[Kairos]

Althouse co discovered that equipment purchased on January 2 for $150,000 was incorrectly expensed at the time. The equipment should have been depreciated over five years with no salvage value. What amount, if any, should be adjusted to Althouse’s depreciation expense at January 2, the beginning of the third year, when the error was discovered?

answer: 0

Why is there no adjustment needed?

Thanks!

[Missy]

Something is obviously missing here.

Licensed Massachusetts Non Reporting CPA since 2012
Finance/Admin/HR Manager

[Kairos]

Apologies, its only althouse.

[Missy]

You wouldn't adjust depreciation expense on Jan 2 of year 3 because it's not a year 3 expense. (I.e. You don't want year three to take the hit for all of the depreciation)

Depending on the materiality you'd restate the prior 2 years financial statements. If that was not necessary for some reason you'd adjust accumulated depreciation and retained earnings

Licensed Massachusetts Non Reporting CPA since 2012
Finance/Admin/HR Manager

[spatel15]

More importantly, depreciation is usually recorded at Year End? (or periodically at least) Because who knows, you may end up selling it off before you recognize full expense.

[Kairos]

Ah good points, thanks! So when it's a matter of fixing errors with depreciation, they aren't adjusted, just restate the prior financial statements right?

[spatel15]

That's true, but I think that's more an “extra” for this problem. If it had asked what is the adjusting entry at Year End, there would be an answer though. They key is understanding that expenses are recognized when they are incurred. Day 1, nothings been incurred.

Errors are fixed for the period they were made; unless of course it was too far back and your statements do not show the “error” year, in which case you adjust RE for the earliest year presented and work from there.

[Missy]

No not at all. When it's an error with a prior year (could be any account not just depreciation) if it's material and would affect someone's interpretation of the financials you go back and restate them.

There IS an adjusting entry to be made but it's not to an expense.

Basically the income statement should only reflect the current year transaction. The balance sheet is cumulative.

Licensed Massachusetts Non Reporting CPA since 2012
Finance/Admin/HR Manager

[Anonymous]

Regarding the original question, the adjustment is zero because depreciation expense isn't adjusted, as previously mentioned. I'm going to discuss what adjustment is made, however, since that's being discussed.

The answer would be the same whether the problem occurs on Jan 2, March 31, or Dec 31. A correction of an error is a PPA and restatement. Your PPA will correct the balance sheet accounts to the proper amount.

Dr. — Equipment 150,000

Cr. — Acc. Depr. 60,000

Cr. — Retained E. 90,000

That's your PPA. The equipment wasn't recorded, it was expensed, so it has to be added to the books. The two years of depreciation that weren't recorded should be added to accumulated depreciation. The remainder increases retained earnings (it was incorrectly lowered by 90,000 of expense that has not hit the books yet).

Because no year 3 depreciation has been incurred, nor should it have been, depreciation will be carried out as usual at year end.

Dr — Depreciation Expense 30,000

Cr — Accumulated Depr. 30,000

[Author]

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