As at December 31, 2020, Kendrick Corporation is having its financial statements audited for the first time ever

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As at December 31, 2020, Kendrick Corporation is having its financial statements audited for the first time ever. The auditor has found the following items that might have an effect on previous years.

 

1. Kendrick purchased equipment on January 2, 2017, for $130,000. At that time, the equipment had an estimated useful life of 10 years, with a $10,000 residual value. The equipment is depreciated on a straight-line basis. On January 2, 2020, as a result of additional information, the company determined that the equipment had a total useful life of seven years with a $6,000 residual value.
2. During 2020, Kendrick changed from the double-declining-balance method for its building to the straight-line method because the company thinks the straight-line method now more closely follows the benefits received from using the assets. The current year depreciation was calculated using the new method following straight-line depreciation. In case the following information was needed, the auditor provided calculations that present depreciation on both bases. The building had originally cost $1.2 million when purchased at the beginning of 2018 and has a residual value of $120,000. It is depreciated over 20 years. The original estimates of useful life and residual value are still accurate.
3. 2020 2019 2018
4. Straight-line $54,000 $ 54,000 $ 54,000
5. Double-declining-balance 97,200 108,000 120,000
6. Kendrick purchased a machine on July 1, 2017, at a cost of $160,000. The machine has a residual value of $16,000 and a useful life of eight years. Kendrick's bookkeeper recorded straight-line depreciation during each year but failed to consider the residual value.
7. Prior to 2020, development costs were expensed immediately because they were immaterial. Due to an increase in development phase projects, development costs have now become material and management has decided to capitalize and depreciate them over three years. The development costs meet all six specific conditions for capitalization of development phase costs. Amounts expensed in 2017, 2018, and 2019 were $300, $500, and $1,000, respectively. During 2020, $4,500 was spent and the amount was debited to Deferred Development Costs (an asset account).

 

Instructions

 

a. Prepare the necessary journal entries to record each of the changes or errors. The books for 2020 have been adjusted but not closed. Ignore income tax effects and round to the nearest dollar.

b. Calculate the 2020 depreciation expense on the equipment.

c. Calculate the comparative net income amounts for 2019 and 2020, starting with income before the effects of any of the changes identified above. Income before depreciation expense was $600,000 in 2020 and $420,000 in 2019.

d. From the perspective of an investor, comment on the quality of Kendrick Corporation's earnings as reported in 2019 and 2020.