ExpertHard1 markMultiple Choice
CPA · Question 10 · Area III: Select Transactions
At the beginning of Year 1, Delta Co. discovered it had erroneously expensed a $100,000 equipment purchase in Year 0. The equipment should have been depreciated over 5 years (straight-line, no salvage). The tax rate is 30%. <br/><br/>What is the adjustment to the beginning Retained Earnings of Year 1 (net of tax)?
At the beginning of Year 1, Delta Co. discovered it had erroneously expensed a $100,000 equipment purchase in Year 0. The equipment should have been depreciated over 5 years (straight-line, no salvage). The tax rate is 30%. <br/><br/>What is the adjustment to the beginning Retained Earnings of Year 1 (net of tax)?
Answer options:
A.
Increase $70,000
B.
Increase $56,000
C.
Decrease $56,000
D.
Increase $80,000
How to approach this question
1. Determine the correct accounting vs actual accounting. 2. Calculate the pre-tax difference in Year 0 income. 3. Apply tax rate. 4. Determine direction (Understated or Overstated NI).
Full Answer
B.Increase $56,000✓ Correct
Year 0 Error Analysis:<br/>Actual Expense: $100,000 (Full cost)<br/>Correct Expense: $20,000 (Depreciation: 100k/5)<br/>Difference: Expenses were Overstated by $80,000.<br/>Therefore, Year 0 Net Income was Understated by $80,000 (pre-tax).<br/><br/>Correction:<br/>Increase Retained Earnings by the understated amount, net of tax.<br/>Adjustment = $80,000 * (1 - 0.30) = $56,000 Increase.
Common mistakes
Forgetting to deduct the depreciation that should have been taken; forgetting tax effect.
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