Question

Ancelotti, Inc. is a calendar-year corporation. Its financial statements for the years 2011 and 2010 contained errors as follows:

1) Ending Inventory for 2011 is overstated by $3,000

2) Ending Inventory for 2010 is overstated by $8,000

3) Salaries expense for 2011 is understated by $2,000

4) Salaries expense for 2010 is overstated by $6,000

No correcting entries were made at December 31, 2010. Assuming no taxes, by how much will retained earnings at December 31, 2011 be overstated or understated?

a. $1,000 understated b. $5,000 overstated c. $5,000 understated d. $9,000 understated

The answer is a. $1,000 but I need an explanation because I do not know how to solve this question, thanks.

Answer 1

Accounting terminology describes specific events. Understated and overstated are two terms that describe the inaccuracy of accounting figures. Accountants use these terms primarily when reviewing financial statements.

Understated amounts indicate a reported amount is not correct and the reported amount is less than the true amount.

Overstated is the opposite of understated in accounting terminology. Accountants use this term to describe an incorrect reported amount that is higher than the true amount.

In Point No2, Inventory for the year ending 2010 overstated by $8000 it means profit and loss statement increased by $8000, However, the inventory for the year ending 2010 is the Opening Balance for the year 2011, it results the Opening balance is higher than the actual i.e, understated of $8000 in 2011. Hence the impact will be Nil.

Overstated in 2010 will results in Understated in 2011 Due to carry forward of the inventory.

Point No4, Salary Expenses in 2010 is overstated by $6000 will result in reducing the netproffit by $6000.

For Example Gross profit if the above statements are not included would be $100,000 in 2010 and $ 100,000 in 2011.

Profit and Loss statement for the year ended 2010 in $

To Gross Profit(Increased by 8000) 108000	By Inventory(increased) 8000
	By Gross Profit (C/F) 108000
To Salaries(Increased by) 6000
To Net Profit 102000

Profit and Loss statement for the year ended 2011

To Opening stock 8000	By Closing Stock 3000
To Gross Profit (100000+3000-8000) 95000
	By Grosss Profit (C/F) 95000
To Salaries (2000)
To Net Profit 97000

Net Profit as per 2010 is $ 102,000

Net Profit as per 2011 is $ 97,000 Actual Profit is $200,000

------------------------------------- Profit after considering the above is $199,000

199,000 Difference $1000 Understated

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