Presented below are the comparative income and retained earnings statements for
ID: 2329449 • Letter: P
Question
Presented below are the comparative income and retained earnings statements for Martinez Inc. for the years 2017 and 2018.
2018
2017
The following additional information is provided:
Prepare the revised retained earnings statement for 2017 and 2018, assuming comparative statements. (Ignore income taxes.)
MARTINEZ INC.
Retained Earnings Statement
For the Year Ended
2017 2018
RETAINED EARNING, DECEMBER 31
2018
2017
Sales $334,000 $264,000 Cost of sales 217,000 144,000 Gross profit 117,000 120,000 Expenses 95,200 50,700 Net income $21,800 $69,300 Retained earnings (Jan. 1) $121,700 $76,300 Net income 21,800 69,300 Dividends (31,400 ) (23,900 ) Retained earnings (Dec. 31) $112,100 $121,700Explanation / Answer
Answers
* CORRECT ANSWER
First: Methods of depreciation has to be changed from Sum of Digit to Straight Line method, and
Second: Overstatement of Ending Inventory for 2017
The depreciation method in 2018 has to be changed to Straight Line Method. But Depreciation expense of $ 31,950 (mentioned in the question) is already recorded in Income Statement under ‘Expenses’.
The above $ 31,950 is calculated using Sum of Digit method as follows:
Life = 4 years: Sum of digit = 1 + 2 + 3 + 4 = 10
Year
Depreciable base
Formula
Depreciation expense
Accumulated Depreciation
Ending Book Value
2017
$ 106,500.00
[106500 x 4/10]
$ 42,600.00
$ 42,600.00
$ 63,900.00
2018
$ 106,500.00
[106500 x 3/10]
$ 31,950.00 [matching with the amount of 2018 depreciation expense]
$ 74,550.00
$ 31,950.00
2019
$ 106,500.00
[106500 x 2/10]
$ 21,300.00
$ 95,850.00
$ 10,650.00
2020
$ 106,500.00
[106500 x 1/10]
$ 10,650.00
$ 106,500.00
$ -
Now, as you can see, Book Value at the beginning of 2018 or Ending book Value for 2017 (after 2017’s depreciation expense) = $ 63,900.
This $ 63,900 will be depreciated for remaining life of 3 years [4 years – Year 2017 already passed]
If Straight Line method was followed, annual depreciation for 2018 would have been: $ 63,900 / 3 years = $ 21,300
A
Depreciation expenses recorded as per 'sum of digits' method
$ 31,950.00
B
Depreciation expense that should have been recorded as per Straight Line Method
$ 21,300.00
C = A - B
Excess depreciation recorded
$ 10,650.00
D
Net Income for 2018 (when Sum of digit method was used)
$ 21,800.00
E = C + D
Updated Net Income for 2018 will be (before taking into account Issue #2 of Inventory)
$ 32,450.00
This error has two main effects:
>Effect 1: Since Ending inventory of 2017 is overcasted, Cost of Sales would have been undercasted, leading to Higher Gross profits and Higher Net Income, ultimately leading to Higher Retained Earnings.
>Effect 2: Ending Inventory of 2017 becomes Beginning inventory for 2018. Now Beginning Inventory of 2018 is Overstated. This has lead to overstatement of Cost of Sales, leading to lower gross profits and lower net income, ultimately leading to Lower retained earnings.
Note:
---Updated Net Income for 2018 after Straight Line Depreciation = $ 32,450 (calculated above)
---Adjustment of overcasting of Beginning Inventory = $ 24,200
---Correct Net Income for 2018 = $ 32,450 + $ 24,200 = $ 56,650 (to be used in answer)
MARTINEZ INC.
Retained Earnings Statement
For the Year Ended
2018
2017
RETAINED EARNINGS, JANUARY 1, UNADJUSTED [given]
$ 121,700.00
$ 76,300.00
LESS: CORRECTION OF ERROR FOR INVENTORY OVERSTATEMENT
$ 24,200.00
$ 24,200.00
RETAINED EARNINGS, JANUARY 1, ADJUSTED
$ 97,500.00
$ 52,100.00
ADD: NET INCOME
$ 56,650.00 [updated as calculated above]
$ 69,300.00
LESS: DIVIDENDS
$ 31,400.00
$ 23,900.00
RETAINED EARNING, DECEMBER 31
$ 122,750.00
$ 97,500.00
Year
Depreciable base
Formula
Depreciation expense
Accumulated Depreciation
Ending Book Value
2017
$ 106,500.00
[106500 x 4/10]
$ 42,600.00
$ 42,600.00
$ 63,900.00
2018
$ 106,500.00
[106500 x 3/10]
$ 31,950.00 [matching with the amount of 2018 depreciation expense]
$ 74,550.00
$ 31,950.00
2019
$ 106,500.00
[106500 x 2/10]
$ 21,300.00
$ 95,850.00
$ 10,650.00
2020
$ 106,500.00
[106500 x 1/10]
$ 10,650.00
$ 106,500.00
$ -
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