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Langley Company's December 31 year-end financial statements contained the following errors:

An insurance premium of $18,000 was prepaid in 2010 covering the years 2010, 2011, and 2012.The prepayment was recorded with a debit to insurance expense.In addition, on December 31, 2011, fully depreciated machinery was sold for $9,500 cash, but the sale was not recorded until 2012.There were no other errors during 2011 or 2012 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, 2011?

Question

Use the following information for questions.
Langley Company's December 31 year-end financial statements contained the following errors:
  
An insurance premium of $18,000 was prepaid in 2010 covering the years 2010, 2011, and 2012.The prepayment was recorded with a debit to insurance expense.In addition, on December 31, 2011, fully depreciated machinery was sold for $9,500 cash, but the sale was not recorded until 2012.There were no other errors during 2011 or 2012 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, 2011?

Quizplus · Accepted Answer

The insurance premium prepaid in 2010 was recorded with a debit to insurance expense, which would have reduced working capital. However, the prepayment covered the years 2010, 2011, and 2012, so at the end of 2011, only two-thirds of the prepayment had been used up. Therefore, working capital was overstated by $18,000/3 x 2 = $12,000. 
The fully depreciated machinery sold for $9,500 cash in 2011 but the sale was not recorded until 2012. This error does not affect working capital at the end of 2011. 
Therefore, the total net effect of the errors on the amount of Langley's working capital at December 31, 2011, is an understatement of $12,000 (overstatement of $0 - overstatement of $12,000).

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