Peter Henning Tool Company\'s December 31 year-end financial statements containe

Question

Peter Henning Tool Company's December 31 year-end financial statements contained the following errors. An insurance premium of $56,490 was prepaid in 2014 covering the years 2014, 2015, and 2016. The entire amount was charged to expense in 2014. In addition, on December 31, 2015, fully depreciated machinery was sold for $18,600 cash, but the entry was not recorded until 2016. There were no other errors during 2014 or 2015, and no corrections have been made for any of the errors. (Ignore income tax considerations.) (Enter negative amounts using either a negative sign preceding the number e.g. -15,000 or parentheses e.g. (15,000).) Compute the total effect of the errors on 2015 net income. Total effect of errors on net income. Compute the total effect of the errors on the amount of Henning's working capital at December 31, 2015. Total effect on working capital Compute the total effect of the errors on the balance of Henning's retained earnings at December 31, 2015. Total effect on retained earnings

Explanation / Answer

(a). Computation of effect of errors on 2015 net income:

Ending inventory (Overstated)                                                       ($7081)

Opening inventory in 2015 (Understated) i.e closing of 2014        ($9041)
Insuarance premium it is to be charged to 3 years equally           ($18830)

Machine sold entry not made                                                          $18600

Effect of errors on 2015 net income                                             = ($16352)

Net income of 2015 is overstated by $16352 due to errors.

b). Effect on working capital :

Opening inventory in 2015 (Understated) i.e closing of 2014                                      ($9041)

Ending inventory (Overstated)                                                                                      ($7081)

Cash / Account receivable is not account for because machine entry is not made.     $18600

Effect on working capital                                                                                            =   $2478

working capital of 2015 is un derstated by $2478

c). Total effect on Retained Earnings at Dec '15

Effect of errors on 2014 net income  

Ending Inventory (understated)                                                     $9041

Depreciation expense understated                                               ($ 2611)

Insuarance premium fully debited in 2015. But it is to be

equally dividedin 3 years.                                                              $37660

Effect of errors on 2014 net income                                             = $44090

Net income of 2015 is understated by $44090 due to errors.

Total effect on Retained Earnings at Dec '15 = Accumulated effects of errors of income of 2014 & 2015

= ($16352) + $44090

= $27738

Total Retained Earnings has been understated by $27738.

                                          

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