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 Year 1
Retained earnings, 1/1 $700,000 $500,000
Net income 150,000 200,000
Retained earnings, 12/31 $850,000 $700,000

Dek’s year 3 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 3 and year 2 comparative financial statements?

Year Retained earnings Net income
year 2 --    150,000
year 3    ($50,000)      180,000
year 2 ($50,000) $150,000
year 3    --      180,000
year 2 ($50,000) $125,000
year 3    --      180,000
year 2 -- $125,000
year 3    --      180,000

Answer 1

Answer:

Dek Corp.

The amounts should be adjusted to retained earnings and presented for net income in Dek’s year 3 and year 2 comparative financial statements are:

Year    Retained earnings  Net income

year 2       ($50,000)          $150,000

year 3           --                       180,000

Explanation:

a) Data and Calculations:

Years 1 and 2 net income overstated by $25,000 each.

                                              Year 2      Year 1

Retained earnings, 1/1      $700,000  $500,000

Net income                          150,000    200,000

Retained earnings, 12/31 $850,000  $700,000

b) With the above amounts, the retained earnings of Year 2 are adjusted by a negative $50,000 value, representing the overstated net income for years 1 and 2.  This will reduce Year 2's ending retained earnings to $800,000 ($850,000 - $50,000).  The second amount will simply state the net income for year 3 as it is.