Question

Baxter company failed to accrue $30,000 of salary expense at the end of 2017. The salaries expense was recorded as paid in 2018. Ignoring taxes, what journal entry will Baxter make in 2018 to correct this error?

Answer 1

Ans

Since Bexter Company failed to accrue Salary Expense of $ 30,000 as on December 31, 2017 and record them at the time of payment in the year 2018

Thus in December 31, 2017, it has made an error by not recording the following entry :

Salary Expense A/c Dr. $ 30,000

To Salary Expense Payable A/c $ 30,000

And further in 2018 it made an error by the following:

Salary Expense A/c Dr. $ 30,000

To Cash A/c    $ 30,000

This is an error because this salary expense belong to the year 2017 and not 2018. In short income statement of 2018 do not deserve this expense.

If we analyse the above situation, we can conclude the following :

For the Year 2017

- Expense were understated and thus Net income was overstated

-Retained Earnigs was overstated as net income flows into Retained Earnings

- Salary Expense Payable is understated or you can say Laibilities are understated.

For the Year 2018

- Expenses are overstated and thus Net Income is understated

- Salary Expense Payable is correct and Retained Earning is also correct.

Now you can argue how Retained Earnings are correct. Since last year i.e. 2017 Net Income was overstated and this year i.e 2018 Net Income is understated by same amount. Hence they both have offset each other. This is know as Counterbalancing.

Now you can understand from aboove that this is a counterbalance error.

In order to rectify this counterbalancing error there are two possibilities :

i)

If the error is discovered before closing entries have been made in the second period i.e. 2018. Then in such a case an entry must be made to correct retained earnings. As counterbalance action would be effected at closing and we are still before closing. This correction entry is known as Prior Period adjustments.

In order to make the correction following entry is required to be passed in 2018

Retained Earnings A/c Dr $ 30,000

To Salary Expense A/c    $ 30,000

Explanation :

Retained Earnings is debited, as it was overstated in 2017

Salary Expense is credited because it was earlier recognised as an expense for 2018 which was incorrect. Hence to reverse the effect it should now be credited.

ii) If the error is discovered after closing is effected, then no need to take any corrective actions as due to counterbalancing action on closing retained earnings would be auto corrected. Balance sheet accounts are correct and income statement would have zero balances due to closing.