Understating Accrued Expenses Overstates Profit and Net Assets

Steps:

• Accrued expenses are costs incurred but unpaid at year-end, requiring accrual for accurate reporting.
• Understating them records lower expenses than actual, reducing total expenses.
• Profit = Revenue - Expenses, so lower expenses increase reported profit.
• Higher profit boosts retained earnings, increasing net assets (Assets - Liabilities).

Why A is correct:

• Expenses understated → profit overstated (via profit formula); profit overstated → net assets overstated (retained earnings component of equity).

Why the others are wrong:

• B: Net assets cannot be understated if profit is overstated, as profit directly increases equity.
• C: Profit is not understated; understating expenses raises profit.
• D: Neither is understated; both are overstated due to reduced expense recognition.

Final answer: A