A prepayment of insurance of £900 and an accrual for electricity of £400 were both omitted from the draft accounts. What is the net effect on profit?
Answer and explanation
Correct answer: C. Profit is understated by £500
- Step 1: The omitted prepayment means insurance expense is too high by £900, so profit is understated by £900.
- Step 2: The omitted accrual means electricity expense is too low by £400, so profit is overstated by £400.
- Step 3: Net: understated by £900 - £400 = £500.
Answer
Profit is understated by £500.
Why not the others: Overstated by £500 has the direction reversed. £1,300 adds the two items together although they work in opposite directions. Overstated by £1,300 adds them and also reverses the direction.
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