In the course of routine checking of all journal entries prior to preparing year-end reports, Betty Eller discovered several strange entries. She recalled that the presidents son Joe had come in to help out during an especially busy time and that he had recorded some journal entries. She was relieved that there were only a few of his entries, and even more relieved that he had included rather lengthy explanations. The entries Joe made were:

(3)
Wages Expense		120,000
Cash				120,000
(This is for the factory workers wages. I have a note that employer payroll taxes are $18,000. I still think thats part of wages expense and that well have to pay it all in cash sooner or later, so I credited Cash for the wages and the taxes.)

Correct the journal entry and then answer the question: If entry (3) was not corrected, which financial statements (income statement or balance sheet) would be affected? What balances would be overstated or understated?

MY ANSWER FOR PT 2 of the question:

In this entry, both the I/S and B/S are affected. COGS is understated and wages expense is overstated on the income statement. The net income will be overstated by $18,000.

Cash, employer taxes payable, and factory wages payable will be understated and would be shown on the balance sheet. Wages payable are understated since there was no liability. Retained earnings will be overstated on the balance sheet by the $18,000.

Since the payroll tax expense and wages were unpaid, the company should record liabilities for these.

PROFESSOR NOTE: 3. When payroll is processed there are 4 accounts used. For factory wages, they are: Wages Expense, Factory Wages Payable, Employer Tax Expense, and Employer Taxes Payable. You did not discuss all of them. You mentioned Employer Tax Expense but did not state which financial statement it is on and how it is impacted (over/understated).