Hi.
Else here.
And today, I'm going to do a video with regards
to the correction of an error.
I'm actually going to solve this question.
This question has been posted in the description
below the YouTube video.
Please download it and attempt it yourself
before you watch me solve it.
This will have the best impact on your learning.
Generally, I get students to read the question
all the way through first.
Often, students read a question partway through,
decide they know what's going on,
and then they start solving it.
Later on, they find that they've missed something.
Or what happens is they solve that portion,
and they forget that there's other portions,
and they move on to the next question.
This results in major loss of marks.
Be sure you read the question all the way through first.
I'm not going to do that, because I'm
going to assume that you've downloaded the question
and you've already read it.
In this case, we've got Blue Corporation, 2019,
and there were two errors to their financial statements.
One of those errors was in 2016.
The company received $180,000, and that
was in settlement of an accounts receivable.
It was accidentally credited to service revenue
and reported in the 2016 statement
of comprehensive income.
So it appears to have increased income,
which of course is going to have income tax impact.
In 2017, the company paid for a major overhaul
of their existing equipment, ensuring
it was in peak condition.
The entry was made to increase the equipment account
by 24,000.
However, upon review, controller does not
feel that the equipments-- oh, this should be an apostrophe.
Useful life efficiency or effectiveness was improved.
Well, no long-term , benefit, so we should have recorded it
as a maintenance expense.
So we need to know the depreciation.
They use straight line depreciation.
Useful life of 10 years.
And their policy is a full year's depreciation
in the year of acquisition.
Excellent.
25% tax rate.
So now let's look at the required-- calculate
the earnings correction that Blue Corporation
would present in their 2019.
So they're specifically asking only for their 2019
financial statements.
We want the journal entry to record the correction in 2019.
And appropriate disclosure.
Now, there are many ways to determine the impact
on the 2019 financial statements.
I'm going to show you one way that I do it.
If you do it another way, totally acceptable.
I'm simply showing you one way that I think about it.
The first thing I'm going to deal with is the 2016 issue.
Let's move forward.
The way I think about an error correction is what they did.
So I look at what occurred in that year
and what they actually did in the financial records.
Let's look at 2016.
Now, we know that they recognized $180,000 of cash
as revenue, so there must have been
a debit to cash of $180,000.
And there must have been a credit to revenue of $180,000.
There was also tax implications of this,
so let's look at the tax implications.
They do tell us that the tax rate was 25%,
so I'm going to do the calculation over at the side.
$180,000 of revenue taxed at 25% would be $45,000 of income tax.
Let's do the entry they would have had to do.
Debit income tax expense $45,000, and then
credit income tax payable of $45,000.
Now I am in 2019, so I want to look at 2017.
There would be no entry.
Think forward.
Don't be shortsighted.
Think forward all the time.
2018-- no entry.
And we're sitting in 2019, so I don't have to think about that.
So I've got the full impact of this error
right now, what they did.
Don't forget-- I'm looking at what they did,
not what I'm supposed to do to correct it-- what they actually
did in 2016, 2017, and 2018.
What I want to do now is flow this through retained earnings
so I can see what retained earnings
would have as an error in 2019.
There's retained earnings.
Debit credit.
When I close the revenue account,
I'm going to debit revenue and credit retained earnings.
There's also income tax expense.
When I close an expense account, I'm
going to credit the expense account
and debit retained earnings.
No impact in 2017, no impact in 2018.
What is the net impact on retained earnings?
In 2019, retained earnings is overstated by $135,000.
Now what do I do?
I want to look what would have happened
if I had done it right--
what they should have done.
What should they have done in all those years?
Let's look at it.
Starting with 2016 when they made the error,
there should have been a debit to cash
of $180,000 and a credit to accounts
receivable of $180,000.
Now let's look at tax implications.
Well, these are both stated in a financial position, also called
balance sheet accounts.
So therefore, there is no effect on our taxes.
Move on to the next year, 2017.
No effect.
2018, no effect.
Excellent.
Now let's move on and look at the impact
on retained earnings.
Nothing and nothing.
Excellent.
What's important to do now is to compare the two years.
Because what you're trying to do is
you're trying to move from where you were,
which was wrong, to, where you should be, which was right.
So therefore, I'm going to get rid of anything
that's exactly the same.
