Blue Tool Company’s December 31 year-end financial statements contained the foll

Question

Blue Tool Company’s December 31 year-end financial statements contained the following errors.

                                         December 31, 2017.               December 31, 2018

Ending inventory.         $10,500 understated.                  $8,400 overstated

Depreciation expense.   $2,300 understated.                           ___

An insurance premium of $65,700 was prepaid in 2017 covering the years 2017, 2018, and 2019. The entire amount was charged to expense in 2017. In addition, on December 31, 2018, fully depreciated machinery was sold for $16,000 cash, but the entry was not recorded until 2019. There were no other errors during 2017 or 2018 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).)

(a) Compute the total effect of the errors on 2018 net income.

___________

(b) Compute the total effect of the errors on the amount of Blue's working capital at December 31, 2018.

__________

(c) Compute the total effect of the errors on the balance of Blue's retained earnings at December 31, 2018

__________

Explanation / Answer

1. The ending inventory of 31 dec, 2017 becomes opening inventory of 31 dec, 2018

2.Insurance premium to be charged in 2018 = $65,700/3 = $21,900

3. As the machinery was fully depreciated, it had no book value. Therefore, the selling price is the gain.

(b) Effect on Working Capital

(c) No effect on retained earnings

Event Effect Amount opening inventory understated Leads to decrease in net income ($10,500) Ending inventory overstated Leads to decrease in net income ($8,400) Insurance premium to be recorded Leads to decrease in net income ($21,900) Profit on sale of machinery Leads to increase in net income $16,000 Total effects of errors on net income of 2018 net decrease in income ($24,800)

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