Question

At the end of 2003, Ritzcar Co. fails to accrue sales commissions earned during 2003, but paid in 2004. The error is not repeated in 2004. What was the effect of this error on 2003 ending working capital and on the 2004 ending retained earnings balance

Answer 1

Answer:

The effect of this error on 2003 ending working capital is that it overstated the ending 2003 working capital.

The error does not have effect on the 2004 ending retained earnings balance.

Explanation:

Let the amount of the commission expense be xxxx.

At the end of 2003, the journal entries should have been as follows:

Debit Commission expense for xxxx

Credie Commission payable for xxxx

Also, we have:

Working capital = Current assets – Current liabilities ………… (1)

From equation (1), current liabilities are understated because commission payable which was not recorded is an item under current liabilities. Since the current liabilities are understated, that indicates that the working capital in equation is overstated. Therefore, the effect of this error on 2003 ending working capital is that it overstated the ending 2003 working capital.

When the 2003 commission expense in the entries above was paid in 2004, it would have been recognized as an expense. This made the error to counterbalance. This implies that the 2004 ending retained earnings balance is still correct despite that there are errors in the earnings of the two years. Therefore, the error does not have effect on the 2004 ending retained earnings balance.