For each of the following potential unrecorded liabilities, determine the effect
ID: 2577644 • Letter: F
Question
For each of the following potential unrecorded liabilities, determine the effects of the omission on both the balance sheet and income statement of the client. Assume that the inventories recorded on the balance sheet reflect the results of a year-end (December 31) physical inventory. (If there is no effect select "No effect" from dropdown.)
An invoice for $3,000 worth of inventory items, dated January 1 and bearing terms of FOB destination, was not recorded. The goods were shipped December 27 and were received on December 30.
Balance Sheet Effect:
Income Statement Effect:
An invoice for $5,500 worth of inventory items, dated December 30 and bearing terms of FOB destination, was not recorded. The goods were shipped December 28 and received January 2.
Balance Sheet Effect:
Income Statement Effect:
An invoice for $8,000 for a delivery truck, dated January 2 and bearing terms of FOB shipping point, was not recorded. The truck was shipped December 30 and received on January 3.
Balance Sheet Effect:
Income Statement Effect:
An invoice for $1,000 for legal fees rendered in December was not recorded.
Balance Sheet Effect:
Income Statement Effect:
Explanation / Answer
Effects of omission on balance sheet and income statement of client or buyer are shown as under:
[An invoice for $3,000 worth of inventory items, dated January 1 and bearing terms of FOB destination was not recorded. The goods were shipped December 27 and were received on December 30.]
Balance sheet Effect:
Explanation: As per FOB destination accounting rules, when the goods are at client’s destination or received by the client or buyer, the ownership of goods passes to the client or buyer.
Asset- In the above transaction, goods are received by client on 30th December (i.e. before 31st December year end), so now client is the owner of goods. Because of this, the value of inventory should be shown on asset side of balance sheet.
Liability- As the invoice is dated January 1, the amount will be paid in next financial year. But, as the goods are received on 30th December, so $ 3,000 is current liability (of current year) payable on 1st January of next financial year.
Income Statement Effect:
Value of cost of goods sold overstated because of which the amount of net income gets reduced.
Explanation: Cost of goods sold is calculated as:
Opening stock + Net purchases+ Direct expenses- Closing stock
-If closing stock is understated with $ 3000, cost of goods sold will increase. And if cost of goods sold increases it will reduce net income.
[An invoice for $5,500 worth of inventory items, dated December 30 and bearing terms of FOB destination was not recorded. The goods were shipped December 28 and received January 2.]
Balance sheet Effect: No effect
Income Statement Effect: No effect
Explanation: As per FOB destination accounting rules, the ownership of goods passes to the client or buyer only when the goods are at client’s destination.
In the above transaction, goods are received on 2nd January (i.e. in next financial year), so client is not responsible for the inventory of $5,500 irrespective of invoice date (i.e. December 30).
[An invoice for $8,000 for a delivery truck, dated January 2 and bearing terms of FOB shipping point, was not recorded. The truck was shipped December 30 and received on January 3.]
Balance sheet Effect:
Income Statement Effect: Expenses understated
Explanation: As per FOB shipping accounting rules, once the goods are at shipping point, client is responsible for the expenses and also gets ownership.
In the above transaction, $ 8,000 is the expense of delivery truck (not the value of inventory) incurred on December 30. So, this expense will be shown in books of client.
Asset- Expense of $ 8,000 should be deducted from cash, which will reduce the amount of cash.
Also, this is also shown as expenses in income statement, which will reduce net income as expenses will increase.
[An invoice for $1,000 for legal fees rendered in December was not recorded]
Balance sheet Effect: Cash understated
Income Statement Effect: Expenses understated
Explanation: As legal fees is expense, it will reduce cash in balance sheet and increase expenses in income statement.
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