A business receives its electricity account every three months, with the next one expected at the end of July. It needs to record electricity consumption for May and June, which is estimated at $400 per month.
1: Without an adjustment at 30 June, liabilities would be: ____
2: Without an adjustment at 30 June, profit would be: ____

Question

BlackTom AI · Accepted Answer

The scenario presents a business that records electricity consumption on an accrual basis and estimates May and June consumption at $400 per month. Since the account is billed every three months, the expense for May and June should be recognized as an accrual at 30 June to reflect the use incurred but not yet billed.

Option analysis:
- Under-stated by $800: This statement would be true for liabilities at 30 June if the electricity expense for May and June had not been recognized at all (i.e., no accrual recorded). The total unrecorded expense would be 2 months × $400 = $800, which would increase current liabilities (accrued expenses) if recorded, hence liabilities would be understated prior to adjusting.
- Over-stated by $800: This would occur if the company had recorded $800 of expense or liability that did not actually pertain to May and June, or had over-recognized prior to the adjustment. In the given scenario, the proper adjustment would be to recognize $800 of accrual for May and June, not to over-recognize. Therefore, this statement is incorrect.
- Over-stated by $400: An over-statement of $400 would imply recognizing only one month’s accrual instead of two, which would not match the requirement to accrue two months’ expense. This would misstate both liabilities and expenses, making it incorrect.
- Over-stated by $1,200: This would correspond to accruing three months of expense, which is inconsistent with the fact that only May and June (two months) are to be recognized by 30 June. Hence this option is incorrect.
- Under-stated by $1,200: This would imply missing three months of accrual by 30 June, which cannot be justified given the information (two months’ consumption need accrual). Therefore, incorrect.
- Under-stated by $400: This would reflect only one month’s accrual, missing the second month’s consumption. Since two months are relevant (May and June), this option is not appropriate.

Pulling the reasoning together, the correct alignment is that liabilities are understated by $800 before the adjustment, and profit is overstated by $800 before the adjustment, because recognizing the $800 accrual increases expenses and reduces profit by the amount incurred but not yet billed.

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