Concept explainers
Videos
If a corporation overstates its earnings, are its liabilities more likely to be overstated or understated? Explain.
Explain whether the overstatement of the income would result in the overstated liabilities or understated liabilities.
Explanation of Solution
Overstatement:
It refers to the situation where the amount of any item has been stated more than its actual figure. Overstated revenue results in an overstatement of profits. Similarly, overstated liability results in understating of shareholders’ equity.
Understatement:
It refers to the situation where the amount of any item has been stated less than its actual figure. Understated revenue results in an understatement of profits. The understated liability results in overstating of shareholders’ equity.
Explain whether the overstatement of the income would result in the overstated liabilities or understated liabilities:
Overstatement of the income would result in the understated liabilities. When the income of the company has increased then the shareholder’s fund would result in the overstated. The overstated shareholder fund would result in the understated of other liabilities in order to balance the liability side. When the profit earns for the company, then the resulted profit would decrease the overall balance of the liabilities. So there is an inverse relationship between the profit balance and the liabilities balance of the business.
Thus, the overstatement of income would lead to understated liabilities.
Want to see more full solutions like this?
Chapter 14 Solutions
Principles Of Auditing & Other Assurance Services
- Is there a consequence for reported profit or loss if a particular financial instrument, for example, a preference share, is designated as debt rather than equity? Explain the consequence.arrow_forwardWhich of the following statements is incorrect? Earnings and profits are conceptually similar to retained earnings. A distribution from earnings and profits in excess of stockholder basis is a nontaxable return of capital. A distribution of appreciated property creates a gain to the corporation. Distributions paid in excess of earnings and profits are nontaxable to the extent of stockholder basis.arrow_forwardQuestion: Why is it that fair value's are thought to be more relevant in some financial reporting situations? Please Explain.arrow_forward
- Why might a company want to hedge its balance sheet exposure? What is the paradox associated with hedging balance sheet exposure?arrow_forwardWhy are liability accounts included in the capital acquisitionand repayment cycle audited differently from accounts payable?arrow_forwardHow is a business activity distinguished from an investment activity? why is this distinction important for the purpose of calculating federal income taxes? What types of losses may potentially be characterized as passive losses?arrow_forward
- Appropriation of retained earnings is necessary when the corporation reacquires its own share capitalTrue or False?arrow_forwardProvide an example of items that would be adjusted directly against equity rather than being included as part of profit or loss.arrow_forwardExplain what is meant by the term ‘financial distress’. If we assume that financial distress exists, explain how and why financial distress would cause a firm’s equity to become riskier.arrow_forward
- Why do the basis and at-risk rules usually prevent the same amount of losses from passing through to shareholders of S corporations? Need Proper explanationarrow_forwardsome examples of items that would be adjusted directly against equity, rather than beingincluded as part of profit or loss.arrow_forward
College Accounting, Chapters 1-27AccountingISBN:9781337794756Author:HEINTZ, James A.Publisher:Cengage Learning,