Question

Eddie Zambrano Corporation began operations on January 1, 2017. During its first 3 years of operations, Zambrano reported net income and declared dividends as follows.

Net Income Dividends Declared

2014 \( 40,000 \) –0–

2015 125,000 50,000

2016 160,000 50,000

The following information relates to 2017.

Income before income tax \(240,000

Prior period adjustment: understatement of 2015 depreciation expense (before taxes) \)25,000

Cumulative decrease in income from change in inventory methods (before taxes) \(35,000

Dividends declared (of this amount, \)25,000 will be paid on Jan. 15, 2018) \(100,000

Effective tax rate 40%

Instructions

1. Prepare a 2017 retained earnings statement for Eddie Zambrano Corporation.
2. Assume Eddie Zambrano Corporation restricted retained earnings in the amount of \)70,000 on December 31, 2017. After this action, what would Zambrano report as total retained earnings in its December 31, 2017, balance sheet?

Short answer

On December 31, 2017, the retained earnings statement balance is $233,000.

Step-by-step solution

Meaning of Net Income

Net income means net earnings after deducting all taxes and deductions. Earnings per Share are used to calculate net business income.

Preparing Retained Earnings Statement for Eddie Zambrano Corporation

Eddie Zambrano Corporation
Retained Earnings Statement
For the year ended in December 2017
Balance on January 1, 2017	$225,000
Correction for depreciation error	15,000
Cumulative decrease in income from the change in inventory methods	21,000
Adjusted balance on January 1, 2017	189,000
Add: Net income after taxes	144,000
	333,000
Less: Dividends declared	100,000
Balance on December 31, 2017	233,000

Working Notes:

1. Calculation of Amount reported for correcting depreciation error

$\begin{array}{rcl}\mathrm{Depreciation}\mathrm{Expense}& =& \mathrm{Depreciation}\mathrm{amount}\times \left(1-\mathrm{Tax}\mathrm{rate}\right)\\ & =& 25,000\times \left(1-40\%\right)\\ & =& 15,000\end{array}$

2. Calculation of Cumulative decrease in income from the change in inventory methods

$\begin{array}{rcl}\mathrm{Cumulative}\mathrm{decrease}\mathrm{in}\mathrm{income}& =& \mathrm{Income}\mathrm{amount}\times \left(1-\mathrm{Tax}\mathrm{rate}\right)\\ & =& \$35,000\times \left(1-40\%\right)\\ & =& \$21,000\end{array}$

Calculation of restricted Retained Earnings statement

Particulars	Amount ($)
Retained Earnings (Restricted)	70,000
Retained Earnings (Unrestricted)	163,000
Total Retained Earnings Balance	233,000