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.
-Before the correction was made and before the books were closed on December 31, 2016, retained earnings was understated by
A) $996,000.
B) $1,008,000.
C) $1,062,000.
D) $1,350,000.

Question

Quizplus · Accepted Answer

The depreciation expense should have been $240,000 per year (($2,250,000 - $90,000) / 9 years). For 2014, 2015, and 2016, the total depreciation should have been $720,000. Since the entire cost was expensed, the error is $2,250,000 - $720,000 = $1,530,000. After tax, the error affecting retained earnings is $1,530,000 * (1 - 0.40) = $918,000. Retained earnings was understated by $1,062,000, which is the difference between the total expense recorded and the correct depreciation expense after tax.

Use the Following Information for Questions 66 and 67