Ernst Company purchased equipment that cost $750,000 on January 1,2010. The enti

Question

Ernst Company purchased equipment that cost $750,000 on January 1,2010. The entire cost was recorded as an expense. The equipment had a nine year life and a $30,000 residual value. Ernst uses the straight-line method to account for depreciation expense. The error was discovered on December 10,2012. Ernst is subject to 40% tax rate.
Before the correction was made and before the books were closed on December 31,2012, retained earnings was understated by
a) $354,000
b) $450,000
c) $332,000
d) $336,000

Explanation / Answer

Answer is A: $354,000 $750,000 expense * 0.6 = $450,000 net income change Now to figure out the correct net income change $750,000 - $30,000 = $720,000 / 9 years = $80,000 per year accumulated depreciation 2 years have elapsed (Jan 1, 2010 to Dec 31, 2012) So $160,000 depreciation has accumulated $160,000 expense * 0.6 = $96,000 $450,000 - $96,000 = $354,000 difference in expense/net income

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