Question

On November 1, 20X3, your calendar year company receives $40,000 for space it is subletting for 5 months (November 1, 20X3 through March 31, 20X4). The $40,000 was recorded as revenue. On December 31, 20X3, you discover that an adjusting entry was never made. If you fail to make the correcting entry, liabilities will be understated and net income will be understated liabilities will be overstated and net income will be overstated liabilities will be understated and net income will be overstated liabilities will be overstated and net income will be understated the financial statements will be accurate because an adjusting entry was not necessary

Answer 1

• Amount received = $ 40,000

Amount received on 1 Nov, 20X3

Amount received for 5 months [Nov to Mar]

• Since, rental revenue is received for 5 months, out of which 2 months [Nov and Dec] falls under this current year, ONLY two months of rental revenue should have been recorded.

	Entry posted (Wrong entries)			Correct entries that should have been posted
Date	General Journal	Debit	Credit	General Journal	Debit	Credit
1 Nov 20X3	Cash	$            40,000.00		Cash	$      40,000.00
	Rental Revenue		$              40,000.00	Unearned Rent Revenue		$      40,000.00
31 Dec 20X3	No entry			Unearned Rent Revenue	$      16,000.00
				Rent Revenue [40000 x 2months/5months]		$      16,000.00

• Hence, under given circumstance Revenues have been recorded as $40,000, while they should have been recorded as $16,000 only (for 2 months)
• This will result in:

Liabilities Understated (by $ 24,000: amount of Unearned revenue - for 3months), and
Net Income Overstated (by $ 24,000: $40000 - $16000)