X Company is a merchandiser and prepares monthly financial statements. On May 14

Question

X Company is a merchandiser and prepares monthly financial statements. On May 14, X Company purchased merchandise from a supplier on account, and its accountant recorded the transaction as an increase in Inventories and a decrease in Retained Earnings. What was the effect of this incorrect entry on the May 31 financial statements?

a. Accounts Receivable was overstated.
b. Accounts Payable was understated.
c. Inventories were understated.
d. Retained Earnings was overstated.
e. Profit was overstated.
f. Revenue was understated.

The answer is not e.

Explanation / Answer

When the Company purchased merchandise from a supplier on account - Journal entry would be

Inventory(debit)

Accounts Payable(credit)

a - No impact on Accounts Receivable

b - As Accounts Payable was not recorded, Accounts Payable will be understated

c - As the transaction was recorded as an increase in inventories, Inventories was not understated.

d - As the transaction was recorded as a decrease in retained earnings, retained earnings was understated but not overstated.

f - No impact on revenue.

The answer is B.

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