Question

At the end of the fiscal year, the usual adjusting entry for depreciation on equipment was omitted (i.e., the entry was not made). Which of the following statements is true?

a. Net income will be understated (too low) for the current year.

b. Total liabilities and total assets will be overstated (too high).

c. The Balance Sheet and Income Statement will be misstated but the Statement of Retained Earnings will be correct for the current year.

d. Total assets will be overstated (too high) at the end of the current year.

Answer 1

The correct answer is (d) Total assets will be overstated (too high) at the end of the current year.

Depreciation is the decrease in the value of an asset due to usage and passage of time. Charging depreciation expense to accumulated depreciation is an adjusting entry made at the end of every year while preparing the books of account. That means depreciation expense is debited which is increase in expense and accumulated depreciation credited which is a credit - offseting entry for the asset. When the adjusting entry for depreciation on equipment is omitted, depreciation expense is not debited and the expense is not reduced in the income statement. Hence, income statement would be overstated. Hence, option (a) is wrong.
When income statement is overstated, retained earnings and shareholders equity also would be overstated. Hence, option (c) is also wrong.
In the Balance sheet, the value of equipment asset will be overstated because increase in accumulated depreciation is not recorded and deducted. Therefore, total assets also would be overstated. It will not cause any change to total liability in the balance sheet. Hence, option (b) is also wrong.
So the correct answer is, Total assets will be overstated (too high) at the end of the current year.