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 Payable was understated.
B. Profit was overstated.
C. Inventories were understated.
D. Revenue was understated.
E. Retained Earnings was overstated.
F. Accounts Receivable was overstated.

Explanation / Answer

A. Accouhts payable was understated

The actual entry should have increased inventory balance and at the same time increase accounts payable balance, since it is a purchase on account.

SInce instead of increasing accoutns payable , the entity reduced the retained earnings it can be said that the entity understated the accounts payable.

Retained earnings in under stated (so option E is not correct).

Accounts receivable is not affected by the transaction.

Inventory is correctly recorded.

Profits and revenues are also unaffected by this error.

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