Question

In 2021, internal auditors discovered that PKE Displays, Inc. had debited an expense account for the $357,000 cost of equipment purchased on January 1, 2018. The equipment’s life was expected to be five years with no residual value. Straight-line depreciation is used by PKE.

Required:
1. Determine the cumulative effect of the error on net income over the three-year period from 2018 through 2020, and on retained earnings by the end of 2020.
2. Prepare the correcting entry assuming the error was discovered in 2021 before the adjusting and closing entries. (Ignore income taxes.)
3. Assume instead that the equipment was disposed of in 2022 and the original error was discovered in 2023 after the 2022 financial statements were issued. Prepare the correcting entry in 2023.

Answer 1

1.During 2018 to 2020 year end (Four year period), depreciation expense has been understated by $285600 ($71400*4 yrs) but other expenses was overstated by $357,000, so net income during the period was understated by 71400 ($357000 - $285600) (i.e.retained earnings are understated by $71400). The accumulated depreciation was also understated by $285600 over the Four-year period.

2.

Particulars	Debit	Credit
Equipment	357000
Accumulated depreciation		285600
Retained Earnings		71400
( Being rectification entry passed)

3. no entry will be passed as the asset no longer exist