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Chapter 22 Accounting Changes and Error Analysis
1. In recent years, the Wall Street Journal has indicated that many companies have changed their accounting principles.
What are the major reasons why companies change accounting methods?
2. State how each of the following items is reflected in the financial statements.
(a) Change from FIFO to LIFO method for inventory valuation purposes.
(b) Charge for failure to record depreciation in a previous period.
(c) Litigation won in current year, related to prior period.
(d) Change in the realizability of certain receivables.
(e) Write-off of receivables.
(f) Change from the percentage-of-completion to the completed-contract method for reporting net income.
3. Discuss briefly the three approaches that have been suggested for reporting changes in accounting principles.
4. Identify and describe the approach the FASB requires for reporting changes in accounting principles.
5. What is the indirect effect of a change in accounting principle?
Briefly describe the reporting of the indirect effects of a change in accounting principle.
6. Define a change in estimate and provide an illustration.
When is a change in accounting estimate effected by a change in accounting principle?
7. Lenexa State Bank has followed the practice of capitalizing certain marketing costs and amortizing these costs over their expected life. In the current year, the bank determined that the future benefits from these costs were doubtful.
Consequently, the bank adopted the policy of expensing these costs as incurred. How should the bank report this accounting change in the comparative financial statements?
8. Indicate how the following items are recorded in the accounting records in the current year of Coronet Co.
(a) Impairment of goodwill.
(b) A change in depreciating plant assets from accelerated to the straight-line method.
(c) Large write-off of inventories because of obsolescence.
(d) Change from the cash basis to accrual basis of accounting.
(e) Change from LIFO to FIFO method for inventory valuation purposes.
(f) Change in the estimate of service lives for plant assets.
9. Whittier Construction Co. had followed the practice of expensing all materials assigned to a construction job without recognizing any salvage inventory. On December 31, 2014, it was determined that salvage inventory should be valued at $52,000. Of this amount, $29,000 arose during the current year. How does this information affect the financial statements to be prepared at the end of 2014?
10. Parsons Inc. has proposed a change from the completed contract to the percentage-of-completion method for financial reporting purposes. The auditor indicates that a change would be permitted only if it is to a preferable method.
What difficulties develop in assessing prefer ability?
11. Discuss how a change to the LIFO method of inventory valuation is handled when it is impracticable to determine previous LIFO inventory amounts.
12. How should consolidated financial statements be reported this year when statements of individual companies were presented last year?
13. Simms Corp. controlled four domestic subsidiaries and one foreign subsidiary. Prior to the current year,
Simms Corp. had excluded the foreign subsidiary from consolidation. During the current year, the foreign subsidiary was included in the financial statements. How should this change in accounting entity be reflected in the financial statements?
14. Distinguish between counterbalancing and noncounter balancing errors. Give an example of each.
15. Discuss and illustrate how a correction of an error in previously issued financial statements should be handled.
16. Prior to 2014, Heberling Inc. excluded manufacturing overhead costs from work in process and finished goods inventory. These costs have been expensed as incurred. In
2014, the company decided to change its accounting methods for manufacturing inventories to full costing by including these costs as product costs. Assuming that these costs are material, how should this change be reflected in the financial statements for 2013 and 2014?
17. Elliott Corp. failed to record accrued salaries for 2013, $2,000; 2014, $2,100; and 2015, $3,900. What is the amount of the overstatement or understatement of Retained Earnings at December 31, 2016?
18. In January 2014, installation costs of $6,000 on new machinery were charged to Maintenance and Repairs
Expense. Other costs of this machinery of $30,000 were correctly recorded and have been depreciated using the straight-line method with an estimated life of 10 years and no salvage value. At December 31, 2015, it is decided that the machinery has a remaining useful life of 20 years, starting with January 1, 2015. What entry(ies) should be made in 2015 to correctly record transactions related to machinery, assuming the machinery has no salvage value?
The books have not been closed for 2015 and depreciation expense has not yet been recorded for 2015.
19. On January 2, 2014, $100,000 of 11%, 10-year bonds were issued for $97,000. The $3,000 discount was charged to
Interest Expense. The bookkeeper, Mark Landis, records interest only on the interest payment dates of January 1 and July 1. What is the effect on reported net income for
2014 of this error, assuming straight-line amortization of the discount? What entry is necessary to correct for this error, assuming that the books are not closed for 2014?
