Wilkins Food Products, Inc. acquired a packaging machine from Lawrence Specialists Corporation. Lawrence completed construction of the machine on January 1, 2004. In payment for the machine Wilkins issued a three-year installment note to be paid in three equal payments at the end of each year. The payments include interest at the rate of 10%.
Lawrence made a conceptual error in preparing the amortization schedule which Wilkins failed to discover until 2006. The error had caused Wilkins to understate expense by $45,000 in 2004 and $40,000 in 2005.
1. Determine which accounts are incorrect as a result of these errors at January 1, 2006, before any adjustments. Explain your answer. (Ignore income taxes)
2. Prepare a journal entry to correct the error.
3. What other step(s) would be taken in connection with the error.
1. The interest expense is understated by $45,000 and $40,000=$85,000. This would mean that net income would be overstated by $85,000. The understatement of interest expense would lead to understatement of notes payble. The journal entry for interest payment is
Interest expense ...
The solution discusses the error in the amortization schedule.