Question

Early in 2018 Johnson Company was acquired by a new owner who discovered errors in the accounting records. The new owner would like you to analyze the error described and then determine the impact the accounting items listed. Each error should be analyzed separately. Be Sure to indicate the dollar amount or not the error caused the items to be overstated (OS) or Understated (US) or No Effect.

Vacation pay earned in 2017 of 31100 was not accrued in 2017. The vacation pay occurred in 2018 and expensed when paid.

Analysis:

Net Income for the period ending 12/31/2017__________________

Retained Earnings as of 12/31/2017__________________

Working Capital as of 12/31/2017_______________

Net Income for the period ending 12/31/2018________________

Retained Earnings as of 12/31/2018________________________

December 31, 2017 ending inventory was overstated by 50,000

Analysis:

Net Income for the period ending 12/31/2017 _______________

Retained Earnings as of 12/31/2017__________________

Working Capital as of 12/31/2017_________________

Net Income for the period ending 12/31/2018__________________

Retained Earnings as of 12/31/2018_________________

3.At the beginning of 2017 a machine was purchased for total cost of $50,000. The Machine had no salvage value and had a life of 15 years. The bookkeeper accidentally expensed the entire cost of the machine in 2017. Johnson company normally uses straight line depreciation.

                Analysis:

Net Income for the period ending 12/31/2017____________________________

Retained Earnings as of 12/31/2017_____________________

Working Capital as of 12/31/2017_____________________

Net Income for the period ending 12/31/2018_____________________

Retained Earnings as of 12/31/2018_______________________

4.At the end of 2017. $30,000 of cash collected in advance for future services was included is Service revenue for the period ending 12/31/2017. The services will be performed equally in 2018 and 2019.

Net Income for the period ending 12/31/2017____________________________

Retained Earnings as of 12/31/2017_____________________

Working Capital as of 12/31/2017_____________________

Net Income for the period ending 12/31/2018_____________________

Retained Earnings as of 12/31/2018_______________________

Answer 1

• All working forms part of the answer
• Error #1: Expenses of $ 31,100 not accrued. This means expenses are not shown in Income Statement as well as Current Liability got failed to be recorded.

Effect on	Effect	Reason
Net Income for the period ending 12/31/2017	Overstated by $ 31,100	because $ 31,100 of expenses were not recorded.
Retained Earnings as of 12/31/2017	Overstated by $ 31,100	because $ 31,100 of expenses were not recorded, and Net Income got overstated.
Working Capital as of 12/31/2017	Overstated by $ 31,100	because, accrual would have lead to creation of current liabilities, which would have decreased the working capital.
Net Income for the period ending 12/31/2018	Understated by $ 31,100	because expense of $ 31,100 of 2017 is expensed in 2018
Retained Earnings as of 12/31/2018	No Effect	because by the end of year, 2017's error got compensated in 2018

• Error #2: Ending inventory overstated by $ 50,000

Effect on	Effect	Reason
Net Income for the period ending 12/31/2017	Overstated by $ 50,000	Overstatement of ending inventory = lower cost of goods sold = higher gross profits and income.
Retained Earnings as of 12/31/2017	Overstated by $ 50,000	Overstatement of Net Income
Working Capital as of 12/31/2017	Overstated by $ 50,000	because overstated ending inventory forms part of Current Assets while calculating working capital.
Net Income for the period ending 12/31/2018	Understated by $ 50,000	because, overstated ending inventory of 2017 will become beginning inventory of 2018
Retained Earnings as of 12/31/2018	No effect.	Net effect of both the years will neutralize each other.

• Error #3: Depreciation each year must have been = 50000/15 years = $ 3333.33. Expenses actually considered = $ 50,000. Difference in 2017 = $ 46,666.67.

Effect on	Effect
Net Income for the period ending 12/31/2017	Understated by $ 46,666.67
Retained Earnings as of 12/31/2017	Understated by $ 46,666.67
Working Capital as of 12/31/2017	No Effect, as the error does not affect any working capital related account.
Net Income for the period ending 12/31/2018	Overstated by $ 3333.33
Retained Earnings as of 12/31/2018	Understated by $ 43,333.33

• Error #4: Unearned Revenue of $ 15,000 (for 2018) and $ 15,000 (for 2019) recorded as revenues of 2017.

.

Effect on	Effect	Reason
Net Income for the period ending 12/31/2017	Overstated by $ 30,000	as income of 2018 and 2019 considered in 2017
Retained Earnings as of 12/31/2017	Overstated by $ 30,000	as income of 2018 and 2019 considered in 2017
Working Capital as of 12/31/2017	Overstated by $ 30,000	as Unearned Revenue (Current Liability) was not created due to error.
Net Income for the period ending 12/31/2018	Understated by $ 15,000	2018's $ 15,000 income already considered in 2017
Retained Earnings as of 12/31/2018	Understated by $ 15,000	2019's $ 15,000 already included in the balance in 2017