In Year 2, a company discovered it failed to accrue $50,000 of warranty expense in Year 1. The tax rate is 30%. What is the adjustment to beginning Retained Earnings in the Year 2 Statement of Changes in Equity?

Answer options:

Debit $50,000

Credit $35,000

Debit $35,000

Debit $15,000

How to approach this question

1. Identify Error: Expense understated. 2. Effect on NI: NI Overstated. 3. Effect on RE: RE Overstated. 4. Correction: Debit RE (reduce it). 5. Amount: Net of Tax ($50k * 70%).

Full Answer

C.Debit $35,000✓ Correct

The error overstated Year 1 Net Income. To correct, we must reduce (Debit) Beginning Retained Earnings. The amount is the error net of tax: $50,000 * (1 - 0.30) = $35,000.

Common mistakes

Forgetting tax effect; wrong direction (Credit instead of Debit).

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