Question

Your company purchased some expensive, sophisticated equipment in January of Year 5. The cost was $2,000,000 and the equipment was expected to have a useful life of 10 years. Now, in Year 6, the company has spent an additional $1,000,000 on the same equipment. $400,000 of this total was on ordinary repairs to fix things in order to maintain expected operating condition. However, the other $600,000 was spent on extraordinary repairs, which consisted of replacing the original engine so that the useful life of the entire equipment will be extended another five years. Company management was to "capitalize" the entire $1,000,000.

Write a memo around one page in length to your supervisor that explains the following:

The accounting error that has been made
The effect this error will have on the company's financial statements this year
The problems that might result
The importance of fixing the error and what needs to be done to fix the error
General outline of the memo:
Traditional Memo Header to Me from You with a nice summary title and date
para 1 - What is the problem and what is the impact - one or two sentences
para 2 - What should have happened - can be done as one sentence with a journal entry view
para 3 - How to adjust - once sentence with a journal entry view
para 4 - What should be done for the future monthly depreciation - one sentence showing the calculation with a journal entry
para 5 - Closing statement - one or two statements and request for review and approval

Answer 1

The accounting error that has been committed is the error of principle by treating $400000 as capital expenditure.

What is an accounting error?

It should be noted that an accounting error simply means an error in account that wasn't intentional.

The effect this error include:

• Understatement of expenses.
• Overstatement of depreciation.
• Overstatement of assets.

In this case, the financial position of the company won't reflect a true and fair view of the position of the company.

In conclusion, in order to rectify the error, the ordinary repair should be treated as revenue.

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