Question

During the first month of its current fiscal year, Green Co. incurred repair costs of $19,000 on a machine that had 4 years of remaining depreciable life. The repair cost was inappropriately capitalized. Green Co. reported operating income of $169,000 for the current year.

Required:

a. Assuming that Green Co. took a full year's straight-line depreciation expense in the current year, calculate the operating income that should have been reported for the current year.

b. Assume that Green Co.'s total assets at the end of the prior year and at the end of the current year were $946,000 and $1,017,000, respectively. Calculate ROI (based on operating income) for the current year using the originally reported data and then using corrected data. (Round your answers to 1 decimal place.)

c. Indicate the effect on ROI of subsequent years if the error is not corrected.

	ROI will be too low.
	ROI will be too high.
	ROI will remains the same.

Answer 1

Computation of Operating income that should be reported
					Calculate depreciation expenses for current year
Particulars				Amount
To be depreciated (Repair cost capitalized in error) (a)				19000
Remaining life (b)				4 years
Depreciation expenses in current year (a)/(b)				4750
Calculation of corrected operating income
Particulars			Amount
operating income originally reported			169000
increase in repair expenses			-19000
Decrease in depreciation expenses			4750
Corrected operating income			154750
Calculate ROI for the current year using original Data
particulars			amount
Operating income (a)			169000
Average total assets (946000+1017000/2) (b)			981500
ROI = (a)/(b)			17.2%
calculate corrected year end assets
Particulars			amount
Year end assets originally reprted			1017000
less: net book value of mistakenly
cost                                                      19000
less : accumulated depreciation 4750			14250
Corrected year end assets			1002750
Calculate ROI for the current year using corrected date
Particulars			amount
Operating income			154750
average total assets (946000+1002750)/2			974375
ROI = operating income/ average total assets			15.8%
The depreciation expenses will be high in the subsequent years therefore the
net income will be low and average assets will be high therefore ROI will be low