Mad Hatter Inc. purchased land with an old warehouse already on it. On January 1

Question

Mad Hatter Inc. purchased land with an old warehouse already on it. On January 1, 2015, Mad Hatter tore down the old warehouse to make room for a building it was planning to construct on the land. At that time, the company capitalized dollar 100.000 in costs to tear down the old warehouse to the building account. Mad Hatter sold the scraps from the torn-down warehouse for dollar 40,000 and used the proceeds to decrease the new building account. The company spent an additional 875.000 to construct the building and capitalized the amount to the building account. Mad Hatter was able to complete the building on April 1, 2015, so the company started depreciating the costs in the building account at that time. The building account is depreciated using a 20 year useful life and the double-declining method. The company estimates the new building's salvage value will be zero. Determine the impact on total assets, liabilities and shareholders' equity for any errors noted in Mad Hatter's accounting at the end of the year. In other words, are total assets, total liabilities, or total shareholders' equity overstated/not affected/understated, and if yes, by how much?

Explanation / Answer

Since the sale proceeds from the old warehouse has been reduced from the new building account so the Asset side is undertstated by 40,000 and it shoul be treated as income for sale of old asset which understated the total shareholder's equity which ultimately leads to undertstated total Liability side.

So Total Asset , Total Liability and total Share holder's equity is under stated by $ 37,000 which is as follows:

Amount = 40,000

Less Depreciation Impact = - 3,000

Net impact = 37,000

Working

Depreciation rate : 1 - 0 /20 = 5%

Double declining rate = 5 X 2 = 10%

Depreciation = 40,000X 10% X 9 / 12 = 3,000

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