Six Above Company’s December 31 year-end financial statements contained the foll
ID: 2419036 • Letter: S
Question
Six Above Company’s December 31 year-end financial statements contained the following errors.
December 31, 2013 December 31, 2014
Ending inventory $15,600 overstated $36,000 overstated
Depreciation expense $21,500 understated —
Rent of $165,000 was prepaid in 2014 covering the 12-month period beginning July 1, 2014. The entire
amount was charged to expense in 2014. In addition, on December 31, 2014, vacant land was sold for
$65,000 cash ($5,000 cost), but the entry was not recorded until 2015. There were no other errors during
2013 or 2014, and no corrections have been made for any of the errors. (Ignore income tax
considerations.)7
Instructions
(a) Compute the total effect of the errors on 2015 net income.
(b) Compute the total effect of the errors on the amount of Six Above Company’s working capital at
December 31, 2015.
(c) Compute the total effect of the errors on the balance of Six Above Company’s retained earnings at
December 31, 2015.
Explanation / Answer
The effect of Inventory Opening Inventory+Purchases-Closing inventory=Cost of goods sold In 2013 Closing inventory is overstated by $ 15,600.00 Cost of goods sold is understated by $ 15,600.00 Net Income is overstated by $ 15,600.00 The effect of this error will be in net income opposite in 2014 ,Net income will be understated by $ 15,600.00 In 2014 Closing inventory is overstated by $ 36,000.00 Cost of goods sold is understated by $ 36,000.00 Net Income is overstated by $ 36,000.00 Total cumulative effect of net income will be $15,600+$36000-$15,600 $ 36,000.00 In 2014 Depreciation Expense understated by $ 21,500.00 Net income will be overstated by $ 21,500.00 In 2014 Rent A/C debit by $ 1,65,000 instead of $ 82,500 Net Income will be understated by $ 82,500.00 Correct Entry Rent A/C Dr $82,500 To Prepaid Rent $82,500 In 2014 Entry not done of land sold at profit of $ 60,000 it means net profit is understated by $ 60,000 Correct Entry Cash A/C Dr $65,000 To Land $5,000 To Profit on slae of land $60,000 Effect in Net Income of 2015 Overstated Inventory 2014 $36,000 Rent Overstated $82,500 Profit on sale of land understated ($60,000) Total effect of error on net income overstated Net Income will be increased by $58,500 Six Above Company’s working capital at December 31, 2015. Current Assets Cash $ 60,000.00 Inventory $ (36,000.00) Prepaid Expenses $ (82,500.00) $ (58,500.00) Total effect of Working capital understated $ (58,500.00) Six Above Company’s retained earnings at December 31, 2015. Overstated inventory of 2014 $ 36,000.00 Under stated depreciation expense of 2013 $ 21,500.00 Expenses of prepaid rent $ (82,500.00) Sale of land not recorded $ (60,000.00) Total effect of error on retained earning understated $ (85,000.00)