Armstrong Inc. is a calendar-year corporation. Its financial statements for the

Question

Armstrong Inc. is a calendar-year corporation. Its financial statements for the years ended 12/31/14 and 12/31/15 contained the following errors:

                                                                  2014                                                   2015               

Ending inventory                    $25,000 overstatement                  $40,000 understatement

Depreciation expense            10,000 understatement                20,000 overstatement

            Assume that no correcting entries were made at 12/31/14, or 12/31/15. Ignoring income taxes, by how much will retained earnings at 12/31/15 be overstated or understated?

Explanation / Answer

Retained earnings at 12/31/15 are understated by $25000

In 2014, Ending inventory is overstated by $25,000 which means the profits would be overstated by $25000 and Depreciation expense is understated by $10000 which means the profits would be overstated by $10000

at 12/31/2014 the retained earnings are overstated by $35000 (25000+10000)

In 2015 Ending inventory is understated by $40,000 which means the profits are understated by $40000 and depreciation expense is overstated at $20000 which again means profits are understated by $20000

at 12/31/15 the profits are understated by 60000 - 35000 =$25000

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