Part 1The current pay period ends on Friday, January 2, yet the company's fiscal year-end is on Wednesday, December 31. If the company does not make the proper adjusting entry to accrue payroll expenses at year-end, what would be the impact? Part 1
A. Assets will be understated. B. Liabilities will be overstated. C. Operating income will be overstated. D. Stockholders' equity will be understated.

Question

Part 1The current pay period ends on​ Friday, January​ 2, yet the​ company's fiscal​ year-end is on​ Wednesday, December 31. If the company does not make the proper adjusting entry to accrue payroll expenses at​ year-end, what would be the​ impact? Part 1
A. Assets will be understated. B. Liabilities will be overstated. C. Operating income will be overstated. D. ​Stockholders' equity will be understated.

BlackTom AI · Accepted Answer

Under accrual accounting, expenses are recorded when incurred, not when paid; therefore unpaid payroll at year-end requires an adjusting entry (debit Salaries Expense; credit Salaries Payable).

1) Relevant knowledge points and concepts
- Matching principle: record expenses in the period they are incurred to match with related revenues.
- Adjusting entry for accrued payroll: increases expenses and increases liabilities (salaries or wages payable).
- Effects on the basic accounting equation and income statement: Expenses affect operating income; net income affects retained earnings and thus stockholders’ equity.

2) Step-by-step reasoning
- At fiscal year-end (Dec 31) employees have earned wages for work done, but cash will be paid Jan 2. An adjusting entry should recognize those earned wages as an expense and a liability.
- Correct adjusting entry: Debit Salaries Expense (increase expense); Credit Salaries Payable (increase liability).
- If this entry is omitted, the Salaries Expense is too low for the year and Salaries Payable is not recorded.

3) Numerical illustration (intermediate steps)
- Suppose unpaid payroll = $10,000.
- Proper entry would increase expenses by $10,000 and liabilities by $10,000.
- Omission means reported expenses are $10,000 lower than they should be, so operating income (revenues − expenses) is $10,000 higher than it should be.
- Liabilities are $10,000 understated; retained earnings (and total stockholders’ equity) are $10,000 overstated because net income was overstated.

4) Why the correct answer is correct
- Operating income is based on recognized expenses; omitting an accrued payroll expense understates total expenses, which directly overstates operating income.

5) Why the other choices are incorrect
- A. Assets will be understated — incorrect: assets are unaffected by this payroll accrual.
- B. Liabilities will be overstated — incorrect: liabilities would actually be understated because the payable isn’t recorded.
- D. Stockholders’ equity will be understated — incorrect: because net income is overstated, retained earnings (equity) will be overstated, not understated.

Conclusion: Operating income will be overstated, which matches the provided correct answer C.

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