Question

On 23 November 20X7, when engaged in preparing for the 20X7 fiscal year end, the chief accountant of Harper Ltd. discovered two accounting errors in the 20X5 statements:

a. A government ministry had paid $4.5 million in partial settlement of an amount due for a large contract. The contract revenue had already been recognized. However, the payment was accidentally credited to contract revenue instead of to accounts receivable and was included in taxable income.

b. Inventory purchases of $2.4 million had inadvertently been charged to equipment, a capital asset account, and had been amortized by 10% for each of 20X5 and 20X6. The accounting amortization rate is the same as the CCA rate for tax purposes. The ending and beginning inventories had been properly stated. Therefore, the mistake caused cost of sales to be understated by $2.4 million and pretax earnings to be overstated by the same amount.

Answer 1

Requirement 1: 

Earnings correction:

a. Inventory error:
	Understatement of cost of sales	$ 2,400,000
	Overstatement of depreciation	(480,000)
	Pre-tax overstatement of income	1,920,000
	Income tax (20%)	(384,000)	1,536,000
b. Revenue error:
	Overstatement of revenue	$ 4,500,000
	Income tax (20%)	(900,000)	3,600,000
Total overstatement of 20X5 net income			$ 5,136,000

 

Disclosure: The earnings correction (reduction) of $5,136,000 will be shown in the 20X7 statements as an adjustment to the opening balance of retained earnings. As well, other balances must be restated by the following amounts on the 20X6 comparative balance sheet:

Adjustments to 20X6 balance sheet:	Dr./(Cr.)
Equipment	$ (2,400,000)
Accumulated depreciation	480,000
Accounts receivable	(4,500,000)
Deferred income tax ($384,000 + $900,000)	1,284,000
Retained earnings	5,136,000

 

Requirement 2: 

Correcting entries in 20X7

Accumulated depreciation		480,000
Retained earnings†		1,536,000
Income tax receivable*		384,000
	Equipment		2,400,000

 

Income tax receivable*		900,000
Retained earnings†		3,600,000
	Accounts receivable		4,500,000

 

* Income tax was overpaid in 20X5 as a result of these errors. The entries recognize a recovery of taxes available by correcting the error. An alternative account can be deferred tax receivable, pending realization of the amounts.

 

Note that the sum of the retained earnings debits in these two correcting entries is equal to the 20X6 retained earnings adjustment of $5,136,000.

Note that the sum of the retained earnings debits in these two correcting entries is equal to the 20X6 retained earnings adjustment of $5,136,000.