Question

During the first month of its current fiscal year, Green Co. incurred repair costs of $24,000 on a machine that had 4 years of remaining depreciable life. The repair cost was inappropriately capitalized. Green Co. reported operating income of $164,000 for the current year.

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 $932,000 and $1,012,000, 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

Solution a:

Depreciation taken on Repair Expense = $24000 / 4 = 6,000

Correct Operating Income that should have been reported = Reported operating Income + Depreciation taken on repair expense - Repair expense

= $164000 + 6000 - $24000

= 146,000

Solution b:

ROI - using the originally reported data:

Average Assets = ($932000 + $1012000)/ 2 = $972000

ROI (using original data) = Reported Operating Income/ Average assets = $164000 / $972000 = 16.9%

ROI - using the Corrected data:

Correct Total assets at the end of fiscal year = $1012000 - Repair Expense capitalized + Depreciation Expense taken

= $1012000 - $24000+ $6000 = $994,000

Average Assets = ($932000 + $994000)/ 2 = $963,000

ROI (using corrected data) =Corrected Operating Income/ Average assets = $146000 / $963000 = 15.2%

Solution c:

ROI of subsequent years if the error is not corrected will be too low. Because Operating income will be less due to depreciation in subsequent years and due to less operating income ROI will be low.

Hence first option is correct that is "ROI will be too low".