What is the effect on the financial statements when a company fails to accrue utilities expense at year-end?

Question

BlackTom AI · Accepted Answer

When evaluating the impact of not accruing utilities expense at year-end, the first step is to think about what accrual accounting does: it recognizes expenses in the period incurred and records a corresponding liability for the amount owed.
Option 1: 'Expenses are understated and stockholders' equity is understated.' If utilities expense is not accrued, expenses are indeed understated, but stockholders' equity would not be understated; it would actually be overstated because lower expenses (relative to recognizing them) lead to higher net income and thus higher retained earnings, increasing equity. This makes this option incorrect.
Option 2: 'Net income is overstated and liabilities are overstated.' Since the expense was not accrued, expenses are too low, so net income would be overstated. However, liabilities should be understated (we owe utilities but haven’t recorded the payable), not overstated. This option is inconsistent with the accrual principle and is incorrect.
Option 3: 'Net income is overstated and assets are overstated.' Not accruing an expense does raise net income, but it does not typically affect assets directly; the missing entry is a liability, not an asset, so assets would not be understated or overstated due to this omission. This option is inaccurate for both parts.
Option 4: 'Expenses are understated and liabilities are understated.' This aligns with the accrual concept: by not recognizing the utilities expense, both the expense line is understated and the corresponding liabilities (accrued utilities payable) are also understated. As a result, net income is not reduced as it should be, and liabilities on the balance sheet are lower than they should be. This option correctly describes the financial-statement impact of failing to accrue utilities expense at year-end.

What is the effect on the financial statements when a company fails to accrue utilities expense at year-end? Single choice

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