Question

In 2021, internal auditors discovered that PKE Displays, Inc. had debited an expense account for the $350,000 cost of equipment purchased on January 1, 2018. The equipment’s life was expected to be five years with no residual value. Straight-line depreciation is used by PKE.
Required:

1. Determine the cumulative effect of the error on net income over the three-year period from 2018 through 2020, and on retained earnings by the end of 2020.

2. Prepare the correcting entry assuming the error was discovered in 2021 before the adjusting and closing entries. (Ignore income taxes.)

3. Assume instead that the equipment was disposed of in 2022 and the original error was discovered in 2023 after the 2022 financial statements were issued. Prepare the correcting entry in 2023.

Answer 1

Answer:

1. 210.000

2. 140.000

3. No entral journey is required.

Explanation:

1. To calculate the accumulated depreciation of the equipment:

Accumulated depreciation = depreciation expected for 1 year * 3 years

                    = (Cost of the asset - Residual Value)/Life of the asset  * 3 years  

                    = ((350.000 - 0) / 5) * 3              

                    = 210.000        

   2. Calculate the amount to be adjusted to the retained earnings as show below:

Amount to be adjusted = Expense Wrongly debited - depreciation expense for 3 years.

= 350.000 - 210.000

=140.000

3. No journal entry is required to record in the books of accounts because the equipment will not have any value after 2019.

Thus, no journal entry is required.