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? O Profit was overstated O Retained Earnings was overstated. Accounts Payable was understated. Revenue was understated. Accounts Receivable was overstated Inventories were understated. Submit Answer Tries 0/2

Explanation / Answer

Solution:

Due to incorrect entry, accountant debited inventory correctly (Inventory increased) but debited retained earnings (Decrease in retained earnings) incorrectly.

The correct recording of this transaction is increase in inventories and increase in accounts payable.

Due to incorrect entry Retained earnings was understated and Accounts payable was also understated due to non booking of liability.

Hence option 3, "Accounts payable was understated" was the effect of this incorrect entry.

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