Question

Pink Advertising obtained a loan of £12,000 on March 1, 2007 at an annual interest rate of 3%. The loan is payable on March 30, 2007 (including interest payment). At the end of the month, the firm had properly recorded the interest expense incurred and paid for, but made no entry to record the repayment of the principal amount of the loan. Assuming that the company follows IFRS and a financial year reporting period, what is the effect (U/S, O/S, or NO) of this omission on its assets, liabilities and shareholders’ equity as of March 31, 2007? Give a well-reasoned answer.

Answer 1

The following is the effect of non recording of repayment of principal amount of the loan

Assets – Assets are overstated since cash is not reduced for repayment of principal amount of the loan

Liabilities – Liabilities are overstated since loan amount is not reduced by the repayment of principal amount of the loan

Shareholders’ equity- no impact on shareholders’ equity

Accounting equation:

So overall Assets = Liabilities + Shareholders’ equity

Equation gets balanced with overstated assets and overstated liabilities