Chapter 11, Problem 18P

1.

To determine

Compute the effect of earnings (increase or decrease) of Company J that arise from the company’s error in determining the depreciation of the truck.

Explanation of Solution

Depreciation expense: Depreciation expense is a non-cash expense, which is recorded on the income statement reflecting the consumption of economic benefits of long-term asset on account of its wear and tear or obsolesces.

The effect of earnings that arise from the company’s error in determining the depreciation of the truck as follows:

Year	Increase or decrease
2013	$(2,600) Decrease
2014	$496 Increase $\left(\$2,540-\$2,044\right)$
2015	$(7,094) Decrease $\left(\$5,050-\$2,044\right)$
2016	$(2,044) Decrease

Table (1)

Compute the correct depreciation:

Truck	2013	2014	2015	2016
1.	$1,200	-	-	-
2.	$2,080	$2,080	$1,040	-
3.	$2,560	-	-	-
4.	$3,000	$3,000	$1,500	-
5.	-	$2,400 (5)	$2,400 (5)	$2,400 (5)
6.	-	-	$2,000 $\left(\text{\$4,000}\times \frac{6}{12}\right)$	$4,000 (6)
Total	$8,840	7,480	6,940	6,400
Depreciation recorded previously	8,840	5,436	4,896	4,356
Depreciation Corrected	0	$2,044	$2,044	$2,044

Table (2)

Compute the effort of earnings (increase or decrease) of Company J that arise from the company’s error in determining the depreciation of the truck as follows:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Correct entry:
July 1, 2013	Cash		1,000
	Accumulated Depreciation- Truck (2)		8,400
	Loss on disposal of plant property, equipment $\left(\$8,400+\$1,000-\$12,000\right)$		2,600
	Truck (Number 1)			12,000
	(To record the loss on disposal of plant, property and equipment)
	Entry made:
	Cash		1,000
	Truck (Number 1)			1,000
	(To record the sale of truck)
	Correcting entry:
	Accumulated Depreciation: Trucks (2)		8,400
	Retained Earnings		2,600
	Truck (Number 1)			11,000
	(To record the accumulated depreciation)
	Correct entry:
January 1, 2014	Accumulated Depreciation: Trucks $\left(\$2,560(1)\times 2\text{ years}\right)$		5,120
	Truck (Number 5)		12,000
	Cash			1,780
	Truck (Number 3)			12,800
	Gain on Exchange (3)			2,540
	(To record the gain on exchange)
	Entry made:
	Truck		1,780
	Cash			1,780
	(To record the cash paid for other company)
	Correcting entry:
	Accumulated Depreciation: Trucks		5,120
	Truck			2,580
	Retained Earnings (3)			2,540
	(To record the accumulated depreciation)
	Correct entry:
July 1, 2015	Accumulated Depreciation –Truck (Number 4)  (4)		9,000
	Cash		1,000
	Loss on disposal of plant property, equipment $\left(\$9,000+\$1,000-\$15,000\right)$		5,000
	Truck (Number 4)			15,000
	(To record the loss on disposal of plant, property and equipment)
	Entry made:
	Cash		1,000
	Miscellaneous Revenue			50
	Truck (Number 4)			950
	(To record the cash receipt from the damaged truck)
	Correcting entry:
	Accumulated Depreciation –Truck (Number 4)  (4)		9,000
	Retained Earnings $\left(\$14,050-\$9,000\right)$		5,050
	Truck (Number 4) $\left(\$15,000-\$950\right)$			14,050
	(To record the accumulated depreciation)

Table (3)

Working note (1):

Compute the total accumulated depreciation of the trucks:

Truck	Cost (a)	Life (b)	Annual Depreciation (c) $\left(\text{a}÷\text{b}\right)$	Years Owned (d)	Accumulated Depreciation $\left(\text{c}\times \text{d}\right)$
1.	$12,000	5	$2,400	3	$7,200
2.	$10,400	5	2,080	2.5	5,200
3.	$12,800	5	2,560	1	2,560
4.	$15,000	5	3,000	0.5	$1,500
Total					$16,460

