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.) Compute the total effect of the errors on 2015 net income. Compute the total effect of the errors on the amount of Henning's working capital at December 31, 2015. Compute the total effect of the errors on the balance of Henning's retained earnings at December 31, 2015.

Explanation / Answer

Net working capital and retained earnings are both important indicators of a company’s health. Net working capital describes a company’s liquidity -- how well it can pay its bills. Retained earnings are the accumulated profits of the business. While at first glance the two measures might seem only distantly related, if you own a private business and are in divorce proceedings, net working capital and retained earnings play an important role in settling the marital estate.

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