On December 31, 2014, the Maggie Company recognized $15,000 in revenue from rent of $5,000 due in 2015 and $10,000 due in 2016, all collected in advance from another company. Ignoring income taxes, if this error is not detected
A) Retained Earnings at December 31, 2015, will be overstated by $10,000
B) Retained Earnings at December 31, 2015, will be understated by $10,000
C) Retained Earnings will be overstated by $15,000 until the error is discovered
D) Retained Earnings at December 31, 2015, will be understated by $15,000

Question

Quizplus · Accepted Answer

The revenue recognition principle requires companies to recognize revenue when earned or realized, regardless of when payment is received. In this case, the Maggie Company recognized $15,000 in revenue for rent that will not be earned until 2015 and 2016. As a result, the company has overstated its revenue and net income in 2014. The $5,000 due in 2015 will be recognized as revenue in 2015, reducing retained earnings by $5,000. The remaining $10,000 due in 2016 will be recognized as revenue in 2016, reducing retained earnings by another $10,000. Therefore, the error will result in an overstatement of retained earnings by $10,000 until the revenue is actually earned in the years the rent is due.

On December 31, 2014, the Maggie Company Recognized $15,000 in Revenue