Question

July 9,2024, Ivanhoe Enterprises Inc. discovered it had recorded the $68,000 purchase of land as a legal expense on November 8 , 2023. The company had reported retained earnings of $516,000 at its previous year end, December 31,2023 . During 2024, Ivanhoe had profit of $174,000 and it declared and paid cash dividends of $194,000. Ivanhoe has a 25% income tax rate. Prepare the journal entry to correct the error.

Answer 1

To correct the error of recording a land purchase as a legal expense, reverse the original entry by debiting Legal Expense and crediting Land for $68,000. Then, adjust Retained Earnings for the net of tax effect of the error.

Step-by-step explanation:

The student has asked to prepare the journal entry to correct an accounting error where the purchase of land was incorrectly recorded as a legal expense. To correct this error, the following journal entry needs to be made:

1. Debit Legal Expense for $68,000 to remove the expense originally recorded.
2. Credit Land for $68,000 to properly record the purchase of land as an asset.
3. Debit Retained Earnings for the net effect of the error considering the income tax rate of 25%, since the error occurred in the previous year and affected the income statement of that year. The correction amount is 75% of $68,000 (since the expense was overstated and income tax would have been paid on the amount that was overstated).

The tax effect is calculated as $68,000 * 25% = $17,000, and the correction to retained earnings is calculated as $68,000 - $17,000 = $51,000.

Journal Entry

• Legal Expense $68,000
• Land $68,000
• Retained Earnings $51,000
• Income Tax Expense $17,000

This entry ensures that the land is correctly recorded on the balance sheet, the legal expense is removed from the income statement, and retained earnings are properly adjusted for the financial statements of the current year.