Misclassification of rent accrual as prepayment

Steps:

• Correct accrual: Debit rent expense (reduces profit), credit rent payable (increases current liabilities).
• Error: Debit prepaid rent (capitalizes cost as asset), credit rent payable (records liability).
• No expense hits income statement, overstating profit by deferring cost.
• Liability recorded without expense offset, overstating current liabilities relative to net position.

Why B is correct:

• Accrual basis requires matching expense to period; capitalizing it violates this, overstating profit, while crediting liability overstates obligations without equity reduction.

Why the others are wrong:

• A: Liabilities understated only if liability omitted, but error records it.
• C: Profit not understated; expense omission overstates it.
• D: Neither is understated; both overstated due to mismatch.

Final answer: B