Cash between the two years is exactly the same,
so I don't have to correct it.
I never have to correct an account that
is an income statement account.
These are temporary accounts, and they're already
closed to retained earnings.
So I'm going to put a line through all of my income
statement accounts, because I'm not supposed to correct them.
There's revenue, income tax expense.
I don't have to fix those.
What do I have to fix?
I have to fix every account that's
a balance sheet or a statement of financial position account.
I have to fix that.
I have to make it go away.
Let's move on.
I have to cause this to happen.
This is what it should be.
I need to make this happen.
Now, the final thing I have to do--
I look at the retained earnings, and this is where I should be.
Then I look at the retained earnings,
and this is where I actually am.
Fix it.
I need to have retained earnings of 0.
So do whatever is necessary to make it work.
And that would be 135,000 debit to retained earnings.
All right.
So now I know what I'm going to do.
I'm going to make this account go away.
I'm going to fix retained earnings,
and I'm going to fix accounts receivable.
Let's look at the correcting entry.
In 2019, I'm going to do the following correcting entry.
I'm going to debit retained earnings for the amount that
has to disappear, $135,000.
I'm going to credit accounts receivable for the amount that
should disappear, because I've got to correct the accounts
receivable account.
That's $180,000.
And then finally, I'm going to fix income tax payable.
I'm going to debit income tax payable by the $45,000.
Because remember that income tax payable was credited.
Let's look at that.
Income tax payable was credited right here,
and we had to make it go away.
We had to fix the retained earnings.
And finally, we had to make this happen.
And our correcting entry did exactly that.
Let's move on.
The next mistake was in 2017.
We know that they put $24,000 in the equipment account,
so let's start with what they did.
In 2017, the company debited their equipment account
for $24,000.
They must have credited something like cash in accounts
payable.
What else must have happened?
The company takes depreciation on their equipment.
We know from the question that the depreciation was 10 years,
and they take a full year in the year of acquisition.
Let's calculate the depreciation.
24,000 divided by 10 years is equal to 2,400 every year.
Let's do the entry.
Debit depreciation expense 2,400 and credit accumulated
depreciation 2,400.
Now, there would have been income tax impact.
That's because an expense was recorded.
Let's do the income tax impact-- $2,400
times a 25% tax rate, $600.
Since we're recording an expense,
expenses reduce income tax, so this
would be a reduction to the income tax expense.
So this would be a debit to income.
I'm going to use the short form-- tax
payable, $600, and a credit to income tax expense, $600.
Perfect.
Let's move on.
In 2018, what did they do?
They must have recognized depreciation expense again.
Debit depreciation expense for the $2,400 and credit
accumulated depreciation for the $2,400.
Income tax impact-- debit income tax
payable for $600, credit income tax expense for $600.
Now we know everything that happened in 2017 and 2018.
Now we have to look at what was the impact on retained earnings
of all of these entries.
Didn't give myself much space.
Let's just squeeze it in right here.
For 2017, the first entry--
no impact on retained earnings, because it's
all balance sheet statement of financial position accounts.
Next, depreciation expense-- that's
a debit, so we would credit depreciation expense, debit
retained earnings.
That is $2,400.
And then for the income tax payable-- no impact,
but income tax expense--
credit income tax expense, debit it to close it,
and then we credit retained earnings $600.
And in 2018, we would do exactly the same thing--
$600.
And so what is the overall error in our retained earnings?
$3,600 debit error in our retained earnings.
Now we have to look at what they should have done.
In 2017, what should they have done?
Well, they should have made an entry debit
to maintenance expense.
You could call it repair expense, whatever you want--
24,000.
Credit to cash or accounts payable $24,000.
What's the income tax impact of this entry?
We know that income taxes is 25%,
so we multiply it times 25%.
And that will tell us that the impact on income taxes is
a reduction in income taxes-- because remember,
this is an expense, so it reduces income taxes--
reduction in income taxes of $6,000.
So that would be a debit to income
tax payable of $6,000 and a credit
to income tax expense of $6,000.
2018-- no effect.
Let's look at the T account and where it should
be for retained earnings.
I've got a maintenance expense, and that
would be closed with a credit but a debit
to retained earnings.
I've got an income tax expense.
That would be closed with a debit but a credit
to retained earnings.