Table (4)

Working note (2):

Compute the accumulated depreciation of the trucks for January 1, 2013:

$\begin{array}{c}\text{Accumulated depreciation}=\left[\begin{array}{l}\text{Year owned (1)}+\text{Depreciation}\\ \text{till July 1, 2013}\end{array}\right]\\ =\$7,200\times \left(\$2,400\times 0.5\text{ years}\right)\\ =\$7,200+\$1,200\\ =\$8,400\end{array}$

Working note (3):

Compute the gain or loss on exchange:

$\begin{array}{c}\text{Gain on exchange}=\left[\text{Fair value of old truck }-\text{Book value of old truck}\right]\\ =\$12,000-\$1,780-\left(\$12,800-\$5,120\right)\\ =\$10,220+\$7,680\\ =\$2,540\end{array}$

Working note (4):

Compute the accumulated depreciation of Truck 4:

Cost (a)	Life (b)	Annual Depreciation (c)$\left(\text{a}÷\text{b}\right)$	Years Owned (d)	Accumulated Depreciation $\left(\text{c}\times \text{d}\right)$
$15,000	5	3,000	0.5 (From July 1, 2015 to December 31, 2015)	$1,500
$15,000	5	3,000	1 year (2013)	3,000
$15,000	5	3,000	1 year (2014)	3,000
$15,000	5	3,000	0.5 (From January 1, 2015 to July 1, 2015	$1,500
Total				9,000

Table (5)

Working note (5):

Compute the depreciation expenses for truck 5:

$\begin{array}{c}\text{Depreciation expenses}=\frac{\text{Acquisition cost}-\text{Residual value}}{\text{Estimated life}}\\ =\frac{\text{\$12,000}}{\text{5 years}}\\ =\$2,400\text{ per year}\end{array}$

Working note (6):

Compute the depreciation expenses of truck 6:

$\begin{array}{c}\text{Depreciation expenses}=\frac{\text{Acquisition cost}-\text{Residual value}}{\text{Estimated life}}\\ =\frac{\text{\$20,000}-0}{\text{5 years}}\\ =\$4,000\text{ per year}\end{array}$

2.

To determine

Prepare a correcting compound journal entry as of December 31, 2016.

Explanation of Solution

Prepare a correcting compound journal entry as of December 31, 2016 as follows:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2016	Retained Earnings (7)		9,198
	Accumulated Depreciation of Trucks (8)		16,388
	Depreciation expenses  (Refer Table (2))		2,044
	Truck (9)			27,630
	(To record the compound entry)

Table (6)

• Retained earnings are the component of stockholder’s equity, and it decreases the value of equity. Hence, debit the retained earnings account with $9,198.
• Accumulated depreciation is a contra-asset, and it increases the value of assets. Hence, debit the accumulated depreciation account with $16,388.
• Depreciation expense is the component of stockholder’s equity, and it decreases the value of equity. Hence, debit the depreciation expense account with $2,044.
• Truck is an asset account, and it decreases the value of assets. Hence, credit the truck account with $27,630.

Working note (7):

Calculate the total retained earnings:

$\begin{array}{c}\text{Retained earnings}=\left[\begin{array}{l}\text{Decrease in retained earnings in 2013}-\\ \text{Increase in retained earnings in 2014}+\\ \text{Decrease in retained earnings in 2015}\end{array}\right]\\ =\$2,600-\$496+\$7,094\\ =\$9,198\end{array}$

Working note (8):

Calculate the accumulated depreciation:

Particulars	Amount ($)
Accumulated depreciation:
2013	8,400
2014	5,120
2015	9,000
	22,520
Less: corrected depreciation
2014	2,044
2015	2,044
2016	2,044
Total	16,388

Table (6)

Working note (9):

Calculate the total cost of truck:

Particulars	Amount ($)
Cost of truck:
2013	11,000
2014	2,580
2015	14,050
Total	27,630

Table (7)