Question

The Accountant for Herald Company forgot to make an adjusting entry to record depreciation expense for the year. The effect of this error would be:

a) An overtstatement of equity and an undertstatement of assets.

b) An understatement of equity and an overstatement of assets.

c) An understatement of equity and assets.

d) An overstatement of equity and assets.

e) None of the above

Answer 1

• When adjusting entry for Depreciation expense is recorded:

Depreciation expense is debited,
Accumulated Depreciation is credited.

• This lead to INCREASE in Depreciation Expense a/c (an expense account), and
  INCREASE in Accumulated Depreciation a/c (CONTRA ASSET account).
• Increase in Depreciation expense leads to Increase in Expenses, and Lower Net Incomes which ultimately results in lower Retained earnings and hence lower Equity.
• Increase in Accumulated depreciation will lead to greater amount deducted from “Plant, property and Equipment” section on Asset side, leading to Decrease in Assets side.
• Hence, when the adjusting entries for depreciation ARE RECORDED:

Equity will decrease, and
Assets will increase.

• Answer: When accountant FORGOT to record depreciation:

Equity will be Overstated, and
Assets will be Overstated.

Hence, correct answer is Option ‘d’: An overstatement of Equity and Assets.