QUESTION THREE (35 MARKS)

Question

Takalani Ltd is a listed company on the JSE and has a December year end. The company made an error in calculating depreciation on its equipment in 20X2. The company depreciates on the reducing balance method. The rate applied to equipment is 20% per annum, but the accountant made a mistake in 20X2 and applied a rate of 10% per annum in that year. The book value of the equipment on 1 January 20X2 was R550 000. The error was only picked up and corrected during the current 20X4 financial year.

The calculated book value of the equipment at the end of 20X2 was used as the basis for calculating the 20X3 depreciation which was calculated using the correct rate of 20%.

Net profit for the current year (i.e. after tax of 30%) but before accounting for depreciation on the equipment, amounted to R920 000. The tax authority will allow the corrected depreciation charge to be deducted for tax purposes and will re-open the prior year tax assessments and reassess the company’s taxable income for the periods affected.

Net profit after tax for the past two years, prior to correcting the error, was as follows:

20X2 - R750 000

20X3 – R840 000

The accumulated profits as at 1 January 20X3 were R2 100 000.

The effect of the error is considered material.

REQUIRED:

Give the note disclosure relating to the correction of the prior period error in the financial statements for the year ended 31 December 20X4. Show all workings.
Give the journal entries necessary to correct for the prior period error.
Give the accumulated profits column of the statement of changes in equity for the year ended 31 December 20X4. Comparatives are required.

Answer 1

To address the questions regarding the correction of the prior period error in relation to Takalani Ltd's financial statements, I’ll break this down into the required sections including the note disclosure, journal entries, and the statement of changes in equity.

Note Disclosure for Prior Period Error

Note X: Correction of Prior Period Error

In the current financial year, the company identified an error in the depreciation calculation for its equipment. This error arose in the assessment of the depreciation expense for the financial years 20X2 and 20X3. The depreciation rate used in 20X2 was 10% instead of the correct rate of 20%.

The impact of this error is material, and thus the company has corrected the prior period financial statements in accordance with the requirements of International Accounting Standards (IAS) 8 - Accounting Policies, Changes in Accounting Estimates and Errors. The effect of this error is summarized as follows:

1. Calculation of the Depreciation Charge

• Book Value at 1 January 20X2: R550,000

• Depreciation for 20X2 (Incorrect Rate):

  • 10% of R550,000 = R55,000
  • Book Value at 31 December 20X2 (Incorrect):
    • R550,000 - R55,000 = R495,000

• Depreciation for 20X2 (Correct Rate):

  • 20% of R550,000 = R110,000
  • Book Value at 31 December 20X2 (Correct):
    • R550,000 - R110,000 = R440,000

2. Calculation of 20X3 Depreciation

• Book Value at 1 January 20X3 (Incorrect): R495,000

• Depreciation for 20X3 (Correct Rate):

  • 20% of R495,000 = R99,000
  • Book Value at 31 December 20X3 (Incorrect):
    • R495,000 - R99,000 = R396,000

• Book Value at 1 January 20X3 (Correct): R440,000

• Depreciation for 20X3 (Actual Correct Rate):

  • 20% of R440,000 = R88,000
  • Book Value at 31 December 20X3 (Correct): R440,000 - R88,000 = R352,000

3. Effect on Net Profit

• 20X2 Net Profit (Original): R750,000

• Correction of Depreciation for 20X2:

  • Extra Depreciation: R110,000 - R55,000 = R55,000
  • Adjusted Net Profit for 20X2: R750,000 - R55,000 = R695,000

• 20X3 Net Profit (Original): R840,000

• Correction of Depreciation for 20X3:

  • Extra Depreciation: R99,000 - R88,000 = R11,000
  • Adjusted Net Profit for 20X3: R840,000 - R11,000 = R829,000

Summary of Adjusted Net Profits:

• 20X2 Net Profit: R695,000
• 20X3 Net Profit: R829,000

Journal Entries to Correct the Error

1. For 20X2

   • Debit: Retained Earnings (Correction of error) – R55,000
   • Credit: Accumulated Depreciation – R55,000

2. For 20X3

   • Debit: Retained Earnings (Correction of error) – R11,000
   • Credit: Accumulated Depreciation – R11,000

Total Correction to Retained Earnings: R55,000 + R11,000 = R66,000

Statement of Changes in Equity for the Year Ended 31 December 20X4

| Accumulated Profits            | Current Year (20X4) | Prior Year (20X3) |
| ------------------------------ | -------------------- | ------------------ |
| Opening Balance                | R2,100,000           | R2,100,000         |
| Adjustment for Prior Period Error: | (66,000)           | -                  |
| Adjusted Opening Balance (20X3)| R2,034,000           | -                  |
| Net Profit for the Year (after tax) | R920,000        | R829,000           |
| Closing Balance                | R2,954,000           | R2,034,000        |

Summary

The adjustments necessary to correct Takalani Ltd’s financial statements involve recalculating accumulated profits and retaining the corrections made in the financial records and disclosures to show the true financial position of the company after addressing the prior period errors.