Question

3. What would be the result on your balance sheet of recording unearned revenue as revenue? a. Overstated income and overstated liabilities b. Understated revenue and understated assets c. Overstated income and understated liabilities d. Understated income and understated liabilities

Answer 1

3) Unearned revenue (also known as deferred revenue or deferred income) represents revenue already collected but not yet earned.It is to be noted that under the accrual concept, income is recognized when earned regardless of when collected.Unearned revenue should actually be shown as current liability.If it is shown as revenue the liability will be overstated in balance Sheet.

A)If you overstate sales or income  you’ll pay more income tax than necessary.ou arrive at net income when you subtract the tax on your taxable income. If you overstate net income, you inflate retained earnings and owner’s equity, because you add net income to retained earnings at the end of the period.If liabilities are overstated it will affect companys financial ratios and will have a negative impact on the users interest of financial statement.

B) If revenues are understated, so is net income and vice versa. However, accountants must keep a close eye on errors regarding deferred and accrued revenue. Deferred revenue occurs when a company receives cash for a product or service that they haven't delivered yet. If the accountant unnecessarily defers revenue, it understates net income.

Understated Assets.

If inventory is understated at the end of the year, the net income for the year is also understated.
Here's a brief explanation. If a company has a cost of goods available of $100,000 and it assigns too little of that cost to inventory, then too much of that cost will appear on the income statement as the cost of goods sold. Too much cost on the income statement will mean too little net income.

C)You arrive at net income when you subtract the tax on your taxable income. If you overstate net income, you inflate retained earnings and owner’s equity, because you add net income to retained earnings at the end of the period.

If Liablities are understated it shows inflated position of the company and reflects a fake position of the company.

D)Revenues (sales) understated; the ending inventory overstatement causes an understatement of CGS which causes total expenses to beunderstated; because revenues are understated by more than the expenses,income is understated

When an accountant says that an amount is understated, it means two things:

1. The amount is not the correct amount, and
2. The amount is less than the true amount. In other words, the amount is too small.

To illustrate the term understated, let's assume that a company is reporting its accounts payable as $11,000. Let's also assume that the correct or true amount of accounts payable is $20,000. An accountant will say that the reported amount of $11,000 is understated by $9,000.

Thus understated liabilities will show wrong position of balance sheet which will result in calculation of financial ratios ase wrong.