In preparing the adjusting journal entries for Year 4, the accountant for a large local law firm discovered that depreciation on furniture, fixtures and office equipment was understated by $40,000 for Year 3. The previous accountant had not depreciated a leasehold improvement because she believed that the improvement would revert to the office owner at the end of the lease term. The present accountant, knowing better, prepared the journal entry to make the correction. That entry, assuming a tax rate of 30%, would include which of the following:
A) cr. retained earnings $28,000.
B) cr. accumulated depreciation $28,000.
C) dr. retained earnings $28,000.
D) dr. depreciation expense $28,000.

Question

Quizplus · Accepted Answer

The correction of depreciation expense for Year 3 would result in a decrease in net income for Year 3 and therefore a decrease in retained earnings as a result. The entry would be a debit to depreciation expense and a credit to accumulated depreciation for $40,000. However, since this is a tax-adjusting entry, we need to consider the tax implications. Since the firm's tax rate is 30%, the tax savings from the increased depreciation expense would be $12,000 ($40,000 x 30%). Therefore, we need to credit retained earnings for the net effect, which is $28,000 ($40,000 - $12,000).

In Preparing the Adjusting Journal Entries for Year 4, the Accountant