20. An entry to record Purchases and related Accounts Payable of $13,000 for merchandise purchased on December 23,
2015, was recorded in January 2016. This merchandise was not included in inventory at December 31, 2015. What effect does this error have on reported net income for
2015? What entry should be made to correct for this error, assuming that the books are not closed for 2015?
21. Equipment was purchased on January 2, 2014, for $24,000, but no portion of the cost has been charged to depreciation.
The corporation wishes to use the straight-line method for these assets, which have been estimated to have a life of 10 years and no salvage value. What effect does this error have on net income in 2014? What entry is necessary to correct for this error, assuming that the books are not closed for 2014?
BE22-1 Wertz Construction Company decided at the beginning of 2014 to change from the completedcontract method to the percentage-of-completion method for financial reporting purposes. The company will continue to use the completed-contract method for tax purposes. For years prior to 2014, pretax income under the two methods was as follows: percentage-of-completion $120,000, and completed-contract $80,000.
The tax rate is 35%. Prepare Wertz’s 2014 journal entry to record the change in accounting principle.
BE22-2 Refer to the accounting change by Wertz Construction Company in BE22-1. Wertz has a profitsharing plan, which pays all employees a bonus at year-end based on 1% of pretax income. Compute the indirect effect of Wertz’s change in accounting principle that will be reported in the 2014 income statement, assuming that the profit-sharing contract explicitly requires adjustment for changes in income numbers.
BE22-3 Shannon, Inc., changed from the LIFO cost flow assumption to the FIFO cost flow assumption in 2014. The increase in the prior year’s income before taxes is $1,200,000. The tax rate is 40%. Prepare
Shannon’s 2014 journal entry to record the change in accounting principle.
BE22-4 Tedesco Company changed depreciation methods in 2014 from double-declining-balance to straight-line. Depreciation prior to 2014 under double-declining-balance was $90,000, whereas straight-line depreciation prior to 2014 would have been $50,000. Tedesco’s depreciable assets had a cost of $250,000 with a $40,000 salvage value, and an 8-year remaining useful life at the beginning of 2014. Prepare the 2014 journal entries, if any, related to Tedesco’s depreciable assets.
BE22-5 Sesame Company purchased a computer system for $74,000 on January 1, 2013. It was depreciated based on a 7-year life and an $18,000 salvage value. On January 1, 2015, Sesame revised these estimates to a total useful life of 4 years and a salvage value of $10,000. Prepare Sesame’s entry to record 2015 depreciation expense.
BE22-6 In 2014, Bailey Corporation discovered that equipment purchased on January 1, 2012, for $50,000 was expensed at that time. The equipment should have been depreciated over 5 years, with no salvage value. The effective tax rate is 30%. Prepare Bailey’s 2014 journal entry to correct the error.
BE22-7 At January 1, 2014, Beidler Company reported retained earnings of $2,000,000. In 2014, Beidler discovered that 2013 depreciation expense was understated by $400,000. In 2014, net income was $900,000 and dividends declared were $250,000. The tax rate is 40%. Prepare a 2014 retained earnings statement for
BE22-8 Indicate the effect—Understate, Overstate, No Effect—that each of the following errors has on 2014 net income and 2015 net income.
(a) Equipment purchased in 2012 was expensed.
(b) Wages payable were not recorded at 12/31/14.
(c) Equipment purchased in 2014 was expensed.
(d) 2014 ending inventory was overstated.
(e) Patent amortization was not recorded in 2015.
BE22-9 Roundtree Manufacturing Co. is preparing its year-end financial statements and is considering the accounting for the following items.
1. The vice president of sales had indicated that one product line has lost its customer appeal and will be phased out over the next 3 years. Therefore, a decision has been made to lower the estimated lives on related production equipment from the remaining 5 years to 3 years.
2. The Hightone Building was converted from a sales office to offices for the Accounting Department at the beginning of this year. Therefore, the expense related to this building will now appear as an administrative expense rather than a selling expense on the current year’s income statement.
