Chapter 20, Problem 20.15P

To determine

Correction of errors:

Correction of errors is the adjustment of inadvertent discrepancies that has occurred while reporting the financial statements. Correction of error is done to rectify the financial statements.

To journalize: The necessary journal entry to rectify the error and adjustment entry related to the situation.

Explanation of Solution

(a)

Error correction entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Equipment		45,000
	Accumulated depreciation  (1)			18,000
	Retained earnings (balancing figure)			27,000
	(To record accumulated depreciation correction)

Table (1)

• Equipment is an asset. There is increase in an asset. Thus, it is debited.
• Accumulated depreciation is a contra asset. There is a decrease in value of asset. Therefore credit accumulated depreciation by $18,000.

Adjustment entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Depreciation expense   (2)		9,000
	Accumulated depreciation			9,000
	(To record accumulated depreciation)

Table (2)

• Depreciation expense is an expense. There is an increase in expense, thus it is debited.
• Accumulated depreciation is a contra asset. There is a decrease in value of asset. Therefore credit accumulated depreciation by $9,000

Working Notes:

Determine the amount of accumulation depreciation of two years.

$\begin{array}{c}\text{Annual depreciation}=\frac{\text{Cost of asset}}{\text{Estimated value of life}}\times \left(\begin{array}{l}\text{Number of }\\ \text{years completed}\end{array}\right)\\ =\frac{\$45,000}{5}\times 2\\ =\$18,000\end{array}$ (1)

Determine the amount of depreciation expense.

$\begin{array}{c}\text{Annual depreciation}=\frac{\text{Cost of asset}}{\text{Estimated value of life}}\\ =\frac{\$45,000}{5}\\ =\$9,000\end{array}$ (2)

(b)

Reverse the wrong entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Cash		17,000
	Office Supplies			17,000
	(To reverse the wrongly recorded transaction)

Table (3)

• Cash is an asset and increased, hence debit cash.
• Office Supplies is an expense. There is a decrease in expense, thus it is credited.

Adjustment entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Assembling Tools		17,000
	Cash			17,000
	(To record purchase of assembling tools)

Table (4)

• Assembling Tools expense is an expense. There is an increase in expense, thus it is debited.
• Cash is paid while purchasing assembling tools which has reduced the amount of cash, so it has been credited.

(c)

Record the correct entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Inventory		78,000
	Retained earnings			78,000
	(To record change in inventory)

Table (5)

• Inventory is an asset. There is an increase in asset, thus it is debited.
• Retained earnings have been understated, so it has been credited.

(d)

Record the correct entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Retained earnings  (3)		22,000
	Paid in capital			22,000
	(To record small stock dividend)

Table (6)

• Stock dividend is paid out of retained earnings. Hence, there is a decrease in retained earnings. Thus, it is debited.
• Paid in excess of capital is a liability. There is an increase in liability. Thus, it is credited.

Working Notes:

Determine the amount of stock dividend.

$\begin{array}{c}\text{Value of common stock}=\left(\begin{array}{l}\text{Market price of}\\ \text{ common shares}\end{array}\right)\times \left(\begin{array}{l}\text{Number of common}\\ \text{shares outstanding }\end{array}\right)\\ =\$12\times 2,000shares\\ =\$24,000\end{array}$

$\begin{array}{c}Stockdividend=\left(\begin{array}{l}\text{Value of }\\ \text{common stock}\end{array}\right)-\left(\begin{array}{l}\text{Previous stock }\\ \text{dividend paid}\end{array}\right)\\ =\$24,000-\$2000\\ =\$22,000\end{array}$ (3)

e)

Error correction entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Retained earnings (5)		104,000
	Interest expense			104,000
	(To record the correct entry)

Table (7)

• Retained earnings have been overstated in the year 2017.  Hence, it is debited.
• Interest expense has been overstated in the year 2018. Hence, it is credited.

This problem can be further explained as follows.

Date	Account Explanations/ Titles	Post Ref.	Amount ($)
			Debit	Credit
2015
September 1	Interest expense		156,000
	Cash			156,000
	( To record the , semi-annual interest payment)
December 31	Interest expense (5)		104,000
	Interest payable			104,000
	( To record the adjusting entry )
2016
March 1	Interest expense (4)		52,000
	Interest payable		104,000
	Cash			156,000
	( To record the semi-annual interest payment)

Table (8)

Determine the interest expense payable.

Interest is payable semi annually. So, interest from January to February.

$\begin{array}{c}\text{ Interest expense payable}=\$156,000\times \frac{2}{6}\\ =\$52,000\end{array}$ (4)

Incorrect entries have been recorded.

Date	Account Explanations/ Titles	Post Ref	Amount ($)
			Debit	Credit
September 1, 2015	Interest expense		156,000
	Cash			156,000
March 1, 2016	( To record the semi-annual interest payment)
	Interest expense		156,000
	Cash			156,000
	(To record the semi-annual interest payment)

Table (9)

Adjustment entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Interest expense (5)		104,000
	Interest payable			104,000
	(To record the adjustment entry)

Table (10)

Working Notes:

Determine the interest expense payable.

Interest is payable semi annually. So, interest of 4 months from September 1 to December 31.

$\begin{array}{c}\text{Interest Expense}=\$156,000\times \frac{4}{6}\\ =\$104,000\end{array}$ (5)

(f)

Error correction entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Prepaid insurance		48,000
	Retained earnings			48,000
	(To correctly record the prepaid insurance as expense )

Table (11)

Working Notes:

Determine the wrongly credited prepaid insurance expense.

The insurance payable for the year 2016-2017:

$\begin{array}{c}\text{Prepaid Expense}=\$72,000\times \frac{2}{3}\\ =\$48,000\end{array}$ (6)

Adjustment entry:

Date	Account Explanation / Titles	Post ref.	Amount ($)
			Debit	Credit
	Insurance (7)		24,000
	Prepaid insurance			24,000
	(To record the adjustment entry for the insurance)

Table (12)

Working Notes:

Determine the annual prepaid insurance expense payable.

The insurance amount payable for the year 2016:

$\begin{array}{c}\text{Prepaid Expense}=\frac{\$72,000}{3}\\ =\$24,000\end{array}$ (7)