The accountant for the Fred Company did not record a purchase of merchandise on

Question

The accountant for the Fred Company did not record a purchase of merchandise on credit or include the items in the ending inventory. The effect of these omissions on assets, liabilities, and retained earnings would be (assume a periodic inventory system):

Assets

Liabilities

Retained Earnings

a.

Understate      Understate          Understate

b.

Understate      Understate          No effect

c.

No effect       Understate          No effect

d.

Understate      No effect           Understate

Please explain the answer.

Thank you.

Assets

Liabilities

Retained Earnings

Explanation / Answer

Option b is correct i.e. assets and liabilities were understated. Since, is it credit credit purchase journla entry is follows

Debit: Purchases

Credit: Accounts payable

At end of the period purchase account is transferred to inventory account. Here purchase entry not recorded it means inventory will show lower balance than actual. Hence assets are understated.

Accounts payable is liability account, in the given problem it is not recorded hence liabilities alwo understated.

Hence, remaining options are incorrect.

We can trace with formula as below:

Assets = Liabilities + Equity

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