On December 31, 2011, before the books were closed, management

On December 31, 2011, before the books were closed, management and the accountant at Madrasa Inc. made the following determinations about three depreciable assets.

1. Depreciable asset A was purchased on January 2, 2008. It originally cost $540,000 and the straight-line method was chosen for depreciation. The asset was originally expected to be useful for 10 years and have no residual value. In 2011, the decision was made to change the depreciation method from straight-line to double-declining-balance, and the estimates relating to useful life and residual value remained unchanged.

2. Depreciable asset B was purchased on January 3, 2007. It originally cost $180,000 and the straight-line method was chosen for depreciation. The asset was expected to be useful for 15 years and have no residual value. In 2011, the decision was made to shorten this asset’s total life to nine years and to estimate the residual value at $3,000.

3. Depreciable asset C was purchased on January 5, 2007. The asset’s original cost was $160,000 and this amount was entirely expensed in 2007 in error. This particular asset has a 10-year useful life and no residual value. The straight-line method is appropriate.

Additional data:

1. Income in 2011 before depreciation expense amounted to $400,000.

2. Depreciation expense on assets other than A, B, and C totalled $55,000 in 2011.

3. Income in 2010 was reported at $370,000.

4. In both 2010 and 2011, 100,000 common shares were outstanding. No dividends were declared in either year. Madrasa follows IFRS.

Instructions

Answer the following questions, ignoring all income tax effects.

(a) Prepare all necessary entries in 2011 to record these determinations.

(b) Calculate the adjusted net income and earnings per share for 2010 and 2011.

(c) Prepare comparative retained earnings statements for Madrasa Inc. for 2010 and 2011. The company reported retained earnings of $200,000 at December 31, 2009.

(d) Prepare the required note disclosures for each of these changes.

(e) How would the changes to Madrasa’s depreciable assets be reflected on the statement of cash flows?

(a) 1.  Depreciation Expense................ 108,108

            Accumulated Depreciation—Asset A       108,108

        Computations:

          Cost of Asset A...................      $540,000

          Less: Depreciation prior to 2011..       162,000*

          Carrying amount, January 1, 2011..      $378,000

        *($540,000 ÷ 10) X 3

        The DDB rate is calculated as 100% ÷ 7 X 2 = 28.6%

        Depreciation for 2011: $378,000 X 28.6% = $108,108*

        * rounded

    2.  Depreciation Expense................ 25,800

          Accumulated Depreciation—Asset B..        25,800

        Calculations:

            Original cost                         $180,000

            Accumulated depreciation (1/1/11)

              $12,000 X 4                            48,000

            Carrying amount (1/1/11)               132,000

            Estimated residual value                  3,000

            Remaining depreciable base             129,000

            Remaining useful life

              (9 years—4 years taken)              ÷      5

            Depreciation expense—2011             $ 25,800

    3.  Asset C............................. 160,000

          Accumulated Depreciation—Asset C..        64,000

              (4 X $16,000)

          Retained Earnings.................        96,000

        Depreciation Expense................  16,000

          Accumulated Depreciation—Asset C..        16,000

 (b) Restated net income and earnings per share:

Net income Earnings per common share

2011 $227,600    $2.28

*

2010 $354,000    $3.54

**

    Calculations:

       *Income before depreciation expense

          (2011)                                  $400,000

        Depreciation for 2011

            Asset A                      $108,108         

            Asset B                        25,800         

            Asset C                        16,000         

            Other Assets                   55,000 (204,908 )

        Income after depreciation expense         $195,092

    ***Income before change in depreciation and error

        correction (2010)                        $370,000

      Error correction—Depreciation Asset C        (16,000 )

      Income after error correction              $354,000

 (c)                   MADRASA INC.

        Comparative Statement of Retained Earnings

             For the Years Ending December 31

                                                         

			2011		2010 (restated)
	Balance, January 1,    as previously reported Plus: Adjustment due to error in      recording Asset C (net of taxes)      (Note B) Balance, January 1, as restated Add:  Net income Balance, December 31		$570,000*     96,000  666,000  195,092 $861,092		$200,000   112,000  312,000  354,000 $666,000

*Amount expensed incorrectly in 2007...... $160,000

 Depreciation to be taken to January 1, 2010
    ($16,000 X 3)........................     48,000

 Prior period adjustment for income....... $112,000

**   Opening balance of $200,000 + unadjusted income for 2010 of $370,000.

 (d)

Note A – Change in Depreciation Method

In 2011, the company has changed its amortization method for certain capital assets from the straight-line basis to the double-declining basis. This change was done to provide more relevant presentation of the company’s financial information (provide specific rationale here). The change has been applied prospectively.

Note B – Error in Depreciation Expense of Prior Periods

The company expensed a capital asset purchased in 2007. Depreciation was not recorded for 2007 and subsequent periods. This error has been corrected and the comparative information has been restated to effect the correction of this error. Depreciation expense of $16,000 has been recorded for each of 2010 and 2011.  Net income and earnings per share have decreased by $16,000 and $0.16 respectively for each of the years presented.

(e) Changes in policy, changes in estimates and corrections of errors will not have any impact on current period cash flows and will not change the totals for any of the three sections of the current period statement of cash flows or the net increase or decrease in cash and cash equivalents. If the statement is prepared on an indirect basis, the changes will be reflected in the net income figure and in the depreciation expense. Since the change affects both net income and depreciation expense, the adjustment to determine cash flow from operations will offset the expense, and the same total cash from operating activities will be achieved. The changes will not have any impact on a current period statement of cash flows prepared on the direct basis.

However, there will be a change in the cash flow statement in the year of the error for the situation described in part 3. While there will be no net change in the amount of cash for 2007, the expenditure was originally recognized as an expense, and therefore as an operating outflow in 2007, whereas the corrected cash flow statement for 2007 will indicate that the $160,000 was an investing outflow.

The change in estimate is applied on a prospective basis only and will not affect the statement of cash flows for prior periods.