Question

 A company has a fiscal year-end of December 31: (1) on October 1, $32,000 was paid for a one-year fire insurance policy; (2) on June 30 the company advanced its chief financial officer $30,000; principal and interest at 8% on the note are due in one year; and (3) equipment costing $80,000 was purchased at the beginning of the year for cash. Depreciation on the equipment is $16,000 per year.

If the adjusting entries were not recorded, would net income be higher or lower and by how much?

Answer 1

Net income would be

higher

by

22800

 

1.      Insurance expense = ($32,000 / 12 months) x 3 months (October – December) = $8,000 for all three months

 

2.      Interest revenue = Amount advanced x Interest rate x Time period =

[($30,000 x 0.08) / 12 months] x 6 months (from June to December) = $1200 for the months from June to December

 

3.      Depreciation expense $16,000

 

Error	Effect on Income
1.      Insurance   expense (unrecorded)	8000 (overstated)
2.      Interest   revenue (unrecorded)	-1200 (understated)
3.      Depreciation   expense (unrecorded)	16000 (overstated)
Total   net effect	22800