Question

IOP Company purchased a machine on 1/1/15 costing $500. Estimated life was 5 years; estimated salvage value was $100. In 2018, IOP discovered that the bookkeeper correctly used straight-line depreciation, but erroneously used an estimated life of 8 years in computing depreciation for the first 3 years of life.

The Prior Period Adjustment to be recorded in 2018 will include what adjustment to Retained Earnings?

Select one:

a. $90 credit

b. $90 debit

c. $50 credit

d. $$50 debit

e. $112.50 credit

On 12/31/14, the Cheboygan Company paid $2,000 of prepaid insurance and expensed the entire amount. The policy covered the period 1/1/15 to 12/31/16.

The error was discovered on 1/10/16; the 2015 books are closed. The correcting journal entry will include what entry to 1/1/16 Retained Earnings?

Select one:

a. $1,000 debit

b. $1,000 credit

c. $2,000 debit

d. $2,000 credit

Answer 1

1. Correct depreciation would have been = ($500-$100)/5 = $80
Depreciation charged wrongly as ($500-$400)/8 = $50
Therefore depreciation has been charged short by $30 for three years, thereby reflecting income greater by $30 each year for 3 years.
Since due to wrong depreciation retained earnings is higher by $90, therefore we have to debit retained earnings by $90

Answer (b)

2. Insurance expenditure was for 2 years i.e. 2015 & 2016, but it has been completely expensed for 2014 wrongly.

Now the books for 2015 have already been closed. Since $2000 was completely charged for 2014 wrongly instead of $1000 for 2015 & $1000 for 2016. Due to which retained earnings were $2000 short, $1000 adjusted for 2015, so short by $1000 at end of 2015.
Therefore we will credit retained earnings by $1000

Answer (b)