Making a Decision as an Auditor: Effects of Errors on Income, Assets, and Liabilities – Megan Company (not a corporation) was careless about its financial records during its first year of operations, 2010. It is December 31, 2010, the end of the annual accounting period. An outside CPA has examined the records and discovered numerous errors, all of which are described here. Assume that each error is independent of the others.
Required:
Analyze each error and indicate its effect on 2010 and 2011 net income, assets, and liabilities if not corrected. Do not assume any other errors. Use these codes to indicate the effect of each dollar amount: O = overstated, U = understated, and NE = no effect. Write an explanation of your analysis of each transaction to support your response. The first transaction is used as an example.
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Independent Errors |
Effect On |
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Net Income |
Assets |
Liabilities |
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2010 |
2011 |
2010 |
2011 |
2010 |
2011 |
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1. Depreciation expense for 2010, not recorded in 2010, $950. |
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2. Wages earned by employees during 2010 not recorded or paid in 2010 but recorded and paid in 2011, $500. |
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3. Revenue earned during 2010 but not collected or recorded until 2011, $600. |
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4. Amount paid in 2010 and recorded as expense in 2010 but not an expense until 2011, $200. |
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5. Revenue collected in 2010 and recorded as revenue in 2010 but not earned until 2011, $900. |
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6. Sale of services and cash collected in 2010. Recorded as a debit to Cash and as a credit to Accounts Receivable, $300. |
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7. On December 31, 2010, bought land on credit for $8,000, not recorded until payment was made on February 1, 2011. |
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Following is a sample explanation of the first error:
Failure to record depreciation in 2010 caused depreciation expense to be too low; therefore, income was overstated by $950. Accumulated depreciation also is too low by $950, which causes assets to be overstated by $950 until the error is corrected.