On May 5, 2012, you were hired by Gavin Inc., a closely held company that follows ASPE, as a staff member of its newly created internal auditing department. While reviewing the company€™s records for 2010 and 2011, you discover that no adjustments have yet been made for the items listed below.
1. Interest income of $18,800 was not accrued at the end of 2010. It was recorded when received in February 2011.
2. Equipment costing $18,000 was expensed when purchased on July 1, 2010. It is expected to have a four-year life with no residual value. The company typically uses straight-line depreciation for all fixed assets.
3. Research costs of $36,000 were incurred early in 2010. They were capitalized and were to be amortized over a three-year period. Amortization of $12,000 was recorded for 2010 and $12,000 for 2011. For tax purposes, the research costs were expensed as incurred.
4. On January 2, 2010, Gower leased a building for five years at a monthly rental of $9,000. On that date, the company paid the following amounts, which were expensed when paid for both financial reporting and tax purposes:
Security deposit ............. $35,000
First month€™s rent .............9,000
Last month€™s rent .............9,000
$53,000
5. The company received $42,000 from a customer at the beginning of 2010 for services that it is to perform evenly over a three-year period beginning in 2010. None of the amount received was reported as unearned revenue at the end of 2010. The $42,000 was included in taxable income in 2010.
6. Merchandise inventory costing $16,800 was in the warehouse at December 31, 2010, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method.
Instructions
Using the table that follows, enter the appropriate dollar amounts in the appropriate columns to indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2010, and the retained earnings figure reported on the balance sheet at December 31, 2011. Assume that all amounts are material and that an income tax rate of 25% is appropriate for all years. Assume also that each item is independent of the other items.
It is not necessary to total the columns on the grid.

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Net Income for 2010 Retained Earnings at Dec. 31, 2011 Item Understated Overstated Understated Overstated