As
at December 31, 2011, Oatfield Corporation is having its financial statements
audited for the first time ever.
The
auditor has found the following items that might have an effect on previous
years.
1.
Oatfield purchased equipment on January 2, 2008, for $130,000. At that time,
the equipment had an estimated useful life of 10 years, with a $10,000 residual
value. The equipment is depreciated on a straight-line basis. On January 2, 2011,
as a result of additional information, the company determined that the
equipment had a total useful life of seven years with a $6,000 residual value.
2.
During 2011, Oatfield changed from the double-declining-balance method for its
building to the straight-line method because the company thinks the
straight-line method now more closely follows the benefits received from using
the assets. The current year depreciation was correctly calculated using the
new method following straight-line depreciation. In case the following
information was needed, the auditor provided calculations that present
depreciation on both bases. The building had originally cost $1.2 million when
purchased at the beginning of 2009 and has a residual value of $120,000. It is
depreciated over 20 years. The original estimates of useful life and residual value
are still accurate.
2011 2010 2009
Straight
line 54,000 54,000 54,000
Double
Declining Balance 97,200 108,000 120,000
3.
Oatfield purchased a machine on July 1, 2008, at a cost of $160,000. The
machine has a residual value of $16,000 and a useful life of eight years.
Oatfield’s bookkeeper recorded straight-line depreciation during each year but
failed to consider the residual value.
4.
Prior to 2011, staff training costs were expensed immediately because they were
immaterial, even though the company would benefit for at least three years
because of improved worker efficiency. With the spurt in growth, these costs
have now become material and management has decided to depreciate them over
three years. Amounts expensed in 2008, 2009, and 2010 were $300, $500, and
$1,000, respectively. During 2011, $4,500 was spent and the amount was debited
to Deferred Training Costs (an asset account).
Instructions
Answer
the following, ignoring income tax considerations.
(a)
Prepare the necessary journal entries to record each of the changes or errors.
The books for 2011 have not been closed.
(b)
Calculate the 2011 depreciation expense on the equipment.
(c)
Calculate the comparative net incomes for 2010 and 2011, starting with income
before the effects of any of the changes identified above. Income before
depreciation expense was $600,000 in 2011 and $420,000 in 2010.
(a) 1. No entry is necessary. A change in estimate is
accounted for prospectively in the current and future years.
2. No entry is necessary as long as Oatfield did
not recognize depreciation expense of $54,000 in 2011. At January 1, 2011, the
asset’s carrying amount was $1,200,000 – ($108,000 + $120,000) = $972,000. The
correct amount of depreciation for 2011 is ($972,000 – $120,000)/18 years =
$47,333. If $54,000 has been recognized, the following entry is needed:
Accumulated
Depreciation—Building.. 6,667
Depreciation Expense............. 6,667
A change
in estimate is accounted for prospectively in the current and future years. A
revision of depreciation policy due to changes in the expected pattern of
benefits is treated as a change in estimate.
3. Accumulated Depreciation—Machine...... 7,000
[($20,000* – $18,000**) X 3½ years]
Retained
Earnings................. 5,000
Depreciation
Expense.............. 2,000
*$160,000
÷ 8 = $20,000
**($160,000
– $16,000) ÷ 8 = $18,000
4. Training expenses ($4,500 / 3)........ 1,500
Deferred
Training Costs........... 1,500
This is not
a change in policy. Since the amounts were not material in previous years, this
is a new policy applied to changed circumstances.
(b) Calculation of 2011
depreciation expense on the equipment:
2008 to 2010
depreciation [($130,000 – $10,000) ÷ 10] $12,000
Cost of
equipment $130,000
Accumulated
depreciation ($12,000 X 3 years) 36,000
Carrying
amount, 1/2/2011 $94,000
2011 depreciation.
expense: 94,000-6,000/7-3 = 88,000/4 = $22,000
Additional
depreciation in 2011: $22,000 – $12,000 = $10,000
(c) OATFIELD
CORPORATION
Comparative Net Income
Calculation
For the Years 2011
and 2010
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2011
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2010
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Income before depreciation expense and before
effects of changes
Depreciation
of equipment – item 1
Depreciation
of building – item 2*
Depreciation
of machine – item 3
Training
costs – item 4
Net income
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$600,000
(22,000 )
(47,333 )
(18,000 )
(1,500 )
$511,167
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$420,000
(12,000 )
(108,000 )
(18,000 )
$282,000
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* Calculation
of 2011 depreciation expense on the
Building –
item 2:
Cost of
building $1,200,000
Accumulated
depreciation ($120,000 + $108,000) 228,000
Carrying
amount, 1/1/2011 $972,000
2011
depreciation expense: 972,000-120,000/20-2 = 852,000/18
=
$47,333
