Auditing Questions

[LYAK]

I have a few auditing / intermediate financial accounting questions I can't seem to figure out.

I am currently working on an auditing assignment which deals with depreciation of property, plant, and equipment. There are 5 main PP&E accounts (for example, Buildings), each containing individual PP&E assets. The information I have (per company books) and (per auditors) include cost, 2012 Accumulated depreciation, 2013 Depreciation expense, 2013 Accumulated depreciation, 2014 Depreciation expense, and 2014 Accumulated Depreciation. Of course, some of the accounts (per company books) and (per auditors) don't agree in amount. I have determined the required adjustments for the difference between the company books and the auditor's assertions. I need to journalize the impact of the adjusting entries on the client's income before taxes for 2014. The requirement indicates a separate entry for each asset class (for example, Buildings). I have been searching for information on how to perform these entries to avail. I have an idea of the correct entries, but I am not sure. My idea is to debit Retained Earnings and credit depreciation expense (or vice versa, depending on the nature of the adjustment). Am I correct in this application?

Also, I need to perform prior period adjusting entries. I have a question concerning the time periods included in the prior period adjustments: would 2014 be included? The reason I ask this question is because from what I understand, until the audit of the current year's financial statements are completed, the financial statements are not published. Therefore, if I am conducting an audit for the 2014 financial statements, and they contain errors, I wouldn't perform any prior period adjustments pertaining to these errors since the financial statements (as I assume) haven't been published yet.

Thanks.

 

[LYAK]

Now that I think about the 2014 correcting entries, how can I produce them if depreciation expense affects retained earnings AND accumulated depreciation?

If the depreciation expense of an account for the year, for example, was overstated by $5,000, how can I debit Accumulated Depreciation for $5,000 while crediting both Depreciation expense and Retained Earnings for the same amount? An imbalance occurs!

 

[Triest123]

Now that I think about the 2014 correcting entries, how can I produce them if depreciation expense affects retained earnings AND accumulated depreciation?

If the depreciation expense of an account for the year, for example, was overstated by $5,000, how can I debit Accumulated Depreciation for $5,000 while crediting both Depreciation expense and Retained Earnings for the same amount? An imbalance occurs!

Dr Accumulated Depreciation $5,000
Cr Retained Earnings $5,000
To adjust the over-provided depreciation made in the last year

 

[LYAK]

Ok, that entry makes sense. However, I still have a problem. If the auditor's are performing a 2014 audit, that means depreciation expense for this year (not 2012 or 2013, since expense accounts are temporary and thus have been closed) has to be adjusted. The instructions state to produce 1 adjusting entry for each asset class (for example, Buildings). How can I then, in one entry, include depreciation expense? Using the simple problem I included in this thread, how can I debit Accumulated Depreciation for $5,000, credit Retained Earnings for $5,000, and change credit Depreciation Expense for $5,000? An imbalance would occur. I have a working trial balance for 2014, and thus have to include a depreciation expense adjustment in the working trial balance. This assignment is getting to me!

Also, as I think about this assignment, would prior period adjustments be necessary? I know for sure that the 2012 and 2013 accounts need to be corrected; however, since these financial statements were never published (the company still hasn't gone public), are the entries to correct the mistakes considered prior period correcting entries?

As you can see, I'm really lost.

 

[Triest123]

Ok, that entry makes sense. However, I still have a problem. If the auditor's are performing a 2014 audit, that means depreciation expense for this year (not 2012 or 2013, since expense accounts are temporary and thus have been closed) has to be adjusted. The instructions state to produce 1 adjusting entry for each asset class (for example, Buildings). How can I then, in one entry, include depreciation expense? Using the simple problem I included in this thread, how can I debit Accumulated Depreciation for $5,000, credit Retained Earnings for $5,000, and change credit Depreciation Expense for $5,000? An imbalance would occur. I have a working trial balance for 2014, and thus have to include a depreciation expense adjustment in the working trial balance. This assignment is getting to me!

Also, as I think about this assignment, would prior period adjustments be necessary? I know for sure that the 2012 and 2013 accounts need to be corrected; however, since these financial statements were never published (the company still hasn't gone public), are the entries to correct the mistakes considered prior period correcting entries?

As you can see, I'm really lost.

=> If the error found in the year 2014 (i.e. the current year), there is no impact on
the retained earnings.

 

[LYAK]

Dr Accumulated Depreciation $5,000
Cr Retained Earnings $5,000
To adjust the over-provided depreciation made in the last year

Hey, I really appreciate the information. Now, this entry does make sense; however, I know that prior period adjustments affecting Retained Earnings are made "net of taxes." So, my problem is understanding the values used in this entry. For simple purposes, suppose that we only take federal income tax (10%, let's say) into account; wouldn't Retained Earnings be credited for $4,500? If $500 of expense doesn't belong in the associated year, our net income is $500 higher, which, taxed at 10%, means that only $450 flows to Retained Earnings. From all the examples I have looked at online, they illustrate the journal entries in the same fashion as you have: credit Retained Earnings for the full amount of the overstated depreciation expense. Which is correct, and why? Also, if the correct entry would include only a $450 credit to Retained Earnings, and a $500 debit to accumulated depreciation, what would the $50 remaining credit be?

