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

Question

Quizplus · Accepted Answer

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.

The Tricia Co Assuming That No Correcting Entries Were Made, by How Much