On March 5, 2015, you were hired by Hemingway Inc., a closely held company, as a

Question

On March 5, 2015, you were hired by Hemingway Inc., a closely held company, as a staff member of its newly created internal auditing department. While reviewing the company's records for 2013 and 2014, you discover that no adjustments have yet been made for the items listed on the next page. Interest income of $14,100 was not accrued at the end of 2013. It was recorded when February 2014. A computer costing $4,000 was expensed when purchased on July 1, 2013. It is expected to have a 4-year life with no salvage value. The company typically uses straight-line depreciation for all fixed assets. Research and development costs of $33,000 were incurred early in 2013. They were capitalized and were to be amortized over a 3-year period. Amortization of $11,000 was recorded for 2013 and $11,000 for 2014. On January 2, 2013, Hemingway leased a building for 5 years at a monthly rental of $8,000. On that date, the company paid the following amounts, which were expensed when paid. The company received $36,000 from a customer at the beginning of 2013 for services that it is to perform evenly over a 3-year period beginning in 2013. None of the amount received was reported as unearned revenue at the end of 2013. Merchandise inventory costing $18,200 was in the warehouse at December 31, 2013, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method. Instructions Indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2013, and the retained earnings figure reported on the balance sheet at December 31, 2014. Assume all amounts are material, and ignore income tax effects. Using the following format, enter the appropriate dollar amounts in the appropriate columns. Consider each item independent of the other items. It is not necessary to total the columns on the grid.

Explanation / Answer

2013 2013 2014 2014 Item Net Income Understated Net Income Overstated Retained earnings Understated retained earnings Overstated Interest Income No Adjustment as expense did not accrue In 2013, and in 2014 was earned and recored 2) 2013 2013 2014 2014 Item Net Income Understated Net Income Overstated Retained earnings Understated retained earnings Overstated Computer 3000 2000.00 Workings for computer Cost of asset 4000.00 Usefull life 4 Year Depreciation 1000.00 = Cost / Life of asset Expense to be booked in 2013 = 1000 Expense recoreded in 2013 = 4000 Net Income Under ststed = 4000-1000, =3000 Retained earnings understated in 2014 Depreciation expense for 2 years = 2000 Expense recorded in 2013 = 4000 Under stateted retained earnings = 4000-2000 , = 2000 3) 2013 2013 2014 2014 Item Net Income Understated Net Income Overstated Retained earnings Understated retained earnings Overstated Research and development Amortization is properly recorede no further adjustment required 4) 2013 2013 2014 2014 Item Net Income Understated Net Income Overstated Retained earnings Understated retained earnings Overstated Lease expense 20000 20000 Security deposit paid must come under heading other assets in balance sheet 5) 2013 2013 2014 2014 Item Net Income Understated Net Income Overstated Retained earnings Understated retained earnings Overstated Advance from customer 24000 12000 Services are to be performed over 3 years in year 2013 proportionate amount of 24000 is unearned which is recodered in income in year 2014 proportionate amount of 12000 is unearned in year 2014 amount accruing to first two year 24000 is earned so it will remain as income 6) 2013 2013 2014 2014 Item Net Income Understated Net Income Overstated Retained earnings Understated retained earnings Overstated Inventory 18200 It will effect year 2013 as closing inventory is not recoreded profits will reduce by 18200 In year 2014 opening stock will be undervalued and hence profits will show higher amount ultimately retained earning will balance at end of 2014

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