 

[Triest123]

Hey, I really appreciate the information. Now, this entry does make sense; however, I know that prior period adjustments affecting Retained Earnings are made "net of taxes." So, my problem is understanding the values used in this entry. For simple purposes, suppose that we only take federal income tax (10%, let's say) into account; wouldn't Retained Earnings be credited for $4,500? If $500 of expense doesn't belong in the associated year, our net income is $500 higher, which, taxed at 10%, means that only $450 flows to Retained Earnings. From all the examples I have looked at online, they illustrate the journal entries in the same fashion as you have: credit Retained Earnings for the full amount of the overstated depreciation expense. Which is correct, and why? Also, if the correct entry would include only a $450 credit to Retained Earnings, and a $500 debit to accumulated depreciation, what would the $50 remaining credit be?

=> Dr Tax expense $50
Cr Tax payable $50
To account for the tax effect on the prior year adjustment in respect to
the over-provided depreciation in the last year

(In other words, your tax liability for the current year is increased)

 

[LYAK]

=> Dr Tax expense $50
Cr Tax payable $50
To account for the tax effect on the prior year adjustment in respect to
the over-provided depreciation in the last year

(In other words, your tax liability for the current year is increased)

OMG... duh. Thanks. I swear my brain doesn't work half of the time.

 

[LYAK]

=> Dr Tax expense $50
Cr Tax payable $50
To account for the tax effect on the prior year adjustment in respect to
the over-provided depreciation in the last year

(In other words, your tax liability for the current year is increased)

Ugh, actually, this doesn't seem to work... Dr. Accumulated Depreciation for $500 and Dr. Tax Expense = Dr. of $550; Cr. Retained Earnings $450 and Cr. Taxes Payable $50 = $500.

This is driving me nuts.

 

[LYAK]

Ugh, actually, this doesn't seem to work... Dr. Accumulated Depreciation for $500 and Dr. Tax Expense = Dr. of $550; Cr. Retained Earnings $450 and Cr. Taxes Payable $50 = $500.

This is driving me nuts.

Maybe a Cr. to Tax Benefit?

 

[Triest123]

Maybe a Cr. to Tax Benefit?

Dr. Accumulated Depreciation 500
Dr. Tax Expense 50
Cr. Retained Earnings 500
Cr. Taxes Payable 50


The note of retaining earnings is :
Retaining earning b/f XXXX
Add : Prior year adjustment 500
Profit for the year XXX
Less : Taxation
Tax on Prior year adjustment (50)
Tax for the current year (XXX)
Retaining earning c/f XXX

 

[LYAK]

Dr. Accumulated Depreciation 500
Dr. Tax Expense 50
Cr. Retained Earnings 500
Cr. Taxes Payable 50


The note of retaining earnings is :
Retaining earning b/f XXXX
Add : Prior year adjustment 500
Profit for the year XXX
Less : Taxation
Tax on Prior year adjustment (50)
Tax for the current year (XXX)
Retaining earning c/f XXX

I was reviewing my textbook and a few problems from earlier classes, and they use a "deferred tax liability" account, which is what I used. I don't think including an expense entry in a correcting entry made in the current period from a previous period error is allowable (or, at least, it's looked down upon on). It's like including a higher depreciation expense in the current year because you forgot to book it in a previous period (matching principle). I'm not sure, however.

 

[Triest123]

I was reviewing my textbook and a few problems from earlier classes, and they use a "deferred tax liability" account, which is what I used. I don't think including an expense entry in a correcting entry made in the current period from a previous period error is allowable (or, at least, it's looked down upon on). It's like including a higher depreciation expense in the current year because you forgot to book it in a previous period (matching principle). I'm not sure, however.

=> Why there is a higher depreciation expense in the current year if you make a
prior year adjustment ?

 

[LYAK]

=> Why there is a higher depreciation expense in the current year if you make a
prior year adjustment ?

There isn't a higher depreciation expense in the current year than what the company should have recorded. I am saying that, because of prior period errors in depreciation expense allocations, which led to improper tax expense values to be recorded, it wouldn't be correct to debit or credit a tax expense account (which would be the current year's account, since the correcting entries are done in the current year and all old expense accounts have been closed anyway) because the entry would affect current year tax expense, even though the changes to the tax expense were affected from prior periods. For example, if in the current year I discovered that I understated depreciation expense last year, I wouldn't correct the entry by debiting depreciation expense, because debiting my depreciation expense for the current year due to a mistake from a prior year is a violation of the matching principle.

 

[Triest123]

There isn't a higher depreciation expense in the current year than what the company should have recorded. I am saying that, because of prior period errors in depreciation expense allocations, which led to improper tax expense values to be recorded, it wouldn't be correct to debit or credit a tax expense account (which would be the current year's account, since the correcting entries are done in the current year and all old expense accounts have been closed anyway) because the entry would affect current year tax expense, even though the changes to the tax expense were affected from prior periods. For example, if in the current year I discovered that I understated depreciation expense last year, I wouldn't correct the entry by debiting depreciation expense, because debiting my depreciation expense for the current year due to a mistake from a prior year is a violation of the matching principle.

=> Remember, you have to paid for the tax due to the understatement of the last year's
profit, hence increasing the current tax liability for the current year.

In other words, your "accural for tax" in the current year should also be
accounted for the effect on the prior year adjustment even though, as you said,
violating the matching concept.