In Year 2, a company discovered that it failed to accrue $10,000 of warranty expense in Year 1. The tax rate is 30%. How should this error be reported in the Year 2 financial statements?

Answer options:

As a $10,000 expense in the Year 2 Income Statement

As a $7,000 adjustment to the beginning balance of Retained Earnings

As a $10,000 adjustment to the beginning balance of Retained Earnings

As a change in estimate prospectively

How to approach this question

Error Correction = Retrospective (Prior Period Adjustment). Adjust Beginning Retained Earnings NET OF TAX.

Full Answer

B.As a $7,000 adjustment to the beginning balance of Retained Earnings✓ Correct

Corrections of errors from prior periods are reported as adjustments to the beginning balance of Retained Earnings (net of tax). Gross Error: $10,000 expense. Tax Effect: $3,000. Net Adjustment: $7,000 decrease to RE.

Common mistakes

Reporting it in current income. Forgetting the tax effect.

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