Question

In 2022, Draper Company discovered errors made in 2019-2021, its first three years of operation.

	2021	2020	2019
Items not recognized:
Prepaid expenses	$1,300	$900	$550
Accrued expenses	950	700	800
Other information:
Reported net income	$23,000	$25,000	$20,000
Dividends declared and paid	4,100	2,600	5,000
Common stock and additional paid in capital at 12/31	22,000	17,000	15,000

Indicate the error in 12/31/21 Working Capital:

Select one:

a. $400 overstated

b. $350 overstated

c. $400 understated

d. $350 understated

Answer 1

Indication of error in 12/31/21 Working Capital:

The correct option is

• $350 Understated

Explanation:

Errors	Current assets	Current liabilities	Impact on working capital
Prepaid expenses unrecognized, $1300	understated	-	$1300 understated
Accrued expenses unrecognized, $950	-	understated	$950 overstated
​​​​​​Error to be indicated	-	-	$350 understated

It was known that,

- working capital = Current assets - current liabilities

So,

- Increase in current assets increases the working capital and decrease in current assets decreases the working capital

- Increase in current liabilities decreases the working capital and decrease in current liabilities increases the working capital

Here, for the year end 2021,

- prepaid expenses $1300, which is a current asset is not recognized. So current assets is understated which result in understatement of working capital by $1300

- Accrued expenses $950, which is a current liability is not recognized. So current liabilities is understated which results in overstatement of working capital by $950

That implies,

Impact on working capital as a whole is

• Understatement of working capital by $350