Question

n 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. Cumulative effect of error on Net income:

The cumulative effect is Depreciation not charged for 3 years ie 357,000/5*3 = 214200

(The retained earnings is understated by 142800 at the end of 2020.)

2.

Rectification entry: before adjusting and closing entry. Hence depreciation will be charged later.

31-12-2021	Equipment a/c Dr	142800
	To retained earnings a/c		142800

3. No journal entry is necessary as the asset will not have any value after 2019 ie considered already as expense. And either way the entire value would be charged as depreciation expense against income which would already be recognised by 2022. Thus both ways no entry would be required.

(Please comment in case of any query regarding the solution)