And the net impact on retained earnings
would be a debit of $18,000.
So if we now go back, this is where
retained earnings stands now.
This is where retained earnings should be.
Remember the step-by-step process.
First thing-- get rid of all the accounts
that you don't need to pay attention to.
Cash was the same, so there's no need to correct it.
Now let's get rid of all the accounts
that are income statement accounts,
because we don't correct income statement accounts.
So I'm going to look at the ones that I don't have to correct.
I don't have to correct this, because it's already
through to retained earnings.
I don't have to correct the income tax expense,
because it's through to retained earnings.
Moving my page down, I don't have to correct this expense,
retained earnings.
And I don't have to correct this expense, retained earnings.
So those things are good.
Let's look at the things that I absolutely have to correct.
The equipment account-- make it go away.
That's a debit.
I'm going to have to credit equipment.
The accumulated depreciation-- make it go away.
That's a credit.
I'm going to have to debit it.
Income tax payable-- it's got to go away.
That's a debit.
I'm going to have to credit it.
Accumulated depreciation-- same as before.
Credit-- I'm going to have to debit it.
Income tax payable-- same as before.
Debit-- I'm going to have to credit it.
For what they should have done, I have to make this happen.
Oh, wait a minute.
That's an expense account.
That's going to go through retained earnings.
I don't have to look at it.
Almost got caught there, didn't I?
Expense account-- I don't have to look at it.
But I do have to make the income tax payable happened.
So make it happen.
And finally, don't forget retained
earnings has to be at $18,000.
But it's only at $3,600.
To make it 18,000, what entry do I have to do here?
I have to do an entry right here.
This is the entry that I need in order to fix retained earnings.
So I think we've got it all.
Let's do the correcting entry.
In 2019, for this second entry, I
have to do a debit to retained earnings.
How much was that debit to retained earnings?
The debit to retained earnings would've been for--
solve for this--
14,400.
I have to correct some accounts.
I have to do a credit to equipment for 24,000.
What else do I have to correct?
I have to debit accumulated depreciation $2,400,
but I have to debit accumulated depreciation for $2,400.
Take those two together-- $4,800.
Debit accumulated depreciation $4,800.
I've got the equipment, accumulated depreciation,
retained earnings.
What's the only other thing I have to correct?
I have to do a credit to income tax
payable, 600, a credit to income tax payable, 600.
Is that all?
Ah, but wait a minute.
I have to do a debit to income tax payable for 6,000.
So looking at that, I've got a credit of 600, a credit of 600,
and a debit of 6,000.
Total amount of the entry that I have to make to income tax
payable is a debit of 4,800.
Let's do it.
By the way, it's just fluke that the income tax payable ended up
being the exact same amount as the accumulated depreciation.
That was not a deliberate thing.
Here we have the two entries to correct the errors.
What else do we have to look at?
Note disclosure: under IFRS, the correction of an error
must be disclosed in the notes of the financial statements.
So what do we have to include?
We have to include the nature of the error.
We have to include the accounts and the amounts
that we changed in all prior periods.
There has to be a listing.
2016, we did this.
This is for all comparative years
that we're actually showing.
So this is only if we're showing the comparative years.
So if we showed 2017, we would actually have to say in 2017,
the following accounts were adjusted.
And then we would have to show the amounts
that they were adjusted by.
We have to show the amount of the summary correction.
This is to the earliest prior period provided.
So if we were only showing, say, 2019, and we
weren't going to show any comparative years-- which,
under IFRS, we're not permitted to do,
but let's just move forward.
If we were only going to show 2019,
we would have to show the total change to retained earnings.
Anything else?
Yes.
If full retrospective restatement is not possible,
such as the details are unknown, or we just can't figure it out,
or the cost would be astronomical--
in that case, we have to explain, explain, explain.
We have to provide an explanation
as to why it is not possible to determine the details
and how the error was corrected.
Anything else?
Yes.
The effect on both basic and diluted earnings per share.
It has to be reported for each prior period presented.
That's it for note disclosure.
Keep in mind that if you're doing a summary
change, like the one we're doing right now, we would have to,
at a minimum, do this.
And because we're not changing any comparatives,
we would have to do that, too.
All right.
Thank you very much for joining me.
I hope this video was beneficial for your learning.