Question

A company has a fiscal year-end of December 31: (1) on October 1, $16,000 was paid for a one-year fire insurance policy; (2) on June 30 the company advanced its chief financial officer $14,000; principal and interest at 8% on the note are due in one year; and (3) equipment costing $64,000 was purchased at the beginning of the year for cash. Depreciation on the equipment is $12,800 per year. If the adjusting entries were not recorded, would net income be higher or lower and by how much?

Answer 1

Insurance expense = 16,000 x 3/12

= $4,000

Interest revenue = Amount advanced x Interest rate x Time period

= 14,000 x 8% x 6/12

= $560

Depreciation expense = $12,800

Error	Effect on Income
1. Insurance expense unrecorded	$4,000 overstated
2. Interest revenue unrecorded	$560 understated
3. Depreciation expense unrecorded	$12,800 overstated
Total net effect	$16,240 overstated

If adjusting entries were not made, net income would be higher by $16,240.

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