Use the following information for questions 66 and 67.
Ernst Company purchased equipment that cost $2,250,000 on January 1, 2014. The entire cost was recorded as an expense. The equipment had a nine-year life and a $90,000 residual value. Ernst uses the straight-line method to account for depreciation expense. The error was discovered on December 10, 2016. Ernst is subject to a 40% tax rate.
-Ernst's net income for the year ended December 31, 2014, was understated by
A) $1,206,000.
B) $1,350,000.
C) $2,010,000.
D) $2,250,000.

Question

Quizplus · Accepted Answer

The cost of the equipment should have been capitalized and depreciated over its useful life, not expensed entirely in the year of purchase. The annual depreciation expense is calculated as (Cost - Residual Value) / Useful Life = ($2,250,000 - $90,000) / 9 = $240,000. For 2014, the net income was understated by the depreciation expense of $240,000 plus the tax effect. The tax effect is $240,000 * 40% = $96,000. Therefore, the total understatement is $240,000 (depreciation expense) + $96,000 (tax effect) = $336,000. However, since the entire cost was expensed, we need to add back the expense minus the correct depreciation and tax effect. So, $2,250,000 (initial expense) - $336,000 (corrected amount) = $1,914,000. The question seems to have an error in calculation or in the provided options, as none of the options directly match the explanation's outcome. Given the options, the closest approach to correct reasoning would involve recognizing the error in the initial calculation and focusing on the impact of the depreciation and tax adjustment, but none of the provided choices accurately reflects the correct calculation based on the given data and standard accounting practices.

Use the Following Information for Questions 66 and 67