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
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. 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. 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.
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 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.
Effect of the errors:
a.
Record credit purchases when the goods are in transit, but did not include in the ending inventory:
Effect:
Net Income | Assets | Liabilities | Shareholders’ Equity |
– | NE | + | – |
Table (1)
Justification:
Revenues | Expenses | Net Income | Assets | Liabilities | Shareholders’ Equity |
Overstated expenses | Understated income | Overstated accounts payable | Understated retained earnings |
Table (2)
b.
Expensing the cost of machine:
Effect:
Net Income | Assets | Liabilities | Shareholders’ Equity |
– | – | NE | – |
Table (3)
Justification:
Revenues | Expenses | Net Income | Assets | Liabilities | Shareholders’ Equity |
Overstated expenses | Understated income | Understated machine value | Understated retained earnings |
Table (4)
c.
Failure to accrue wages:
Effect:
Net Income | Assets | Liabilities | Shareholders’ Equity |
+ | NE | – | + |
Table (5)
Justification:
Revenues | Expenses | Net Income | Assets | Liabilities | Shareholders’ Equity |
Understated wages expense | Overstated income | Understated wages payable | Overstated retained earnings |
Table (6)
d.
Recorded prepaid rent as expense:
Effect:
Net Income | Assets | Liabilities | Shareholders’ Equity |
– | – | NE | – |
Table (7)
Justification:
Revenues | Expenses | Net Income | Assets | Liabilities | Shareholders’ Equity |
Overstated rent expenses | Understated income | Understated prepaid rent | Overstated retained earnings |
Table (8)
e.
Failure to record allowance for uncollectible accounts:
Effect:
Net Income | Assets | Liabilities | Shareholders’ Equity |
+ | + | NE | + |
Table (9)
Justification:
Revenues | Expenses | Net Income | Assets | Liabilities | Shareholders’ Equity |
Understated expenses | Overstated income | Overstated accounts receivables | Overstated retained earnings |
Table (10)
f.
Failure to record discount on note receivable:
Effect:
Net Income | Assets | Liabilities | Shareholders’ Equity |
+ | + | NE | + |
Table (11)
Justification:
Revenues | Expenses | Net Income | Assets | Liabilities | Shareholders’ Equity |
Understated discount on note receivable | Overstated income | Overstated note receivables | Overstated retained earnings |
Table (12)
2.
Journalize the correction of errors at the beginning of the year 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 beginning of the year for the prior period errors.
a.
Journal entry to correct the failure to record credit purchases:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
Accounts Payable | 10,000 | |||||
Retained Earnings | 10,000 | |||||
(Record decrease in overstated accounts payable and retained earnings) |
Table (13)
Description:
- Accounts Payable is a liability account. Since credit purchases were recorded in the prior period before the goods are received, the accounts payable was overstated. The liability account is debited to decrease the overstated value.
- Retained Earnings is an equity account. Since credit purchases was included in the computation of net income, the net income in the prior years was understated. The equity account is credited to increase the understated value.
b.
Journal entry to correct the failure to capitalize cost of the machine:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
Machinery | 2,000 | |||||
Retained Earnings | 1,500 | |||||
Accumulated Depreciation | 500 | |||||
(Record capitalization of cost and increase understated retained earnings) |
Table (14)
Description:
- Machinery is an asset account. Since machine is purchased, asset account increased, and an increase in asset is debited.
- Retained Earnings is an equity account. Since cost of machine which should have been capitalized is expensed, the net income in the prior years was understated. The equity account is credited to increase the understated value.
- Accumulated Depreciation is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.
Working Note:
Compute the depreciation expense for the machine under straight-line method, if cost is $2,000, useful life is 4 years, and no salvage value.
c.
Journal entry to correct the failure to record accrued wages:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
Retained Earnings | 2,000 | |||||
Wages Payable | 2,000 | |||||
(Record increase in understated wages payable and decrease in retained earnings) |
Table (15)
Description:
- Retained Earnings is an equity account. Since accrued wages were not recorded and wages expense was not included in the computation of net income, the net income in the prior years was overstated. Hence, the equity account is debited to decrease the overstated value.
- Wages Payable is a liability account. Since accrued wages were not recorded in the prior period, the wages payable was understated. The liability account is credited to increase the understated value.
d.
Journal to correct the unrecorded prepaid rent as expense:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
Rent Expense | 4,000 | |||||
Retained Earnings | 4,000 | |||||
(Record rent expense for current period and increase prior period understated retained earnings in the current period) |
Table (16)
Description:
- Rent Expense is an expense account. Since expenses decrease equity value and a decrease in equity is debited, expense account is debited.
- Retained Earnings is an equity account. Since prepaid rent which should have been capitalized is expensed, the net income in the prior years was understated. The equity account is credited to increase the understated value.
e.
Journalize to correct the failure to record allowance for uncollectible accounts:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
Retained Earnings | 5,000 | |||||
Allowance for Doubtful Accounts | 5,000 | |||||
(Record decrease in overstated retained earnings and increase in expense) |
Table (17)
Description:
- Retained Earnings is an equity account. Since expenses in prior period are understated and revenue is overstated, the net income in prior period is overstated. To reduce the overstated earnings, the earnings in current year is debited to decrease the overstated equity.
- Allowance for Doubtful Accounts is a contra-asset account to Accounts Receivable account. The contra-asset accounts decrease the asset value, and a decrease in asset is credited.
f.
Journalize to correct failure to record discount on note receivable:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
Retained Earnings | 15,960 | |||||
Discount on Note Receivable | 15,960 | |||||
(Record decrease in overstated retained earnings and increase in expense) |
Table (18)
Description:
- Retained Earnings is an equity account. Since expenses in prior period are understated and revenue is overstated, the net income in prior period is overstated. To reduce the overstated earnings, the earnings in current year is debited to decrease the overstated equity.