3. Estimating the lives of new products in the Leisure Products Division has become very difficult because of the highly competitive conditions in this market. Therefore, the practice of deferring and amortizing preproduction costs has been abandoned in favor of expensing such costs as they are incurred.
Identify and explain whether each of the above items is a change in principle, a change in estimate, or an error.
BE22-10 Palmer Co. is evaluating the appropriate accounting for the following items.
1. Management has decided to switch from the FIFO inventory valuation method to the LIFO inventory valuation method for all inventories.
2. When the year-end physical inventory adjustment was made for the current year, the controller discovered that the prior year’s physical inventory sheets for an entire warehouse were mislaid and excluded from last year’s count.
3. Palmer’s Custom Division manufactures large-scale, custom-designed machinery on a contract basis. Management decided to switch from the completed-contract method to the percentage-ofcompletion method of accounting for long-term contracts.
Identify and explain whether each of the above items is a change in accounting principle, a change in estimate, or an error.
*BE22-11 Simmons Corporation owns stock of Armstrong, Inc. Prior to 2014, the investment was accounted for using the equity method. In early 2014, Simmons sold part of its investment in Armstrong, and began using the fair value method. In 2014, Armstrong earned net income of $80,000 and paid dividends of $95,000. Prepare Simmons’s entries related to Armstrong’s net income and dividends, assuming Simmons now owns 10% of Armstrong’s stock.
*BE22-12 Oliver Corporation has owned stock of Conrad Corporation since 2011. At December 31, 2014, its balances related to this investment were:
Equity Investments $185,000
Fair Value Adjustment (AFS) 34,000 Dr.
Unrealized Holding Gain or Loss—Equity 34,000 Cr.
On January 1, 2015, Oliver purchased additional stock of Conrad Company for $475,000 and now has significant influence over Conrad. If the equity method had been used in 2011–2014, Oliver’s share of income would have been $33,000 greater than dividends received. Prepare Oliver’s journal entries to record the purchase of the investment and the change to the equity method.
E22-1 (Change in Principle—Long-Term Contracts) Pam Erickson Construction Company changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during 2015. For tax purposes, the company employs the completed-contract method and will continue this approach in the future. (Hint: Adjust all tax consequences through the Deferred Tax Liability account.) The appropriate information related to this change is as follows.
Pretax Income from:
Percentage-of-Completion Completed-Contract Difference
2014 $780,000 $590,000 $190,000
2015 700,000 480,000 220,000
(a) Assuming that the tax rate is 35%, what is the amount of net income that would be reported in 2015?
(b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?
E22-2 (Change in Principle—Inventory Methods) Holder-Webb Company began operations on January
1, 2012, and uses the average-cost method of pricing inventory. Management is contemplating a change in inventory methods for 2015. The following information is available for the years 2012–2014.
Net Income Computed Using
Average-Cost Method FIFO Method LIFO Method
2012 $15,000 $19,000 $12,000
2013 18,000 23,000 14,000
2014 20,000 25,000 17,000
(Ignore all tax effects.)
(a) Prepare the journal entry necessary to record a change from the average-cost method to the FIFO method in 2015.
(b) Determine net income to be reported for 2012, 2013, and 2014, after giving effect to the change in accounting principle.
(c) Assume Holder-Webb Company used the LIFO method instead of the average-cost method during the years 2012–2014. In 2015, Holder-Webb changed to the FIFO method. Prepare the journal entry necessary to record the change in principle.
E22-3 (Accounting Change) Taveras Co. decides at the beginning of 2014 to adopt the FIFO method of inventory valuation. Taveras had used the LIFO method for financial reporting since its inception on
January 1, 2012, and had maintained records adequate to apply the FIFO method retrospectively. Taveras concluded that FIFO is the preferable inventory method because it reflects the current cost of inventory on the balance sheet. The following table presents the effects of the change in accounting principles on inventory and cost of goods sold.
1. For each year presented, sales are $3,000 and operating expenses are $1,000.
2. Taveras provides two years of financial statements. Earnings per share information is not required.
(a) Prepare income statements under LIFO and FIFO for 2012, 2013, and 2014.
(b) Prepare income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method for 2014 and 2013.
(c) Prepare the note to the financial statements describing the change in method of inventory valuation.
In the note, indicate the income statement line items for 2014 and 2013 that were affected by the change in accounting principle.
