Question

A financial analyst discovers that Stark Industries has been inappropriately capitalising R&D costs in each year and amortizing them completely over a three-year period on a straight-line basis, beginning in the year after the cost was incurred. A total of $24m, $30m and $36m was inappropriately capitalised for fiscal years 2017, 2018 and 2019, respectively. At the financial year end of 30 June 2019, it had total assets of $280m. Net income was $20m for fiscal 2019. Ignore tax effects for this question.
Required:
a. Compute the amount of total asset and expense misstatement (over or understatement) in each period and provide your answer in the boxes provided below. Show all workings in the spaces provided.
b. Which other account(s), if any, will be mis-stated as a result of the above accounting treatment at the end of fiscal 2019?
c. Prepare the journal entries for correcting the misstatements that arise from the inappropriate capitalisation of R&D at the end of fiscal 2019. Note: Extra space for the journal entries has been provided below

Answer 1

Answer:

Stark Industries

a. Amount of total asset overstatement and expense understatement:

Total Asset and Expense Misstatements:

                  Assets                            Expenses

              Overstatement                  Understatement  

2017        $24m ($24m -$0)             $24m  

2018        $46m (24 -8 + 30)m         $22m ($30m- $8m)

2019       $64m (46 -18 + 36)m        $18m ($36m - $18m)

b. The Retained Earnings account will be misstated as a result of the above accounting treatment at the end of fiscal 2019.

c. Journal Entries:

June 30, 2019:

Debit R&D expense $82m

Credit Total assets $64m

Credit Amortization Expense $18m

To correct the R&D amortization and inappropriate capitalization.

Explanation:

a) Data and Calculations:

30 June 2019:

Total assets = $280m

Net income = $20m

             Amortization      R&D              Amount

               Expense         Costs          Capitalized

2017             $0               $24m          $24m ($24m - $0)

2018            $8m             $30m          $46m ($24m - $8m + $30m)

2019           $18m            $36m          $64m ($46m - $18m + $36m)

Calculation of amortization expenses:

2017 R&D costs =  $24m/3 = $8m

2018 R&D costs = $30m/3 = $10m

2019 R&D costs = $36m/3 =$12m