- Discount on Note Receivable is a contra-asset account to Notes Receivable account. The contra-asset accounts decrease the asset value, and a decrease in asset is credited.
Working Note:
Compute discount on note receivable value.
Want to see more full solutions like this?
Chapter 22 Solutions
Intermediate Accounting: Reporting And Analysis
- Refer to the information in E22-13. Required: Prepare the correcting journal entries if the company discovers each error 2 years after it is made and it has closed the books for the second year. Ignore income taxes. E22-13: 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-vear life, no residual value, and straight-line depreciation is used. c. Wages payable of 2,000 were not accrued. d. Payment of next years 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.arrow_forwardIf Barcelona Companys ending inventory was actually $122,000, but the cost of consigned goods, with a cost value of $20,000 were accidentally included with the company assets, when making the year-end inventory adjustment, what would be the impact on the presentation of the balance sheet and income statement for the year that the error occurred, if any?arrow_forwardThe following are independent errors made by a company that uses a periodic inventory system: a. failure to record a purchase of inventory on credit (however, inventory was properly counted at the end of the period) b. expensing the purchase of a machine c. failure to accrue wages d. failure to record an allowance for uncollectibles e. including collections in advance as revenue f. including payments in advance as expenses g. failure to accrue warranty costs h. discount on a note payable issued for purchase of a machine is ignored i. failure to record depreciation expense on assets purchased during the year Required: Next Level Indicate the effect of each of the preceding errors on the companys 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).arrow_forward
- If Wakowski Companys ending inventory was actually $86,000 but was adjusted at year end to a balance of $68,000 in error, what would be the impact on the presentation of the balance sheet and income statement for the year that the error occurred, if any?arrow_forwardErrors As controller of Lerner Company, which uses a periodic inventory system, you discover the following errors in the current year: 1. Merchandise with a cost of 17,500 was properly included in the final inventory, but the purchase was not recorded until the following year. 2. Merchandise purchases are in transit under terms of FOB shipping point. They have been excluded from the inventory, but the purchase was recorded in the current year on the receipt of the invoice of 4,300. 3. Goods out on consignment have been excluded from inventory. 4. Merchandise purchases under terms FOB shipping point have been omitted from the purchases account and the ending inventory. The purchases were recorded in the following year. 5. Goods held on consignment from Talbert Supply Co. were included in the inventory. Required: For each error, indicate the effect on the ending inventory and the net income for the current year and on the net income for the following year.arrow_forwardIndicate the effect of each of the following errors on the following balance sheet and income statement items for the current and succeeding years: beginning inventory, ending inventory, accounts payable, retained earnings, purchases, cost of goods sold, net income, and earnings per share. a. The ending inventory is overstated. b. Merchandise purchased on account and received was not recorded in the purchases account until the succeeding year although the item was included in inventory of the current year. c. Merchandise purchased on account and shipped FOB shipping point was not recorded in either the purchases account or the ending inventory. d. The ending inventory was understated as a result of the exclusion of goods sent out on consignment.arrow_forward
- Company Edgar reported the following cost of goods sold but later realized that an error had been made in ending inventory for year 2021. The correct inventory amount for 2021 was 12,000. Once the error is corrected, (a) how much is the restated cost of goods sold for 2021? and (b) how much is the restated cost of goods sold for 2022?arrow_forwardCompany Elmira reported the following cost of goods sold but later realized that an error had been made in ending inventory for year 2021. The correct inventory amount for 2021 was 32,000. Once the error is corrected, (a) how much is the restated cost of goods sold for 2021? and (b) how much is the restated cost of goods sold for 2022?arrow_forwardIf Wakowski Company's ending inventory was actually $86,000 but was adjusted at year end to a balance of $68,000 in error, what would be the impact on the presentation of the balance sheet and income statement for the year that the error occurred, if any? If no entry is required, select "None" and leave the amount boxes blank.arrow_forward
- An error in the physical count of goods on hand at the end of a period resulted in a $18,000 overstatement of the ending inventory. The effect of this error in the current period is Cost of Goods Sold Net Income Understated Overstated Understated Understated Overstated Overstated Overstated Understatedarrow_forwardPlatinum Co. failed to record $72,000 credit purchase of goods that were received on the last day of its fiscal year end. However, it included these goods in the ending inventory. Platinum found this error three months later when the supplier contacted it for payment. If Platinum uses the periodic inventory system, which journal entry should it make to correct this error? Debit Inventory $72,000 and credit Retained Earnings $72,000. Debit Retained Earnings $72,000 and credit Accounts payable $72,000. Debit Retained Earnings $72,000 and credit Inventory $72,000. Debit Inventory $72,000 and credit Accounts Payable $72,000.arrow_forwardFor all exercises, assume the perpetual inventory system is used unless stated otherwise. Measuring the effect of an inventory error Hot Bread Bakery reported Net sales revenue of $44,000 and cost of goods sold of $33,000. Compute Hot Bread’s correct gross profit if the company made cither of the following independent accounting errors. Show your work. a. Ending merchandise inventory is overstated by $8,000. b. Ending merchandise inventory is understated by $8,000.arrow_forward
- Intermediate Accounting: Reporting And AnalysisAccountingISBN:9781337788281Author:James M. Wahlen, Jefferson P. Jones, Donald PagachPublisher:Cengage LearningPrinciples of Accounting Volume 1AccountingISBN:9781947172685Author:OpenStaxPublisher:OpenStax College