How to Figure Out Wh a t Is Going to Be Underst a ted or Overst a ted in Accounting PDF

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How to Figure Out Wh a t Is Going to Be Underst a ted or Overst a ted in Accounting...

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How to Figure Out What Is Going to Be Understated or Overstated in Accounting Everyone makes mistakes, including accountants. Because accounts are interrelated, any mistake in the financial records causes a ripple effect. Unnecessary revenue entries will overstate net income and retained earnings, while unnecessary expense entries understate net income and retained earnings. Accountants can post a journal entry to correct any mistakes in the financial statements. Expense Errors As a general rule of thumb, overstated expenses will understate net income and understated expenses will overstate income. Expenses often are accrued and deferred, which complicates matters. If an expense is accrued when it didn't need to be, it understates income. For example, if the accountant accrues interest expense at the end of the year and it turns out the interest expense doesn't need to be paid, net income is understated. Likewise, expenses that are deferred unnecessarily overstate net income. Revenue Errors If revenues are overstated, so is net income and vice versa. However, accountants must keep a close eye on errors regarding deferred and accrued revenue. Deferred revenue occurs when a company receives cash for a product or service that they haven't delivered yet. If the accountant unnecessarily defers revenue, it understates net income. Accrued revenue means the company has earned the revenue but hasn't received the cash yet. If accrued revenue is recorded unnecessarily, net income is overstated. Inventory Errors Errors surrounding inventory balance affect the cost of goods sold account and net income. An accountant calculates cost of goods sold by adding inventory purchases and subtracting the ending inventory balance from the beginning inventory balance. If the value of ending inventory is overstated, that means the cost of goods sold, is understated and net income is overstated. The opposite effect occurs for errors in the beginning balance of inventory; overstating beginning inventory means the cost of goods sold is overstated and net income is understated Effect on Equity Income statement errors don't necessarily affect assets and liabilities, but they do affect equity. At the end of the accounting period, the accountant closes out net income to retained earnings. Retained earnings represents the earnings and equity the company has accumulated. If net income is overstated for the period, retained earnings also will be overstated and vice versa.

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