Question

In 2021, Jimmy Page Company discovered a building addition completed in January 2019, at a cost of $360,000 was charged to building maintenance expense in error. The cost should have been charged to the building asset account. The company uses straight line depreciation; the estimated life of the building addition when it was completed in 2019 was 25 years, the estimated residual value of the building addition was $100,000, and the company records a full year depreciation on all assets place in service during the year. Fixing this error in 2021 would have the following impact on Page’s accounting records:

A)increase the book value of the building asset by $239,200.

B) increase the book value of the building asset by $360,000.

C) decrease retained earnings by $360,000.

D)increase retained earnings by $339,200.

Answer 1

D) increase retained earnings by $339,200.

The addition of the building has more than 1 year of useful life i.e. 25 years and therefore, needs to be capitalised and should have been added to the balance of assets in the year 2019 itself.

If it were added at that time, the depreciation amount for each year would come to $10,400 ( Addition cost - salvage value/ useful life) i.e. $360,000 - $100,000/25 = $10400

Now, it has passed 2 years and therefore the depreciation accumulated during these two year amounts to $20,800.

During 2019, when the amount was considered to be an expense, we understated the income and affected the retained earnings for that year and has continual effect of understated revenue.

Therefore, the depreciation for the said two years will be deducted as an expense and need to match the understated retained earnings by the remaining amount of $339,200 i.e. $360,000 - $20800.