Question

Example of overstated and understated in accounting

Answer 1

An overstated balance is one that is reported as having a greater balance than it actually does, while an understated balance is one that is reported as having a lesser balance than it actually does.

Here are some examples of overstated and understated balances for you to consider:

1-
Suppose that a firm received a utility bill that is due in 28 days, but failed to recognize the expense. Under the accrual basis of accounting, the company should record the receipt of the bill even though it is not due for 28 days. Until the bill is recorded, Utilities Payable (a liability) is understated and Utilities Expense is also understated. Also, because expenses are understated, net income is overstated.


2-
Suppose that a firm paid for six months of insurance and correctly recorded the payment to Prepaid Insurance. After the first month lapses, the firm should expense one-sixth (1/6) of the payment amount. If the company fails to do so, Prepaid Insurance (an asset) is overstated and Insurance Expense is understated. Also, because expenses are understated, net income is overstated.