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A company has a fiscal year-end of December 31: (1) on October 1, $14,000 was paid for a one-year fire insurance policy; (2) on June 30 the company advanced its chief financial officer $12,000; principal and interest at 6% on the note are due in one year, and (3) equipment costing $62,000 was purchased at the beginning of the year for cash. Depreciation on the equipment is $12,400 per year. If the adjusting entries were not recorded, would the net income be higher or lower, and by how much?

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Answer: Higher by $15,540.

Explanation:

Insurance was paid for a year on October 1 therefore it lasted only 3 months in the year. That needs to be reflected.

= 14,000 * 3/12

= $3,500

$3,500 in insurance for the year.

Advanced $12,000 for principal and note due in a year on June 30 leaving only 6 months in the year. Accounting for that will be,

= 12,000 * 6% * 6/12

= $360

Equipment cost was not an adjusting error but the depreciation is. Depreciation for the year is $12,400.

Adding all the adjusting entries,

= 3,500 + 360 + 12,400

= $15,540

All of the above were expenses to be taken out of Net Income. Therefore if they were not recorded, Income would be higher by $15,540.

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