Question

C Co. reported a retained earnings balance of $200,000 at December 31, 2010. In September 2011, C determined that insurance premiums of $30,000 for the three-year period beginning January 1, 2010, had been paid and fully expensed in 2010. C has a 30% income tax rate. What amount should C report as adjusted beginning retained earnings in its 2011 statement of retained earnings?
A. $220,000
B. $214,000
C. $221,000
D. $210,000

Answer 1

Answer:

B. $214,000

Explanation:

The insurance premium paid for a 3 year period should not have been expensed out rightly but recognized as expense through periodic amortization spread over the entire period.

As such, the amount that should have been expensed in 2011 for insurance premium is

= 1/3 × $30,000

= $10,000

Recognizing an expense of $10,000 rather than $30,000 would have resulted in an increase in the tax expense by

= 70% × ($30,000 - $10,000)

= $14,000

As such, the retained earnings would have been

= $200,000 + $14,000

= $214,000

The overstatement of an expense would have resulted in an understatement of net income and thus and understatement of the retained earnings.