(Understanding the effect of errors on the elements of the accounting equation, LO 4, 5) For each of the following situations, indicate how the recording errors affect the amount of assets, liabilities, owners’ equity, revenues, and expenses reported in the 2004 financial statements. Indicate whether each category is overstated (too high), understated (too low), or unaffected by the error. Assume that the year end is June 30. Briefly explain why the effects occur and state any assumptions that you make.

Example:

On January 3, 2004 a three-year insurance policy was purchased for $9,000 cash. The bookkeeper debited insurance expense for $9,000 when the policy was purchased.

No adjusting entry was made at year end.

a. On January 3, 2004 a company purchased a new delivery truck for $35,000. The company estimates the truck will be used for five years. No adjusting entry was made at year end.

b. On June 15, 2004 a sports fan purchased seasons tickets for her city’s hockey team’s games for $6,000 cash. The hockey season begins in October and the team recognizes its revenue when the hockey games are played. The bookkeeper credited revenue for $6,000 when the cash was received.

c. On June 30, 2004 no entry was made to reflect the use of water during June.
The water bill will not be received until late August. In June 2003, the company used $5,000 of water and the managers estimate that about the same amount of water was used this year.

d. On September 1, 2004 a company borrowed $1,000,000 from a private lender.
The interest rate on the loan is 6% per year. Interest must be paid on August 31 and February 28 of each year. The loan principal must be paid in full on August 31, 2008. No adjusting entry was-made by the borrower with respect to the loan and interest on June 30, 2004.

e. On April 17, 2004 a $9,570 cash expenditure for capital assets was recorded as $7,570.

Transcribed Image Text:

Situation Assets Liabilities Example Understated No effect Owners' Equity Revenue Understated No effect Overstated Expense Explanation By expensing 100% of the insurance cost in the current year, three years of insurance is expensed in a single year, thereby overstating expenses. Since expenses are closed to owners' equity, the equity section of the bal- ance sheet would be understated. Assets would be understated because the two years of insurance that should be reported on the bal- ance sheet would not be. After three years the financial statements would be correct if the error were not corrected.