Question

On March 5, 2018, you were hired by Waterway Inc., a closely held company, as a staff member of its newly created internal auditing department. While reviewing the company’s records for 2016 and 2017, you discover that no adjustments have yet been made for the items listed below.

Items
1.		Interest income of $15,000 was not accrued at the end of 2016. It was recorded when received in February 2017.
2.		A computer costing $4,000 was expensed when purchased on July 1, 2016. It is expected to have a 4-year life with no salvage value. The company typically uses straight-line depreciation for all fixed assets.
3.		Research and development costs of $33,600 were incurred early in 2016. They were capitalized and were to be amortized over a 3-year period. Amortization of $11,200 was recorded for 2016 and $11,200 for 2017.
4.		On January 2, 2016, Waterway leased a building for 5 years at a monthly rental of $8,400. On that date, the company paid the following amounts, which were expensed when paid.

Security deposit		$20,100
First month’s rent		8,400
Last month’s rent		8,400
		$36,900

5.		The company received $39,300 from a customer at the beginning of 2016 for services that it is to perform evenly over a 3-year period beginning in 2016. None of the amount received was reported as unearned revenue at the end of 2016.
6.		Merchandise inventory costing $18,900 was in the warehouse at December 31, 2016, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method.

Indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2016, and the retained earnings figure reported on the balance sheet at December 31, 2017. Assume all amounts are material, and ignore income tax effects. Using the following format, enter the appropriate dollar amounts in the appropriate columns. Consider each item independent of the other items. It is not necessary to total the columns on the grid.

Answer 1

	Net Income year ending December 31, 2016		Retained Earnings December 31, 2017
	Understated	Overstated	Understated	Overstated
1)	$15,000.00	$0.00	$0.00	$0.00
2)	$3,500.00	$0.00	$2,500.00	$0.00
3)	$0.00	$22,400.00	$0.00	$11,200.00
4) ($20,100 + 8400)	$28,500.00	$0.00	$28,500.00	$0.00
5)		$26,200.00		$13,100.00
6)	$18,900.00	$0.00	$0.00	$0.00
2) Depreciation charged for 6 months in year 2016 = $4000/ 4 years x 6/12	$500.00
Net Income understated = $4000 - $500	$3,500.00
Depreciation 2017 = 4000/4	$1,000.00
RE understated = $3500 - $1000	$2,500.00
3)
Amortization = $33,600/3	$11,200.00
NI Overstated = $33,600 - $11200	$22,400.00
RE Overstated = $33,600 - 11200 -11200	$11,200.00
5)
Unearned Income = $39,300/3	$13,100.00
NI Overstated = $39,300 - $13,100	$26,200.00
RE Overstated = $39,300 - $13,100 - $13100	$13,100.00