Choice "A" is correct. Net income is overstated because Hayworth should not report the entire $20,000 as sales revenue during the current year. Under the revenue recognition rule, revenue cannot be recognized until services have been performed. Of the $20,000 received by Hayworth, $18,000 is for the equipment and $2,000 is for the two-year service contract. When the $20,000 was received, it should have been recorded with the following journal entry:
| Debit (Dr) | Credit (Cr) |
|---|
| Cash | $ 20,000 | |
| Sales revenue | | $ 18,000 |
| Deferred revenue | | 2,000 |
As services are provided on the contract over the two years, deferred revenue will be debited and sales revenue will be credited. Choice "b" is incorrect. The financial statements are not correct because Hayworth should have only recorded sales revenue for services on the contract performed in the current year.
Choice "c" is incorrect. Total assets are correctly stated as cash of $20,000 was correctly recorded when received.
Choice "d" is incorrect. Total liabilities are understated, not overstated, because Hayworth should have reported deferred revenue, not sales revenue, when the $20,000 was received.
