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On January 1, 2016, ABC purchased a truck for $70,000 and estimated its useful life at 5 years with a residual value of $5,000. The company initially recorded the purchase as an expense of $70,000 by debiting an expense account and crediting cash. ABC uses the straight-line depreciation method for its trucks. An error was identified and corrected in 2018. The company's effective income tax rate is 40%. The instructions are to prepare any necessary journal entries for (1) correcting the error and (2) recording depreciation for 2016.

Paper For Above instruction

The accounting treatment of initial asset purchase, error correction, and depreciation accounting are crucial areas in financial reporting, ensuring that financial statements accurately reflect the company's financial position and performance. Initially, ABC's recording of the truck as an expense instead of capitalizing it as an asset was a misclassification that requires correction. The proper approach involves reversing the erroneous expense entry and then recording the asset acquisition properly.

To correct the error identified in 2018, ABC needs to adjust the financial statements by recognizing the truck as an asset, recording accumulated depreciation, and adjusting retained earnings for the errors made initially. Specifically, the correction would involve a debit to property, plant, and equipment for $70,000, a credit to expense for the same amount, and an adjustment to retained earnings considering accumulated depreciation and tax implications.

Regarding depreciation for 2016, ABC used the straight-line method. Initially, depreciation was not recorded correctly because the asset was treated as an expense rather than a capital expenditure. The annual straight-line depreciation expense should be calculated as:

Depreciation expense = (Cost – Residual value) / Useful life = ($70,000 – $5,000) / 5 = $13,000 per year.

This depreciation would have been recognized for 2016 and subsequent years. Since the error was discovered and corrected in 2018, the company must adjust the prior years' depreciation expenses accordingly, considering the tax effects at 40%. The journal entries involve debiting accumulated depreciation and crediting depreciation expense, along with potential adjustments to retained earnings.

In summary, the correction process involves recognizing the asset, recording accumulated depreciation for prior years, and adjusting income and tax figures. The depreciation expense for 2016, calculated at $13,000, was initially not recorded correctly; upon correction, the proper depreciation expense will affect net income and tax calculations, requiring entries that adjust these accounts for the misclassification and depreciation.

References

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