Chapter 8, Problem 54EP

a.

To determine

Identify the errors in the depreciation calculations and post adjusting entries for rectification.

Explanation of Solution

Depreciation:

Depreciation is an expense due to regular use and consumption of capital assets. Depreciation is generally calculated by using Straight line or Reducing balance methods.

Rectification of accumulated depreciation account for asset P:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Accumulated depreciation-P4		150,000
	Retained earnings			150,000
	(To rectify the opening balance of accumulated depreciation.)

Table (1)

• Accumulated depreciation-P is a contra asset and it is decreased by $150,000. Therefore, accumulated depreciation-P account is debited with $150,000.
• Retained earnings are income and it is increased by $150,000. Therefore, retained earnings account is credited with $150,000.

Rectification of depreciation account for asset P:

Date	Account Title and Explanation	Post Ref.	Debit ($) (Thousand)	Credit ($) (Thousand)
	Accumulated depreciation-P2		75,000
	Purchases $\left(\$75,000\times 10\%\right)$			7,500
	Cost of goods sold $\left(\$75,000\times 90\%\right)$			67,500
	(To rectify the depreciation expense of asset P for the year.)

Table (2)

• Accumulated depreciation-P is a contra asset and it is decreased by $75,000. Therefore, Accumulated depreciation-P account is debited with $75,000.
• Purchases are expenses and it is decreased by $7,500. Therefore, Purchases account is credited with $7,500.
• Cost of goods sold is an expense and it is decreased by $67,500. Therefore, Cost of goods sold account is credited with $67,500.

Rectification of depreciation account for asset C-B:

Date	Account Title and Explanation	Post Ref.	Debit ($) (Thousand)	Credit ($) (Thousand)
	Accumulated depreciation-C-B6		194,000
	General and administrative expense			194,000
	(To rectify the depreciation expense of asset C-B for the year.)

Table (3)

• Accumulated depreciation-C-B is a contra asset and it is decreased by $194,000. Therefore, Accumulated depreciation-C-B account is debited with $194,000.
• General and administrative expense is an expense and it is decreased by $194,000. Therefore, General and administrative expense account is credited with $194,000.

Working Notes:

1. Computation of depreciation for the year for asset P:

$\begin{array}{c}\text{Depreciation}=\frac{\text{Value of Asset}-\text{Residual Value}}{\text{Number of Years}}\\ =\frac{\$1,500,000}{20}\\ =\$75,000\end{array}$

2. Computation of rectification of depreciation for the year for asset P:

$\begin{array}{c}\text{Rectification}=\text{Depreciation Charged}-\text{Correct Depreciation}\\ =\$150,000-\$75,000\\ =\$75,000\end{array}$

3. Computation of opening balance of accumulated depreciation for asset P:

$\begin{array}{c}\text{Rectified Opening Balance}=\text{Opening Balance}\times \frac{\text{Rectified Depreciation}}{\text{Depreciation charged}}\\ =\$300,000\times \frac{\$75,000}{\$150,000}\\ =\$150,000\end{array}$

4. Computation of rectification of opening balance of accumulated depreciation for asset P:

$\begin{array}{c}\text{Rectification}=\text{Opening Balance}-\text{Corrected Opening Balance}\\ =\$300,000-\$150,000\\ =\$150,000\end{array}$

5. Computation of depreciation for the year for asset C-B:

$\begin{array}{c}\text{Depreciation}=\frac{\text{Value of Asset}-\text{Residual Value}}{\text{Number of Years}}\times \frac{\text{Number of Months}}{\text{Total Months}}\\ =\frac{\$3,500,000}{6}\times \frac{8}{12}\\ =\$388,000\end{array}$

6. Computation of rectification of depreciation for the year for asset C-B:

$\begin{array}{c}\text{Rectification}=\text{Depreciation Charged}-\text{Correct Depreciation}\\ =\$583,000-\$389,000\\ =\$194,000\end{array}$

b.

To determine

Explain the two audit procedures that could be made for additions to PP&E.

Explanation of Solution

Audit procedures that could be conducted for additions to PP&E are listed as follows:

• Verification of Documents: Invoice of the assets and the related installation expenses could be verified to check the accuracy of the particulars recorded along with asset’s classification and amount.
• Physical existence and Valuation: Asset’s physical existence could be verified along with the appropriateness of the value recorded. Value can be accessed on the basis of condition of the asset and brand.

c.

To determine

Compute the gain or loss from the sale of assets. Also, explain the amount of cash flow from investing activities in relation to sale and purchase of assets.

Explanation of Solution

Computation of gain or loss from sale of Assets:

Particulars	Amount ($)
Loss on sale of Asset C-A1	542,000
Profit on sale of Asset A-1 2	1,000
Total loss $\left(\$542,000-\$1,000\right)$	541,000

Table (4)

Computation of cash flow from investing activities:

Particulars	Amount ($)
Purchase of asset B-2	42,000,000
Add: Purchase of asset C-B	3,500,000
Add: Purchase of asset A-2	22,000
Less: Sale proceeds of asset C-A	500,000
Less: Sale proceeds of asset A-1	1,000
Cash flow from investing activities	$\left(45,021,000\right)$

Table (5)

Working Notes:

1. Computation of gain or loss from sale of Asset C-A:

Particulars	Amount ($)
Gain or loss from Asset C-A:
Book value of asset	5,000,000
Less: Accumulated depreciation	3,958,000
Remaining value (X)	1,042,000
Sale proceeds (Y)	500,000
Loss on sale of Asset C-A $\left(\text{Z}=\text{X}-\text{Y}\right)$	542,000

Table (6)

2. Computation of gain or loss from sale of Asset A-1:

Particulars	Amount ($)
Gain or loss from Asset A-1:
Book value of asset	15,000
Less: Accumulated depreciation	15,000
Remaining value (P)	0
Sale proceeds (Q)	1,000
Profit on sale of Asset A-1 $\left(\text{R}=\text{Q}-\text{P}\right)$	1,000

Table (7)