[userken8]

On page 95 of the 2011 Wiley FAR textbook,the answer to multiple choice question #7 does not make sense to me.

(Question #7) On Jan 2, 2011, Air, Inc. agree to pay its former president $300,000 under a deferred compensation arrangement. Air should have recorded this expense in 2010 but did not do so. Air’s reported income tax expense would have been $70,000 lower in 2010 had it properly accrued this deferred compensation. In it’s December 31, 2011 financial statements, Air should adjust the beginning balance of its retained earnings by a:

a. $230,000 credit

b. $230,000 debit

c. $300,000 credit

d. $370,000 debit

The answer is b. $230,000 debit. I have read Wiley’s explanation, but it still doesn’t make sense to me. I don’t understand why decreasing 1/11/2011 beginning R/E balance by $230,000, like the answer says will correct the error. I understand that you must take into effect the $70,000 tax savings, but the how’s and why’s of this and decreasing R/E $230,000 is confusing to me. Can someone please explain this answer in a way that anyone can understand?

[SusanStudies]

Ken,

This question is asking what 2010 ending R/E should have been.

In that the $300K should have been expensed in 2010, a debit to R/E would have resulted in 2010. Additionally, a $70k reduction in tax expense would have resulted in 2010 which would have been credited to R/E in 2010. Netting the two, $230K debit would have gone to R/E in 2010. Therefore, to adjust the beginning R/E in 2011, a debit of $230K is necessary.

Hope this helps.

AUD: 07/11/11 - Passed
BEC: 08/27/11 - Passed
FAR: 01/17/12 - Passed
REG: 04/30/12; Re-take 7/16/12 - Passed

FINISHED!!!!!!!!

[kb24]

It's a deferred compensation arrangement which is why the expense should have been included in the 2010 financial statements. If it had been done properly, the 2010 expense total would have been $230K higher ($300K-$70K) and net income would have been $230K lower. Therefore, when the income and expense accounts were closed at the end of the year, R/E should have been $230K lower than was reported on the 2010 F/S. When correcting a material error, you are supposed to restate the prior period F/S. Once the 2010 F/S are corrected the EOY R/E will be $230K lower, which then causes the 2011 BOY R/E to be $230K lower.

Hope this helps.

FAR 4/1/11 - 89
AUD 4/15/11 - 85
REG 4/29/11 - 80
BEC 5/13/11 - 85

[userken8]

Awesome! Both of you explained it beautifully in an easy to understand way. You guys should work for Wiley or Yaeger because these are much better explanations than they give.

[Author]

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