Question

Link Co. purchased machinery that cost $3,000,000 on January 4, 2016. The entire cost was recorded as an expense. The machinery has a nine-year life and a $200,000 residual value. The error was discovered on December 20, 2018. Ignore income tax considerations. Before the correction was made, and before the books were closed on December 31, 2018, retained earnings was understated by:_________.a. $3,000,000.

b. $2,066,667.
c. $2,377,778
d. $2,333,333.

Answer 1

c. $2,377,778

Step-by-step explanation:

Recording the entire cost as expense would have understated Retained Earnings by $3,000,000

Annual Depreciation on machine = Purchase cost - Residual value / Useful life

= ($3,000,000 - $200,000) / 9

= $311,111

Depreciation would have been recorded for $622222 for 2 years had machinery been correctly recorded ($311,111 * 2) = $622,222

On December 20, 2018, the net understatement of Retained Earnings = $3,000,000 - $622,222

= $2,377,778