Question

Assume that Sunshine Reality Co. borrowed $300,000 from Columbia First Bank and Trust. In recording the transaction, Sunshine erroncousl recorded the receipt as a debit to Cash,$300,000, and a credit to Fee Earned, $300,000. (A) How would this error affect the equity of the trial balance? (B) How would this error affect the income statement, retained earnings statement, and balance sheet?

Answer 1

a. The equality of the trial balance would not be affected. Because it is a compensating error

b. On the income statement, revenues (fees earned) would be overstated by $300,000, and net income would be overstated by $300,000. On the retained earnings statement, the beginning retained earnings would be correct. However, net income and ending retained earnings would be overstated by $300,000. The balance sheet total assets is correct. However, liabilities (notes payable) is understated by $300,000, and stockholders' equity (retained earnings) is overstated by $300,000. The understatement of liabilities is offset by the overstatement of stockholders' equity (retained earnings), and thus, total liabilities and stockholders' equity is correct.

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