Question

George Young Industries (GYI) acquired industrial robots at the beginning of 2018 and added them to the company’s assembly process. During 2021, management became aware that the $2.8 million cost of the equipment was inadvertently recorded as repair expense on GYI’s books and on its income tax return. The industrial robots have 10-year useful lives and no material salvage value. This class of equipment is depreciated by the straight-line method for financial reporting purposes and for tax purposes it is considered to be MACRS 7-year property. Cost deducted over 7 years by the modified accelerated recovery system as follows:

Year	MACRS Deductions
2018	$	400,120
2019		685,720
2020		489,720
2021		349,720
2022		250,040
2023		249,760
2024		250,040
2025		124,880
Totals	$	2,800,000

The tax rate is 25% for all years involved.

Required:
1. & 3. Prepare any journal entry necessary as a direct result of the error described and the adjusting entry for 2021 depreciation.
2. Will GYI account for the change (a) retrospectively or (b) prospectively?

Answer 1

Solution
(a)
Capital Expenditure treated as revenue expenditure.
An expenditure made on an asset which increases the revenue earning capacity of the asset for the current year for future period will be treated as Capital expenditure,otherwise such expenditure will be treated as revenue expenditure.
Since the expenditure of $1,575,560 (2018 to 2020) is treated as revenue expenditure the there is a tax savings of $393,890 (25% of 1,575,560 Million).
Adjusting Entry in the year of 2021 will be as follows.
Date	Particulars	Debit	Credit
	Equipment Account	$       1,575,560
	Retained Earnings A/c		$       1,575,560
	(Being the repair expense for 3 years capitalised in 2021)
(Since the amount of $1,575,560 is debited during the years the same have been got reduced from the Income statement.So the same has to be reversed from retained earnings)
Date	Particulars	Debit	Credit
	Depreciation A/c Dr	$    675,240.00
	Accumulated Depreciation A/c		$    675,240.00
	(Depreciation Charged for 3 years)(1575560/7*3)
	Accumulated Depreciation A/c	$    675,240.00
	Equipment A/c		$    675,240.00
	(Depreciation Charged for 3 years adjusted from cost)
(b)
	The GYI account the changes during the year 2021 by passing the entries as above.The same will be having propective changes in the books of accounts since once the books of accounts are closed the same cannot be adjusted.
	So for the adjustment for years 2018,2019 and 2020 the adjustment will be made in the year of 2021.