Ernst Company purchased equipment that cost $3,000,000 on January 1, 2017. The e

Question

Ernst Company purchased equipment that cost $3,000,000 on January 1, 2017. The entire cost was recorded as an expense. The equipment had a nine-year life and a $120,000 residual value. Ernst uses the straight-line method to account for depreciation expense. The error was discovered on December 10, 2019. Ernst is subject to a 40% tax rate. Before the correction was made and before the books were closed on December 31, 2019, retained earnings was understated by: Select one: A. $1,328,000 B. $1,344,000 C. $1,416,000 D. $1,800,000.

Explanation / Answer

Answer is C: $14,16,000

$30,00,000 expense * 0.6 = $18,00,000 net income change

Now to figure out the correct net income change

$30,00,000 - $1,20,000 = $28,80,000 / 9 years = $3,20,000 per year accumulated depreciation
2 years have elapsed (Jan 1, 2017 to Dec 31, 2019)
So $6,40,000 depreciation has accumulated
$6,40,000 expense * 0.6 = $3,84,000

$18,00,000 - $3,84,000 = $14,16,000 difference in expense/net income

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