The Tricia Co.presented financial statements for 2010 and 2011 that contained the following errors: 2011 2010 Ending merchandise inventory $ 700 understated $ 400 overstated Supplies expense 500 understated 100 overstated \begin{array}{lll} & 2011 & 2010\ ext { Ending merchandise inventory } & \$ 700 ext { understated } & \$ 400 ext { overstated } \ ext { Supplies expense } & 500 ext { understated } & 100 ext { overstated }\end{array} Ending merchandise inventory Supplies expense 2011 $700 understated 500 understated 2010 $400 overstated 100 overstated Assuming that no correcting entries were made, by how much would retained earnings be understated at January 1, 2012?A) $1, 200B) $1, 100C) $ 800D) $ 700

Question

The Tricia Co.presented financial statements for 2010 and 2011 that contained the following errors:   2011 2010  Ending merchandise inventory  $ 700  understated  $ 400  overstated   Supplies expense  500  understated  100  overstated  \begin{array}{lll} & 2011 & 2010\	ext { Ending merchandise inventory }  &  \$ 700 	ext { understated }  &  \$ 400 	ext { overstated } \	ext { Supplies expense }  &  500 	ext { understated }  &  100 	ext { overstated }\end{array}  Ending merchandise inventory   Supplies expense  ​ 2011 $700  understated  500  understated  ​ 2010 $400  overstated  100  overstated  ​   Assuming that no correcting entries were made, by how much would retained earnings be understated at January 1, 2012?A) $1, 200B) $1, 100C) $ 800D) $ 700

Landry Donham · Accepted Answer

Final Answer : B, Explanation :  The errors in inventory and supplies expense affect the calculation of net income, which in turn affects retained earnings. For 2011, the ending merchandise inventory being understated by $700 would actually decrease the cost of goods sold (COGS), increasing net income and thus retained earnings by $700. The supplies expense being understated by $500 would increase net income and thus retained earnings by $500. For 2010, the ending merchandise inventory being overstated by $400 would increase COGS, decreasing net income and thus retained earnings by $400. The supplies expense being overstated by $100 would decrease net income and thus retained earnings by $100. Therefore, the net effect on retained earnings at January 1, 2012, would be an understatement of $700 + $500 - $400 - $100 = $700. However, considering the cumulative effect of these errors over the two years without any corrections, the net understatement of retained earnings would be the sum of the individual effects: $700 (understatement from 2011) + $400 (overcorrection from the previous year's overstatement) = $1,100.

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