(d) Prepare comparative retained earnings statements for 2013 and 2014 under FIFO. Retained earnings reported under LIFO are as follows:
Inventory Determined by Cost of Goods Sold Determined by
Date LIFO Method FIFO Method LIFO Method FIFO Method
January 1, 2012 $ 0 $ 0 $ 0 $ 0
December 31, 2012 100 80 800 820
December 31, 2013 200 240 1,000 940
December 31, 2014 320 390 1,130 1,100
Retained Earnings Balance
December 31, 2012 $1,200
December 31, 2013 2,200
December 31, 2014 3,070
E22-4 (Accounting Change) Gordon Company started operations on January 1, 2009, and has used the
FIFO method of inventory valuation since its inception. In 2015, it decides to switch to the average-cost method. You are provided with the following information.
(a) What is the beginning retained earnings balance at January 1, 2011, if Gordon prepares comparative financial statements starting in 2011?
(b) What is the beginning retained earnings balance at January 1, 2014, if Gordon prepares comparative financial statements starting in 2014?
(c) What is the beginning retained earnings balance at January 1, 2015, if Gordon prepares singleperiod financial statements for 2015?
(d) What is the net income reported by Gordon in the 2014 income statement if it prepares comparative financial statements starting with 2012?
Net Income Retained Earnings (Ending Balance)
Under FIFO Under Average-Cost Under FIFO
2009 $100,000 $ 90,000 $100,000
2010 70,000 65,000 160,000
2011 90,000 80,000 235,000
2012 120,000 130,000 340,000
2013 300,000 290,000 590,000
2014 305,000 310,000 780,000
E22-5 (Accounting Change) Presented below are income statements prepared on a LIFO and FIFO basis for Kenseth Company, which started operations on January 1, 2013. The company presently uses the LIFO method of pricing its inventory and has decided to switch to the FIFO method in 2014. The FIFO income statement is computed in accordance with the requirements of GAAP. Kenseth’s profit-sharing agreement with its employees indicates that the company will pay employees 10% of income before profit-sharing.
Income taxes are ignored.
Answer the following questions.
(a) If comparative income statements are prepared, what net income should Kenseth report in 2013 and 2014?
(b) Explain why, under the FIFO basis, Kenseth reports $100 in 2013 and $96 in 2014 for its profit-sharing expense.
(c) Assume that Kenseth has a beginning balance of retained earnings at January 1, 2014, of $8,000 using the LIFO method. The company declared and paid dividends of $500 in 2014. Prepare the retained earnings statement for 2014, assuming that Kenseth has switched to the FIFO method.
E22-6 (Accounting Changes—Depreciation) Kathleen Cole Inc. acquired the following assets in January of 2012.
Equipment, estimated service life, 5 years; salvage value, $15,000 $525,000
Building, estimated service life, 30 years; no salvage value $693,000
The equipment has been depreciated using the sum-of-the-years’-digits method for the first 3 years for financial reporting purposes. In 2015, the company decided to change the method of computing depreciation to the straight-line method for the equipment, but no change was made in the estimated service life or salvage value. It was also decided to change the total estimated service life of the building from 30 years to 40 years, with no change in the estimated salvage value. The building is depreciated on the straight-line method.
(a) Prepare the general journal entry to record depreciation expense for the equipment in 2015.
(b) Prepare the journal entry to record depreciation expense for the building in 2015. (Round all computations to two decimal places.)
E22-7 (Change in Estimate and Error; Financial Statements) Presented below are the comparative income and retained earnings statements for Denise Habbe Inc. for the years 2014 and 2015.
LIFO Basis FIFO Basis 2014 2013 2014 2013
Sales $3,000 $3,000 $3,000 $3,000
Cost of goods sold 1,130 1,000 1,100 940
Operating expenses 1,000 1,000 1,000 1,000
Income before profit-sharing 870 1,000 900 1,060
Profit-sharing expense 87 100 96 100
Net income $ 783 $ 900 $ 804 $ 960
Sales $340,000 $270,000
Cost of sales 200,000 142,000
Gross profit 140,000 128,000
Expenses 88,000 50,000
Net income $ 52,000 $ 78,000
Retained earnings (Jan. 1) $125,000 $ 72,000
Net income 52,000 78,000
Dividends (30,000) (25,000)
Retained earnings (Dec. 31) $147,000 $125,000
The following additional information is provided:
1. In 2015, Denise Habbe Inc. decided to switch its depreciation method from sum-of-the-years’-digits to the straight-line method. The assets were purchased at the beginning of 2014 for $100,000 with an estimated useful life of 4 years and no salvage value. (The 2015 income statement contains depreciation expense of $30,000 on the assets purchased at the beginning of 2014.)
