Chapter 20, Problem 20.11P

Error correction; change in depreciation method

• LO20–6

The Collins Corporation purchased office equipment at the beginning of 2016 and capitalized a cost of $2,000,000. This cost included the following expenditures:

Purchase price	$1,850,000
Freight charges	30,000
Installation charges	20,000
Annual maintenance charge	100,000
Total	$2,000,000

The company estimated an eight-year useful life for the equipment. No residual value is anticipated. The double-declining-balance method was used to determine depreciation expense for 2016 and 2017.

In 2018, after the 2017 financial statements were issued, the company decided to switch to the straight-line depreciation method for this equipment. At that time, the company’s controller discovered that the original cost of the equipment incorrectly included one year of annual maintenance charges for the equipment.

Required:

1. Ignoring income taxes, prepare the appropriate correcting entry for the equipment capitalization error discovered in 2018.

2. Ignoring income taxes, prepare any 2018 journal entries related to the change in depreciation methods.

To determine

Change in depreciation method:

A change in depreciation methods are considered as a change in estimate that is achieved by a change in accounting principle.

Error correction:

Error correction is an adjustment to previously issued financial statements. It is not considered as an accounting change.

Change in estimate

It refers to a change where the new information influences the companies to update the previously made estimates.

To prepare: The correcting entry for the equipment capitalization error discovered in 2018:

Explanation of Solution

Determine the incorrect entry for the equipment capitalization error:

Date	Account Title and Explanation	Debit	Credit
2016	Equipment	$2,000,000
	Cash		$2,000,000
	(To record equipment sale)

Table (1)

Equipment is an asset. There is an increase in asset value. Therefore, it is debited.

Determine the correct entry for the equipment capitalization error:

Date	Account Title and Explanation	Debit	Credit
2016	Equipment	$1,900,000
	Depreciation expense	$100,000
	Accumulated depreciation		$2,000,000
	(To record accumulated depreciation correction)

Table (2)

Equipment is an asset. There is an increase in asset value. Therefore, it is debited.

Depreciation is an expense. An expense will reduce the stock holders’ equity.  There is a decrease in the value of the stock holders’ equity by $100,000.

Accumulated depreciation is a contra asset. There is a decrease in assets value. Therefore, it is credited.

Determine the Incorrect journal entry:

Date	Account Title and Explanation	Debit	Credit
2016	Depreciation expense   (1)	$500,000
	Accumulated depreciation		$500,000
	(To record accumulated depreciation)

Table (3)

Working note:

Calculate the depreciation expense:

$\begin{array}{c}\text{Depreciation expense=\$2,000,000}\times \text{25\%}\\ \text{=\$500,000}\end{array}$ (1)

Depreciation is an expense. An expense will reduce the stock holders’ equity. Since there is a decrease in the value of the stock holders’ equity of $500,000 is debited.

Accumulated depreciation is a contra asset. There is a decrease in assets value. Therefore, it is credited.

Determine the correct journal entry:

Date	Account Title and Explanation	Debit	Credit
2016	Depreciation expense   (2)	$475,000
	Accumulated depreciation		$475,000
	(To record accumulated depreciation)

Table (4)

Working note:

Calculate the depreciation expense:

$\begin{array}{c}\text{Depreciation expense=\$1,900,000}\times \text{25\%}\\ \text{=\$475,000}\end{array}$ (2)

Depreciation is an expense. An expense will reduce the stock holders’ equity. Since there is a decrease in the value of the stock holders’ equity of $475,000 is debited.

Accumulated depreciation is a contra asset. There is a decrease in assets value. Therefore, it is credited.

Determine the Incorrect journal entry:

Date	Account Title and Explanation	Debit	Credit
2017	Depreciation expense   (3)	$375,000
	Accumulated depreciation		$375,000
	(To record accumulated depreciation)

Table (5)

Working note:

Calculate the depreciation expense:

$\begin{array}{c}\text{Depreciation expense=\$2,000,000}-\$500,000\times 25\%\\ =\$375,000\end{array}$ (3)

Depreciation is an expense. An expense will reduce the stock holders’ equity. Since there is a decrease in the value of the stock holders’ equity of $375,000 is debited.

Accumulated depreciation is a contra asset. There is a decrease in assets value. Therefore, it is credited.

Determine the correct journal entry:

Date	Account Title and Explanation	Debit	Credit
2017	Depreciation expense   (4)	$356,250
	Accumulated depreciation		$356,250
	(To record accumulated depreciation)

Table (6)

Working note:

Calculate the depreciation expense:

$\begin{array}{c}\text{Depreciation expense=\$1,900,000}-\$475,000\times 25\%\\ =\$356,250\end{array}$ (4)

Depreciation is an expense. An expense will reduce the stock holders’ equity. Since there is a decrease in the value of the stock holders’ equity of $356,250 is debited.

Accumulated depreciation is a contra asset. There is a decrease in assets value. Therefore, it is credited.

Determine correct the incorrect entry:

Date	Account Title and Explanation	Debit	Credit
2017	Retained earnings	$ 56,250
	Accumulated depreciation	$ 43,750
	Equipment		$ 100,000
	( To correct incorrect accounts)

Table (7)

Depreciation expense was overstated by $43,750, but other expenses were understated by $100,000.

Net income during the period was overstated by $56,250, Retained earnings is currently overstated by that amount.

Accumulated depreciation was overstated, and continues to be overstated by $43,750.

To determine

To prepare: The entries related to the change in depreciation methods.

Explanation of Solution

Determine the entries related to the change in depreciation methods:

Particulars	Amount ($)
Asset’s cost (after correction)	1,900,000
Less: Accumulated depreciation to date ($475,000 + 356,250)	(831,250)
Un depreciated cost, Jan. 1, 2018	1,068,750
Less: Estimated residual value	(0)
To be depreciated over remaining 6 years	1,068,750
Divide	6 years
Annual straight-line depreciation 2018–2023	178,125

Table (8)

Determine the adjusting entry for the year 2018:

Date	Account Title and Explanation	Debit	Credit
2018	Depreciation expense	$178,125
	Accumulated depreciation		$178,125
	(To record accumulated depreciation)

Table (9)

No entry is needed to record the change.

Change in depreciation method:

A change in depreciation methods are considered as a change in estimate that is achieved by a change in accounting principle.

The Corporation C reports the change prospectively and previous financial statements are not revised.

Corporation C uses straight line method

The un-depreciated cost remaining at the time of the change is depreciated straight line over the remaining useful life.