Chapter 11, Problem 18P

Soon after December 31, 2019, the auditor requested a depreciation schedule for trucks of Jarrett Trucking Company, showing the additions, retirements, depreciation, and other data affecting the income of the company in the 4-year period 2016 to 2019, inclusive. The following data were in the Trucks account as of January 1, 2016:

The Accumulated Depreciation—Trucks account, previously adjusted to January 1,2016, and duly entered in the ledger, had a balance on that date of $16,460. This amount represented the straight-line depreciation on the four trucks from the respective dates of purchase, based on a 5-year life and no residual value. No debits had been made to this account prior to January 1, 2016.

Transactions between January 1,2017, and December 31, 2019, and their record in the ledger were as follows:

1. 1. July 1, 2016: Truck no. 1 was sold for $1,000 cash. The entry was a debit to Cash and a credit to Trucks, $1,000.
2. 2. January 1, 2017: Truck no. 3 was traded for a larger one (no. 5) with a 5-year life. The agreed purchase price was $12,000. Jarrett paid the other company $1,780 cash on the transaction. The entry was a debit to Trucks, $1,780, and a credit to Cash, $1,780.
3. 3. July 1, 2018: Truck no. 4 was damaged in a wreck to such an extent that it was sold as junk for $50 cash. Jarrett received $950 from the insurance company. The entry made by the bookkeeper was a debit to Cash, $1,000, and credits to Miscellaneous Revenue, $50, and Trucks, $950,
4. 4. July 1, 2018: A new truck (no. 6) was acquired for $20,000 cash and debited at that amount to the Trucks account. The truck has a 5-year life.

Entries for depreciation had been made at the close of each year as follows: 2016, $8,840; 2017, $5,436; 2018, $4,896; 2019, $4,356.

Required:

1. 1. Next Level For each of the 4 years, calculate separately the increase or decrease in earnings arising from the company’s errors in determining or entering depreciation or in recording transactions affecting trucks.
2. 2. Prove your work by one compound journal entry as of December 31, 2019; the adjustment of the Trucks account is to reflect the correct balances, assuming that the books have not been closed for 2019.

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
2016	$(2,600) Decrease
2017	$496 Increase $\left(\$2,540-\$2,044\right)$
2018	$(7,094) Decrease $\left(\$5,050-\$2,044\right)$
2019	$(2,044) Decrease

Table (1)

Compute the correct depreciation:

Truck	2016	2017	2018	2019
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, 2016	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, 2017	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, 2018	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, 2016:

$\begin{array}{c}\text{Accumulated depreciation}=\left[\begin{array}{l}\text{Year owned (1)}+\text{Depreciation}\\ \text{till July 1, 2016}\end{array}\right]\\ =\$7,200\times \left(\$2,400\times 0.5\text{ years}\right)\\ =\$7,200+\$1,200\\ =\$8,400\end{array}$

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 (2016)	3,000
$15,000	5	3,000	1 year (2017)	3,000
$15,000	5	3,000	0.5 (From January 1, 2018 to July 1, 2018	$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:

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

To determine

Prepare a correcting compound journal entry as of December 31, 2019.

Explanation of Solution

Prepare a correcting compound journal entry as of December 31, 2019 as follows:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2019	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:

$\begin{array}{c}\text{Retained earnings}=\left[\begin{array}{l}\text{Decrease in retained earnings in 2016}-\\ \text{Increase in retained earnings in 2017}+\\ \text{Decrease in retained earnings in 2018}\end{array}\right]\\ =\$2,600-\$496+\$7,094\\ =\$9,198\end{array}$

Working note (8):

Calculate the accumulated depreciation:

Particulars	Amount ($)
Accumulated depreciation:
2016	8,400
2017	5,120
2018	9,000
	22,520
Less: corrected depreciation
2017	2,044
2018	2,044
2019	2,044
Total	16,388

Table (6)

Working note (9):

Calculate the total cost of truck:

Particulars	Amount ($)
Cost of truck:
2016	11,000
2017	2,580
2018	14,050
Total	27,630

Table (7)