On March 5, 2018, you were hired by Waterway Inc., a closely held company, as a

Question

On March 5, 2018, you were hired by Waterway Inc., a closely held company, as a staff member of its newly created internal auditing department. While reviewing the company’s records for 2016 and 2017, you discover that no adjustments have yet been made for the items listed below.

Indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2016, and the retained earnings figure reported on the balance sheet at December 31, 2017. Assume all amounts are material, and ignore income tax effects. Using the following format, enter the appropriate dollar amounts in the appropriate columns. Consider each item independent of the other items. It is not necessary to total the columns on the grid.

Items 1. Interest income of $15,000 was not accrued at the end of 2016. It was recorded when received in February 2017. 2. A computer costing $4,000 was expensed when purchased on July 1, 2016. It is expected to have a 4-year life with no salvage value. The company typically uses straight-line depreciation for all fixed assets. 3. Research and development costs of $33,600 were incurred early in 2016. They were capitalized and were to be amortized over a 3-year period. Amortization of $11,200 was recorded for 2016 and $11,200 for 2017. 4. On January 2, 2016, Waterway leased a building for 5 years at a monthly rental of $8,400. On that date, the company paid the following amounts, which were expensed when paid.

Explanation / Answer

Net Income year ending December 31, 2016 Retained Earnings December 31, 2017 Understated Overstated Understated Overstated 1) $15,000.00 $0.00 $0.00 $0.00 2) $3,500.00 $0.00 $2,500.00 $0.00 3) $0.00 $22,400.00 $0.00 $11,200.00 4) ($20,100 + 8400) $28,500.00 $0.00 $28,500.00 $0.00 5) $26,200.00 $13,100.00 6) $18,900.00 $0.00 $0.00 $0.00 2) Depreciation charged for 6 months in year 2016 = $4000/ 4 years x 6/12 $500.00 Net Income understated = $4000 - $500 $3,500.00 Depreciation 2017 = 4000/4 $1,000.00 RE understated = $3500 - $1000 $2,500.00 3) Amortization = $33,600/3 $11,200.00 NI Overstated = $33,600 - $11200 $22,400.00 RE Overstated = $33,600 - 11200 -11200 $11,200.00 5) Unearned Income = $39,300/3 $13,100.00 NI Overstated = $39,300 - $13,100 $26,200.00 RE Overstated = $39,300 - $13,100 - $13100 $13,100.00

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