Question

On December 1, Cox Company purchased $2,220 of supplies on account and debited Supplies Expense, which is an alternate way of recording the initial expenditure. At the end of the calendar year, $1,970 of supplies remained. If the appropriate adjusting entry is not made at the end of the year, what will be the effect on: (a) Income statement accounts (overstated, understated, or no effect)?

Answer 1

If the appropriate adjusting entry is not made, the supplies expense would be overstated, leading to an understatement of net income on the income statement. An example of calculating accounting profit illustrates the importance of capturing expenses accurately to measure true profitability.

Step-by-step explanation:

If Cox Company fails to make the appropriate adjusting entry at the end of the year to account for the $1,970 of supplies still on hand, the supplies expense on the income statement would be overstated. This is because only $250 ($2,220 - $1,970) of supplies should have been recognized as an expense for the year if we match the expense with the period it was used. Instead, the entire $2,220 was recorded as an expense. The overstating of expenses would lead to an understatement of net income for the year.

Self-check Example

As a demonstration of how to calculate accounting profit, consider a firm with $1 million in sales revenue, and expenses that include $600,000 for labor, $150,000 for capital, and $200,000 for materials. To find the accounting profit, we subtract the explicit costs (expenses) from the revenues:

• Sales Revenue: $1,000,000
• Total expenses: $600,000 + $150,000 + $200,000 = $950,000
• Accounting Profit: $1,000,000 - $950,000 = $50,000

If the firm's actual results mirrored this example, their accounting profit would be $50,000 for the year.