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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Refer to the information in E22-13.

Required:

Prepare the correcting journal entries if the company discovers each error 2 years after it is made and it has closed the books for the second year. Ignore income taxes.

E22-13:

The following are independent errors made by a company that uses the periodic inventory system:

  1. a. Goods in transit, purchased on credit and shipped FOB destination, $10,000, were included in purchases but not in the physical count of ending inventory.
  2. b. Purchase of a machine for $2,000 was expensed. The machine has a 4-vear life, no residual value, and straight-line depreciation is used.
  3. c. Wages payable of $2,000 were not accrued.
  4. d. Payment of next year’s rent, $4,000, was recorded as rent expense.
  5. e. Allowance for doubtful accounts of $5,000 was not recorded. The company normally uses the aging method.
  6. f. Equipment with a book value of $70,000 and a fair value of $100,000 was sold at the beginning of the year. A 2-year, non-interest-bearing note for $129,960 was received and recorded at its face value, and a gain of $59,960 was recognized. No interest revenue was recorded and 14% is a fair rate of interest.

To determine

Journalize the correction of errors that were discovered after two years.

Explanation

Errors: The comparability and consistency of the financial statements decreases when a company records arithmetic mistakes, or errors. Such errors do require adjustments to make the financial information more reliable, and more relevant.

Counterbalancing error: The error that affects an income statement account and a balance sheet account, and could be automatically corrected in the following period, even if they are not discovered, is referred to as counterbalancing error.

Journalize the correction of errors at the beginning of the year for the prior period errors.

a.

Journal entry to correct the failure to record credit purchases: When the company receives goods, the Accounts Payable and Purchases accounts will automatically be counterbalanced. Hence, no journal entry is recorded to correct the error. But the financial statements should be restated for comparative purposes.

b.

Journal entry to correct the failure to capitalize cost of the machine:

DateAccount Titles and ExplanationPost Ref.Debit ($)Credit ($)
  Machinery 2,000 
   Retained Earnings  1,000
   Accumulated Depreciation  1,000
  (Record capitalization of cost and increase understated retained earnings)   

Table (1)

Description:

  • Machinery is an asset account. Since machine is purchased, asset account increased, and an increase in asset is debited.
  • Retained Earnings is an equity account. Since cost of machine which should have been capitalized is expensed, the net income in the prior years was understated. The equity account is credited to increase the understated value.
  • Accumulated Depreciation is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.

Working Note:

Compute the depreciation expense for the machine under straight-line method for two years, if cost is $2,000, useful life is 4 years, and no salvage value...

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