Question

In 2013, due to a change in marketing forecasts, Barney Corporation reduced the projected life of its patent for producing round dice. The cumulative patent amortization prior to 2013 would have been $19 million higher had the new life been used. Barney's tax rate is 40%. Barney's retained earnings as of December 31, 2013, would be:

a. overstated by $10 million

b. overstated by $3 million

c. understated by $3 million

d. overstated by $7 million

e. none of the above

Answer 1

Option e - none of the above

Barney's corporation retained earnings would be overstated by $11.40 million

Cumulative Amortization refers to the total Amortization Expense charged against this intangible asset (patent in this case) over a period of its useful life.

Now because of the changes in marketing forecast , the Barney Corporation decided to reduce the useful life of the patent, earlier if the life would have not been reduced then the cumulative amortization expense on the patent would have been $19 million higher than it is now, which means Barney corporation now has to charge less expenses because now the projected life of patent has been reduced, that leads to the higher profits for the corporation because no the expenses are less. Now we will charge 40% of tax rate on this $19 million which is leading to overestimating the retained earnings of the corporation.

barney's retained earnings = $19 million - $19 million x 40% = $ 11.40 millions