The financial statements of Franklin Company contained the following errors:
$$\begin{array} { l r r r }
\text { Item } &{ December 31, 2009 } & {December 31,2010 } \
\text { Depreciation expense on office } & & \
\text { equipment } & \$ 1,000 understated & \$ 900 overstated \
\end{array}$$ Requirements:
A.Was net income for 2009 understated or overstated?
B.Was total combined net income for the two-year period ended December 31,2010 overstated or understated?

Question

The financial statements of Franklin Company contained the following errors:
 $$\begin{array} { l r r r } 
\text { Item } &{ December 31, 2009 } &  {December 31,2010 }  \
\text { Depreciation expense on office } &  & \
\text { equipment } & \$ 1,000 understated & \$ 900  overstated \
\end{array}$$ Requirements:
A.Was net income for 2009 understated or overstated?
B.Was total combined net income for the two-year period ended December 31,2010 overstated or understated?

Quizplus · Accepted Answer

Depreciation expense reduces net income because it is an expense that is deducted from revenues. If the depreciation expense on office equipment for the year 2009 was understated by $1,000, it means that the expense reported on the income statement was $1,000 less than it should have been. As a result, the net income for 2009 was higher than it should have been because the expenses were not fully accounted for. Therefore, the net income for 2009 was understated by $1,000.
B. Total combined net income for the two-year period ended December 31, 2010, was understated.
 To determine the effect on the total combined net income for the two-year period, we need to consider the errors in both years.
For 2009, as explained above, net income was understated by $1,000 due to the understatement of depreciation expense.
For 2010, the depreciation expense on office equipment was overstated by $900. This means that the expense reported on the income statement was $900 more than it should have been. As a result, the net income for 2010 was lower than it should have been because the expenses were over-accounted for. Therefore, the net income for 2010 was overstated by $900.
When we combine the two years:
- Understatement in 2009: $1,000
- Overstatement in 2010: $900
The net effect on the total combined net income for the two-year period is an understatement of $100 ($1,000 understatement in 2009 minus $900 overstatement in 2010). Thus, the total combined net income for the two-year period ended December 31, 2010, was understated by $100.

The Financial Statements of Franklin Company Contained the Following Errors