the computation of net income, the net income in 2017 was understated. The equity account is credited to increase the understated value.