Error Correction – HELP!!!!!!

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    Topic
  • #178687
    Topsya
    Member

    At the beginning of the current year, Hayworth Co. sold equipment with a two-year service contract for a

    single payment of $20,000. The fair value of the equipment was $18,000. Hayworth recorded this

    transaction with a debit of $20,000 to cash and a credit of $20,000 to sales revenue. Which of the

    following statements is correct regarding Hayworth’s current-year financial statements?

    a. The financial statements are correct.

    b. Net income will be overstated.

    c. Total assets will be overstated.

    d. Total liabilities will be overstated

    The correct answer is “B” . Which I totally agree with: “Hayworth has not earned all of the income because it has not fulfilled all requirements related to the service contract and, therefore, should not recognize all of the revenue in the year the equipment is sold. Consequently, net income is overstated. “

    ok

    BUT

    Wouldn’t the assets be overstated as well?

    Since you didn’t remove them from the books?

    I JUST DONT GET IT!!!!!

    Please someone explain this to me!!!!

    Bunch of thanks,

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Viewing 10 replies - 1 through 10 (of 10 total)
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  • #602054
    Topsya
    Member

    Really? No one knows?

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    #602055
    NYCaccountant
    Participant

    Total assets will not be overstated because the cash balance will be 20k,whether you recorded the entry as revenue or as deferred revenue. Obviously because the entry was recorded incorrectly, Net Income is overstated, and liabilities are understated.

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    #602056
    Topsya
    Member

    But what about Equipment? Hayworth did not remove it from the books therefore Net Assets are overstated…..

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    #602057
    jsmithsae
    Member

    the question does not specifically state the inventory was not removed from the books, nor does it state they were. So we look for the next error.

    this is one of those questions that you must choose the “best” answer. the facts clearly state an error on the sales revenue recognition side so that would be the answer they are looking for.

    that is my opinion on this question…

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    #602058
    Topsya
    Member

    ok

    Thank you @NYCaccountant and @jsmithsae

    i really appreciate your help

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    #602059
    NYCaccountant
    Participant

    Yes, the equipment obviously would have been removed from the books because your don't retain ownership of it any longer.

    You would have to assume that because it's difficult to imagine a scenario where I sell equipment to someone, but retain control of that equipment.

    Here is an example of what i'm describing:

    Debit Credit

    Cash – 20,000 Original entry recording the sale.

    Equipment – 18,000 Assuming the cost of the equipment is the same as fair value

    COGS -18,000

    Revenue 20,000 Incorrectly recording the revenue and overstating revenue.

    Here is how I would recorded it:

    Debit Credit

    Cash- 20,000 In both scenarios, Assets remain the same, so they are not overstated.

    Equipment- 18,000 The only thing that would be overstated is Net Income and retained earnings.

    COGS-18,000

    Revenue 10,000

    Deferred Revenue 10,000

    AUD - 99
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    NYC born and raised.

    FAR - 93
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    BEC - 84!!!!
    AUD - 99!!!!!! CPA exam complete.

    #602060
    Topsya
    Member

    Aren't you suppose to Dr Cash and Cr Equipment and Cr Gain on Sale of Equipment when you are selling it?

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    #602061
    NYCaccountant
    Participant

    Yes, but i was assuming the equipment was apart of inventory and not fixed assets. Either way, your total assets would

    not be overstated,whether you removed the equipment from inventory or fixed assets.

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    #602062
    thehip41
    Participant

    If they didn't remove the equipment from the books, yes, assets would be overstated.

    However, net income will ALWAYS be overstated in this problem.

    So it's easy to see why you would pick the net income option, since it's 100% overstated, and not dependent on an if/then statement.

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    #602063
    se7en.14
    Participant

    is the $2,000 difference always deferred revenue?

    .
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