Question

Langley Company's December 31 year-end financial statements contained the following errors:

Dec. 31, 2012 Dec. 31, 2013
Ending inventory $15,000 understated $22,000 overstated
Depreciation expense 4,000 understated

An insurance premium of $36,000 was prepaid in 2012 covering the years 2012, 2013, and 2014. The prepayment was recorded with a debit to insurance expense. In addition, on December 31, 2013, fully depreciated machinery was sold for $19,000 cash, but the sale was not recorded until 2014. There were no other errors during 2013 or 2014 and no corrections have been made for any of the errors. Ignore income tax considerations.

What is the total net effect of the errors on Langley's 2013 net income?
a. Net income understated by $29,000.
b. Net income overstated by $15,000.
c. Net income overstated by $26,000.
d. Net income overstated by $30,000.

Answer 1

After individually adjusting for each error, Langley Company's 2013 net income appears to be overstated by $22,000, which is not one of the provided answer choices. This discrepancy may suggest an error in the question or answer choices.

Step-by-step explanation:

Impact of Errors on Langley's 2013 Net Income

To determine the total net effect of the errors on Langley Company's 2013 net income, we need to examine and adjust each error individually and then aggregate the impact. Let's start with the inventory errors:

• Ending inventory for 2012 was understated by $15,000. This understatement would cause the cost of goods sold (COGS) for 2012 to be overstated, and as a result, the net income for 2012 would be understated. In 2013, this error would reverse, causing the COGS for 2013 to be understated by $15,000, and the net income for 2013 to be overstated by the same amount.
• Ending inventory for 2013 was overstated by $22,000, which means the COGS for 2013 was understated and net income was overstated by $22,000.
• The depreciation expense was understated by $4,000 in 2012. This error carries over to 2013, where it would result in net income being overstated by an additional $4,000.

Regarding the prepaid insurance:

• The insurance premium of $36,000 covering three years (2012, 2013, and 2014) should have been recorded as a prepaid asset and expensed over the coverage period. The journal entry in 2012 should have been a debit to prepaid insurance (an asset) and credit to cash. Instead, it was all expensed in 2012. The correct yearly expense is $12,000 ($36,000 / 3 years).
• For 2013, only $12,000 should have been expensed, but because the initial entry was incorrect, it did not affect 2013 expenses. Thus, there is no error affecting 2013 net income related to the insurance premium.

Concerning the sale of fully depreciated machinery:

• The sale of machinery for $19,000 in 2013 was not recorded in 2013, it was instead recorded in 2014. This deferral would cause 2013 net income to be understated since the earnings from the sale were not recognized in the correct period.

Summing up the impacts:

• Net income for 2013 is overstated by $15,000 (inventory error from 2012).
• Additionally overstated by $22,000 (inventory error from 2013).
• Further overstated by $4,000 (depreciation error).
• No effect from the prepaid insurance error.
• Understated by $19,000 due to the unrecorded sale of machinery.

When we sum these impacts ($15,000 + $22,000 + $4,000 - $19,000), we get a total overstatement of $22,000 for 2013 net income.

Therefore, the correct answer is that Langley's 2013 net income is overstated by $22,000, indicating a choice not present in the options given, potentially due to an error in the original question or answer choices.