2. In 2015, the company discovered that the ending inventory for 2014 was overstated by $24,000; ending inventory for 2015 is correctly stated.
1388 Chapter 22 Accounting Changes and Error Analysis Instructions
Prepare the revised retained earnings statement for 2014 and 2015, assuming comparative statements.
(Ignore income taxes.)
E22-8 (Accounting for Accounting Changes and Errors) Listed below are various types of accounting changes and errors. ______ 1. Change in a plant asset’s salvage value. ______ 2. Change due to overstatement of inventory. ______ 3. Change from sum-of-the-years’-digits to straight-line method of depreciation. ______ 4. Change from presenting unconsolidated to consolidated financial statements. ______ 5. Change from LIFO to FIFO inventory method. ______ 6. Change in the rate used to compute warranty costs. ______ 7. Change from an unacceptable accounting principle to an acceptable accounting principle. ______ 8. Change in a patent’s amortization period. ______ 9. Change from completed-contract to percentage-of-completion method on construction contracts. ______ 10. Change from FIFO to average-cost inventory method.
For each change or error, indicate how it would be accounted for using the following code letters:
(a) Accounted for prospectively.
(b) Accounted for retrospectively.
(c) Neither of the above.
E22-9 (Error and Change in Estimate—Depreciation) Joy Cunningham Co. purchased a machine on
January 1, 2012, for $550,000. At that time, it was estimated that the machine would have a 10-year life and no salvage value. On December 31, 2015, the firm’s accountant found that the entry for depreciation expense had been omitted in 2013. In addition, management has informed the accountant that the company plans to switch to straight-line depreciation, starting with the year 2015. At present, the company uses the sum-of-the-years’-digits method for depreciating equipment.
Prepare the general journal entries that should be made at December 31, 2015, to record these events.
(Ignore tax effects.)
E22-10 (Depreciation Changes) On January 1, 2011, Jackson Company purchased a building and equipment that have the following useful lives, salvage values, and costs.
Building, 40-year estimated useful life, $50,000 salvage value, $800,000 cost
Equipment, 12-year estimated useful life, $10,000 salvage value, $100,000 cost
The building has been depreciated under the double-declining-balance method through 2014. In 2015, the company decided to switch to the straight-line method of depreciation. Jackson also decided to change the total useful life of the equipment to 9 years, with a salvage value of $5,000 at the end of that time. The equipment is depreciated using the straight-line method.
(a) Prepare the journal entry(ies) necessary to record the depreciation expense on the building in 2015.
(b) Compute depreciation expense on the equipment for 2015.
E22-11 (Change in Estimate—Depreciation) Peter M. Dell Co. purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time.
Depreciation has been entered for 7 years on a straight-line basis. In 2015, it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time.
(a) Prepare the entry (if any) to correct the prior years’ depreciation.
(b) Prepare the entry to record depreciation for 2015.
E22-12 (Change in Estimate—Depreciation) Gerald Englehart Industries changed from the doubledeclining- balance to the straight-line method in 2015 on all its plant assets. There was no change in the assets’ salvage values or useful lives. Plant assets, acquired on January 2, 2012, had an original cost of $1,600,000, with a $100,000 salvage value and an 8-year estimated useful life. Income before depreciation expense was $270,000 in 2014 and $300,000 in 2015.
(a) Prepare the journal entry(ies) to record depreciation expense in 2015.
(b) Starting with income before depreciation expense, prepare the remaining portion of the income statement for 2014 and 2015.
E22-13 (Change in Principle—Long-Term Contracts) Cullen Construction Company, which began operations in 2014, changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during 2015. For tax purposes, the company employs the completedcontract method and will continue this approach in the future. The appropriate information related to this change is as follows.
