How would the following errors affect the account balances and the basic accounting equation, Assets = Liabilities + Owners' Equity? How do the misstatements affect income?
o The purchase of a truck is recorded as an expense instead of an asset.
o A cash payment on accounts receivable is received but not recorded.
o Fictitious sales on account are recorded.
o A clerk misreads a handwritten invoice for repairs and records it as $1,500 instead of $1,800.
o Payment is received on December 31 for the next three months' rent and is recorded as revenue.
To determine the impact of the errors on the account balances and the basic accounting equation, Assets = Liabilities + Owners' Equity, let's analyze each error:
1. The purchase of a truck recorded as an expense instead of an asset:
This error would affect both the balance sheet and income statement. As an expense, it would decrease net income and retained earnings on the shareholders' equity section of the balance sheet. It would also decrease assets (specifically, the Truck account) and increase liabilities (if the purchase was made on credit).
2. Cash payment on accounts receivable received but not recorded:
This error would not affect the basic accounting equation because no entry has been made, but it does affect income. As the cash payment has not been recorded, it would not be included as revenue, causing a decrease in net income and retained earnings.
3. Fictitious sales on account recorded:
This error affects both the income statement and the basic accounting equation. Fictitious sales artificially increase revenue and net income, leading to an overstatement of assets (Accounts Receivable) and retained earnings. The equation would not be balanced because assets would be overstated while owners' equity would be understated.
4. A clerk misreads a handwritten invoice for repairs:
This error affects both income and the basic accounting equation. By recording the invoice as $1,500 instead of $1,800, expenses would be understated, leading to an overstated net income and retained earnings. The accounts payable (liability) balance would be understated, while assets (cash) would be overstated due to the incorrect payment.
5. Payment received for future rent recorded as revenue:
This error affects both the income statement and the basic accounting equation. Since the payment is for future rent, it should be recorded as a liability (unearned revenue) until the services are provided. Recording it as revenue would overstate income and retained earnings while understating the liability.
In summary, these errors affect both the account balances and the basic accounting equation in various ways, leading to inaccurate financial statements. They can result in misstated income and distortions in the balance of assets, liabilities, and owners' equity.