Question

The net income of Thomas & Sons, a landscaping company, decreased sharply during 2018. The owner of the company, Jerry Thomas, anticipates the need for a bank loan in 2019. Late in 2018, Jerry instructs the company’s accountant to record $2,000 service revenue for landscape services for the McGrath family, even though the services will not be performed until January 2019. Jerry also tells the accountant not to make the following December 31, 2018 adjusting entries: Salaries owed to employees $900 Prepaid insurance that has expired $400

Requirements:

1) Calculate the total dollar amount of the affect on net income for the three suggested actions. Be detailed in your response so that we can follow how you calculated the total and why the amounts included in your total impact net income.

2) Of the four financial statements, which are impacted by the suggestions and where in the statement? Be specific and provide sufficient detail to suport your answer.

Answer 1

1)

a. Recording of revenue which won't be performed until next year will increase the Net Income.

The entry that should be passed

Debit Cash
Credit Unearned Revenue

Instead of this following entry is what Jerry Thomas wants

Debit Cash
Credit Revenue

He is asking to recognize revenue that shouldn't be recognized in the current year.

b. Not recording salaries owed to employees would again increase the Net Income

This is because following entry would be required

Debit Salaries Expense
Credit Salaries Payable

Not passing this entry would result in understatement of expenses which would in turn mean Overstatement of profits.

c. Not recording expired prepaid insurance would result in increase in Net Income

This is because following entry would be required

Debit Insurance Expense
Credit Prepaid Insurance

Not passing this entry would result in understatement of expenses which would in turn mean Overstatement of profits.

Due to the above entries, the net income would be overstated by 2,000 + 400 + 900 = $ 3,300

2

	Income Statement	Balance Sheet	Cash Flow	Statement of Change in Equity
a	Overstatement of revenue, therefore overstatement of net income	Overstatement of Equity, understatement of current liabilities (unearned revenue)	No Impact	Overstatement of profit for the current year, therefore overstatement of equity
b	Understatement of expenses, therefore overstatement of net income	Overstatement of Equity, understatement of current liabilities (salaries payable)	No direct impact	Overstatement of profit for the current year, therefore overstatement of equity
c	Understatement of expenses, therefore overstatement of net income	Overstatement of Equity, understatement of current assets (prepaid insurance)	No direct impact	Overstatement of profit for the current year, therefore overstatement of equity