Use the following information for questions 57 through 59.
Langley Company's December 31 year-end financial statements contained the following errors: An insurance premium of $54,000 was prepaid in 2014 covering the years 2014, 2015, and 2016. The prepayment was recorded with a debit to insurance expense. In addition, on December 31, 2015, fully depreciated machinery was sold for $28,500 cash, but the sale was not recorded until 2016. There were no other errors during 2015 or 2016 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 the amount of Langley's working capital at December 31, 2015?
A) Working capital overstated by $15,000
B) Working capital overstated by $4,500
C) Working capital understated by $13,500
D) Working capital understated by $36,000

Question

Use the following information for questions 57 through 59.
Langley Company's December 31 year-end financial statements contained the following errors:  An insurance premium of $54,000 was prepaid in 2014 covering the years 2014, 2015, and 2016. The prepayment was recorded with a debit to insurance expense. In addition, on December 31, 2015, fully depreciated machinery was sold for $28,500 cash, but the sale was not recorded until 2016. There were no other errors during 2015 or 2016 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 the amount of Langley's working capital at December 31, 2015?
A) Working capital overstated by $15,000 
B) Working capital overstated by $4,500 
C) Working capital understated by $13,500 
D) Working capital understated by $36,000

Quizplus · Accepted Answer

Working capital is current assets minus current liabilities. The effect of the errors on working capital is:
- The prepaid insurance, which was erroneously expensed, should have been recorded as a current asset. Therefore, current assets are overstated by $54,000.
- The sale of the machinery should have been recorded in 2015, decreasing the current asset account of machinery and increasing cash. Since the machinery was fully depreciated, its net book value was zero. Therefore, the effect of the sale on working capital is an increase in cash of $28,500.
- There is no effect of the errors on current liabilities.
The net effect of the errors on working capital at December 31, 2015 is therefore an overstatement of current assets by $54,000 and an increase in cash of $28,500, resulting in a total net overstatement of working capital of $25,500. However, the question asks for the effect of the errors on working capital at December 31, 2015 only, so we must subtract the effect of the insurance prepayment, which relates to 2014 and 2015. Thus, the net effect of the errors on the amount of Langley's working capital at December 31, 2015 is an understatement of working capital by $13,500.

Use the Following Information for Questions 57 Through 59