In 2027, management discovered that the company’s accountant had debited expense for the full cost of an asset purchased on January 1, 2024, at a cost of $37.0 million with no expected residual value. The asset’s useful life was 5 years. The company uses straight-line depreciation. Ignoring taxes and assuming the error was discovered in 2027 before preparation of the adjusting and closing entries, the correcting entry should include a:

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To tackle this problem, first restate what happened and what should have been recorded. The asset cost $37.0 million, with a 5-year useful life and no residual value, using straight-line depreciation. Correct accounting would have capitalized the asset: Debit Asset $37.0 million and Credit Cash (or Payable) $37.0 million, and then record depreciation of $7.4 million per year for each year of use.

We need to evaluate the correcting entry as of 2027, after three full years of use (2024, 2025, 2026). Under straight-line depreciation, annual depreciation is 37.0 / 5 = 7.4 million. After three years, accumulated depreciation should be 3 × 7.4 = 22.2 million. If the company had expensed the full cost initially, it would have overstated expenses and under-recorded the asset and its depreciation.

Option A: credit to an asset of $37.0 million. This is not appropriate as a correcting entry. A credit to an asset would reduce the asset balance, but the asset should have been recorded at cost (37.0) in the asset account, not reduced by credit alone in correction. The proper correction involves reclassifying from expense back to asset and recognizing depreciation that should have occurred.

Option B: debit to accumulated depreciation of $14.8 million. This amount corresponds to 2 years of depreciation (2 × 7.4 = 14.8), which would be relevant if the error had only occurred for 2 years of use. However, the error spans three full years of use (2024–2026). Therefore 14.8 is not the correct accumulated depreciation to recognize by the end of 2026.

Option C: debit to retained earnings of $14.8 million. Debiting retained earnings would transfer the error to shareholders’ equity, which is not the proper corrective action. The misstatement is an error in asset recognition and depreciation, not an error in prior equity. The corrective journal should address the asset and depreciation accounts directly, not retained earnings.

Option D: credit to accumulated depreciation of $22.2 million. This aligns with the correct accumulated depreciation that should have been recorded by the end of 2026 (3 years × 7.4 = 22.2). In the correcting entry, recognizing depreciation that should have been recorded and reclassifying the asset from expense to asset would involve crediting accumulated depreciation for the amount of depreciation that should have been recognized, i.e., 22.2, among other debits/credits to reposition the asset and reflect proper depreciation history.

In summary, the misclassification required correcting the asset and depreciation accounts to reflect the asset’s cost and the appropriate accumulated depreciation up to the date of discovery. Among the options, the one that captures the essential adjusting facet is a credit to accumulated depreciation of $22.2 million, reflecting the depreciation that should have been recorded through 2026.

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