[FutureCPA123]

Hi all,

I am getting tripped up by what seems like such a simple question:

FAR-31. Holt Co. discovered that in the prior year, it failed to report $40,000 of depreciation related to a newly constructed building. The depreciation was computed correctly for tax purposes. The tax rate for the current year was 20%. How should Holt report the correction of error in the current year?

A. As an increase in accumulated depreciation of $32,000.
B. As an increase in accumulated depreciation of $40,000.
C. As an increase in depreciation expense of $32,000.
D. As an increase of depreciation expense of $40,000.

The answer is B. I totally understand that we debit retained earnings and credit accumulated depreciation, but I selected A since I accounted for it as net of tax. Most prior period adjustments take into account the income tax effect. Now I understand that book & tax depreciation are different. Is that the reason why it’s B (the gross amount)?

[12tang]

The question tells you that 40k was missed for GAAP depreciation. That's the solution right there, if 40k was missed, then 40k needs to be booked. They try confusing you by saying that depreciation was booked correctly for tax, and they give you a distractor, the tax rate. Tax rates don't affect depreciation. My guess, is they are mixing this question with problems that are net of tax. They are testing to see if you understand that distinction. My advice would be to look at a detailed I/S and see what things are reported net of tax.

Using Becker self-study
FAR: (82) 175 hours - 1st attempt
BEC: (XX)
AUD: (69) 45hrs of study - 1st attempt
REG: (XX)

[AusNat]

You're correct, usually you would adjust RE for a prior period correction net of the tax affects. However, in this case they specifically told you that depreciation was calculated correctly on the tax return (yes, usually tax depreciation expense is independently calculated by the tax preparer – we use our own depreciation schedules for the client's assets, so this is a likely scenario). So the entity isn't going to have to pay any additional tax in future years or go back and amend a return to get a tax refund – for tax purposes, there will be no effect from this prior period adjustment. The tax return was correct even though the books weren't. So you don't have to include any tax effect in your RE adjustment.

[FutureCPA123]

Thank you both!!

[Author]

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