Use the following information for questions.
Cheyenne Ltd.'s December 31 year-end financial statements contained the following errors: An insurance premium of $ 3,600 was prepaid in 2019 covering the calendar years 2019, 2020, and 2021. This had been debited to insurance expense. In addition, on December 31, 2020, fully depreciated machinery was sold for $ 1,900 cash, but the sale was not recorded until 2021. There were no other errors during 2020 or 2021 and no corrections have been made for any of the errors. Ignore income tax considerations.
-What is the total effect of the errors on the balance of Cheyenne's retained earnings at December 31, 2020?
A) Retained earnings understated by $ 2,000
B) Retained earnings understated by $ 900
C) Retained earnings understated by $ 500
D) Retained earnings overstated by $ 700

Question

Use the following information for questions.
Cheyenne Ltd.'s December 31 year-end financial statements contained the following errors:  An insurance premium of $ 3,600 was prepaid in 2019 covering the calendar years 2019, 2020, and 2021. This had been debited to insurance expense. In addition, on December 31, 2020, fully depreciated machinery was sold for $ 1,900 cash, but the sale was not recorded until 2021. There were no other errors during 2020 or 2021 and no corrections have been made for any of the errors. Ignore income tax considerations.
-What is the total effect of the errors on the balance of Cheyenne's retained earnings at December 31, 2020?
A) Retained earnings understated by $ 2,000 
B) Retained earnings understated by $ 900 
C) Retained earnings understated by $ 500 
D) Retained earnings overstated by $ 700

Quizplus · Accepted Answer

The prepaid insurance of $3,600 was debited to insurance expense, resulting in an overstatement of expenses and understatement of net income in 2019, 2020, and 2021. The correct journal entry to record the prepaid insurance should have been a debit to Prepaid Insurance and a credit to Cash. The error results in an understatement of retained earnings by $1,200 ($3,600/3 years). On the other hand, failure to record the sale of fully depreciated machinery for $1,900 on December 31, 2020, resulted in an overstatement of assets (machinery) and retained earnings by $1,900. The correction of the error would decrease both assets and retained earnings by $1,900. Thus, the total effect of the errors on the balance of Cheyenne's retained earnings at December 31, 2020, is an understatement of $500 ($1,200 - $1,900 = -$700, rounded up to $500).

Use the Following Information for Questions