Question

While preparing its year 3 financial statements, Dek Corp. discovered computational errors in its year 2 and year 1 depreciation expense. These errors resulted in overstatement of each year’s income by $25,000, net of income taxes. The following amounts were reported in the previously issued financial statements:

	Year 2	Year 1
Retained earnings, 1/1	$700,000	$500,000
Net income	150,000	200,000
Retained earnings, 12/31	$850,000	$700,000

Dek’s year 3 income is correctly reported at $180,000. Which of the following amounts should be adjusted to retained earnings and presented for net income in Dek’s year 3 and year 2 comparative financial statements?

	Year	Retained earnings	Net income
	year 2   year 3	--   ($50,000)	150,000     180,000
	year 2   year 3	($50,000)   --	$150,000     180,000
	year 2   year 3	($50,000)   --	$125,000     180,000
	year 2   year 3	--   --	$125,000     180,000

This Answer is Correct (Answer is below)

year 2   year 3

($50,000)   --

$125,000     180,000

This answer is correct. ASC Topic 250 requires that items of profit or loss related to the correction of an error in the financial statements of a prior period be accounted for and reported as prior period adjustments and excluded from the determination of net income for the current period. When comparative financial statements are prepared, it is necessary to adjust net income, its components, retained earnings balances, and other affected balances for all of the periods presented to reflect retroactive application of prior period adjustments. Hence, the amounts for each period must be stated in the comparative statements as if the errors had not occurred. Thus, both year 1 and year 2 net income and retained earnings would be retroactively reduced by $25,000 to reflect the correct amounts for each period. After these adjustments are made, the amounts for year 3 will be correctly stated. Note that this retroactive treatment is only used for presentation purposes in the comparative financial statements. The actual journal entry made to correct retained earnings at 1/1/Y3 is

Retained earnings		50,000
	Accumulated depreciation		50,000

I don't understand why the answer below is correct for this problem regardless of explanation above? Can please explain why this is the answer in a easier way so I can understand? Also why is retained earnings in Year 2 ($50,000)

year 2   year 3

($50,000)   --

$125,000     180,000

Answer 1

Given that the net Income for year 1 and year 2 is overstated by $25,000 each

Also given year 3 income is correctly reported at $180,000, hence no adjustment is required in year 3 for prior period errors.

Since the financials for comparative period (Year 2) will also be presented hence, Retained Earnings for year 2  is required to be adjusted for error in year 1 ( $25,000) and the net income of year 2 will be decreased by $25,000 for the error in year 2. Hence, correct net income for year 2 to be presented in comparative income statement will be $150,000 -  $25,000 = $125,000 and adjustment to ending retained earnings of year 2 is $25,000+$25,000 = ($50,000) decreased

Hence, correct answer is

year 2   year 3

($50,000)   --

$125,000     180,000