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2015
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Retained Earnings
Allowance for Doubtful Accounts
1,400
mentioned earlier, the income tax effects are not reported with the above correciing
entries in order to make it easier for you to focus on the effects of the errors themselves,
Once you understand the correcting entries, it is easier to add the income tax effects, as we
will do now.
If a correction increases a previous year's income (either by an increase in revenue
or a decrease in expense), the income tax expense for that period will usually be increased:
more income, more tax. If the correction reduces a previous year's income (either by a
decrease in revenue or an increase in expense), the income tax expense for that period will
usually be reduced: less income, less tax. The net correction to retained earnings, therefore, is made net of tax- Note that for counterbalancing errors, the income tax effects also
oftet each other over the two-year period, assuming tax rates have not changed.
Because the tax return for the previous period has already been filed, most adjustments of the previous year's income affects Income Tax Payable. The Deferred Tax Asset/
Liability account is affected only when the treatrnent for income taxes in the previous year
is a permitted tax treatrnent. Examples include the depreciation and bad debt non-counterbalancing error situations below. In both these cases, taxable income was correct as it
was calculated in the prior yeaq but now the amount of the related temporary difference
has changed.
Illustration 21A-1 identifies the correcting entries that are needed, including the tax
effects for the counterbalancing and non-counterbalancing examples we just walked
through. A-30"/o income tax rate is assumed for all years.
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Not Closed
Closed
COUNTERBALANCING ERRORS
1. Accrued Wages
Retained farnings
lncome Tax Payable
Salaries and Wages
Expense
*No Entry-
1050
450
1,500
(cantinued.)
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EXERCISE 21 -2 (Continued)
Event #4:
Retained Earnings................rr......,...,.......r.f,.r. 7,000
lncome Tax Payablg....,..rrr.rrr.r,!rrrr..r.r,.,,.,r'r,,r 31000
{ 01000
lnventoryr..rrr'r.r,r....rr.r.,,...rrr..rr,.rr.r,.rr..rrr
Ghanges for 2011and 2012 have not been included since
inventory changes are counterbalancing and their impact on
opening z01d_ retained earnings is nil.
Note: Also note that CRA generally requires a company to use
the same inventory costing method for tax as.it uses for financial
reporting purposes. Therefore, the effect of the change in inventory
costing method will result in a curre4t tax amoun_t, not qdeferred tax
(i+J
asset Jr liability. I X + p,^a "A'or'< *7- :
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Accumulated Depreciation-Machinery
Depreciation Expense..... r., r,,. r, r. r... r.,.,. r,.,
7,500
Retained Earn i ngs..........., r. r..r. r., r' r.,. i',..,
15,000
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2014
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$75,000
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Depreciation taken
Depreciation {correct}
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15.000
2.
3,
4.
Goodwill .....,......
..........r..r...... 202,500
Amortization Expense......,,.,....,.rr.
45,000
Retained Earnings ($*S,000 X 3.5 years).
157,500
ln addition, the company should test goodwill for impairment.
5.
No entry necessary.
6. Rgtaingd Earnings.,.....,...:rr.r.,,.rrrrr.,.r..r...r.*.rrr
Loss
871000
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