[Topsya]

So, here’ s a question

While preparing its year 3 financial statements, Dek Corp. discovered computational errors in its year 2 and year 1 depreciation expense. These errors resulted in overstatement of each year’s income by $25,000, net of income taxes. The following amounts were reported in the previously issued financial statements:

Year 2

Retained earnings, 1/1 $700,000

Net income $150,000

Retained earnings, 12/31 $850,000

Year 1

Retained earnings, 1/1 $500,000

Net income $250,000

Retained earnings, 12/31 $700,000

Dek’s year 3 net income is correctly reported at $180,000. Which of the following amounts should be adjusted to retained earnings and presented for net income in Dek’s year 2 and year 3 comparative financial statements?

The Correct answer is:

Year 2

R.E. ($50,000)

Net Income $125,000

Year 3

R.E. – No Adjustments

Net Income $180,000

So this was the problem.

Now, my qauestion is why R.E. would be adjsuted for $50,000 if one of the errors happened 3 years ago and therefore is self-balanced by now?

According to the solution:

The actual journal entry made to correct retained earnings at 1/1/Y3 is

Retained earnings 50,000

Accumulated depreciation 50,000

WHY?

Million thanks,

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[ipasscpa]

In year one net income was overstated by $25,000 and in year two net income was overstated by $25,000 in total of $50,000 for both year. This $50,000 was transferred into retained earnings at the year end. So to balance out you will reduce the retained earnings and increase the accumulated deprecation.

Feel free to correct me because i took Far a while ago.

CPA- VA

[Topsya]

isnt year 1 overstatement suppose to correct itself by the end of year 3?

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[Jason2345]

I think you're trying to apply the concept of self correcting inventory counts to other things.

If they got the depreciation wrong, it won't correct itself unless they fix it themselves.

For this problem, it looks like they messed up for years 1 and 2 and then got it right for year 3.

In order to fix an error, you either go back and restate the financial statements (if they are presented) or fix it through the beginning balance of retained earnings. The beginning balance for year three is the same as the ending balance for year two, so you fix it by adjusting the ending balance for year two at 1/1/year 3.

[Topsya]

Thank you @Jason2345!!!!! SO MUCH!

So, the self-correcting concept of 2 years is only applicable to inventory?

For some reason I though it was a universal rule of thumb! DUH

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[thehip41]

Just try to think through things logically.

With inventory, there is a physical count. Lets say you actually had 10 books year 1 end, but recorded only 5. You still have 10 books.

So year 2 end, you count your books, lets say you have 15 now.

According to your books, you had 5 at the start of the year, now you have 15, so your COGS will be that 10 + the info from what you bought and sold.

But the point is, that mistake you made in yr 1 will auto correct now, because even though the books say 5, you have 10 books.

With depreciation, lets use the same numbers.

Lets say you were supposed to have depreciation of 10, but only put 5 in the books.

In the books, you have 5, when you actually count the depreciation, oh wait, you can't.

So yr 2 end, when you count of depreciation, that 5 you missed is still missing.

That's why when you catch the error, you need to adjust retained earnings for the correct amount.

FAR - 83
AUD - 73 92
BEC - 83
REG - 88

Licensed CPA in the state of Michigan

[Tncincy]

bless your heart….I hope that wasn't a sim. lol

It begins with a 75
Been here too long as a cheerleader....ready to pass

[Author]

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