Percentage-of-Completion Completed-Contract Difference
2014 $880,000 $590,000 $290,000
2015 900,000 480,000 420,000
(a) Assuming that the tax rate is 40%, what is the amount of net income that would be reported in 2015?
(b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?
E22-14 (Various Changes in Principle—Inventory Methods) Below is the net income of Anita Ferreri
Instrument Co., a private corporation, computed under the three inventory methods using a periodic system.
(Ignore tax considerations.)
(a) Assume that in 2015 Ferreri decided to change from the FIFO method to the average-cost method of pricing inventories. Prepare the journal entry necessary for the change that took place during 2015, and show net income reported for 2012, 2013, 2014, and 2015.
(b) Assume that in 2015 Ferreri, which had been using the LIFO method since incorporation in 2012, changed to the FIFO method of pricing inventories. Prepare the journal entry necessary to record the change in 2015 and show net income reported for 2012, 2013, 2014, and 2015.
E22-15 (Error Correction Entries) The first audit of the books of Bruce Gingrich Company was made for the year ended December 31, 2015. In examining the books, the auditor found that certain items had been overlooked or incorrectly handled in the last 3 years. These items are:
1. At the beginning of 2013, the company purchased a machine for $510,000 (salvage value of $51,000) that had a useful life of 6 years. The bookkeeper used straight-line depreciation, but failed to deduct the salvage value in computing the depreciation base for the 3 years.
2. At the end of 2014, the company failed to accrue sales salaries of $45,000.
3. A tax lawsuit that involved the year 2013 was settled late in 2015. It was determined that the company owed an additional $85,000 in taxes related to 2013. The company did not record a liability in
2013 or 2014 because the possibility of loss was considered remote, and charged the $85,000 to a loss account in 2015.
4. Gingrich Company purchased a copyright from another company early in 2013 for $45,000. Gingrich had not amortized the copyright because its value had not diminished. The copyright has a useful life at purchase of 20 years.
5. In 2015, the company wrote off $87,000 of inventory considered to be obsolete; this loss was charged directly to Retained Earnings.
Prepare the journal entries necessary in 2015 to correct the books, assuming that the books have not been closed. Disregard effects of corrections on income tax.
E22-16 (Error Analysis and Correcting Entry) You have been engaged to review the financial statements of Gottschalk Corporation. In the course of your examination, you conclude that the bookkeeper hired during the current year is not doing a good job. You notice a number of irregularities as follows.
1. Year-end wages payable of $3,400 were not recorded because the bookkeeper thought that “they were immaterial.”
2. Accrued vacation pay for the year of $31,100 was not recorded because the bookkeeper “never heard that you had to do it.”
FIFO Average-Cost LIFO
2012 $26,000 $24,000 $20,000
2013 30,000 25,000 21,000
2014 28,000 27,000 24,000
2015 34,000 30,000 26,000
3. Insurance for a 12-month period purchased on November 1 of this year was charged to insurance expense in the amount of $2,640 because “the amount of the check is about the same every year.”
4. Reported sales revenue for the year is $2,120,000. This includes all sales taxes collected for the year.
The sales tax rate is 6%. Because the sales tax is forwarded to the state’s Department of Revenue, the
Sales Tax Expense account is debited. The bookkeeper thought that “the sales tax is a selling expense.” At the end of the current year, the balance in the Sales Tax Expense account is $103,400.
Prepare the necessary correcting entries, assuming that Gottschalk uses a calendar-year basis.
E22-17 (Error Analysis and Correcting Entry) The reported net incomes for the first 2 years of Sandra
Gustafson Products, Inc., were as follows: 2014, $147,000; 2015, $185,000. Early in 2016, the following errors were discovered.
1. Depreciation of equipment for 2014 was overstated $17,000.
2. Depreciation of equipment for 2015 was understated $38,500.
3. December 31, 2014, inventory was understated $50,000.
4. December 31, 2015, inventory was overstated $16,200.
Prepare the correcting entry necessary when these errors are discovered. Assume that the books are closed.
(Ignore income tax considerations.)
E22-18 (Error Analysis) Peter Henning Tool Company’s December 31 year-end financial statements contained the following errors.
December 31, 2014 December 31, 2015
Ending inventory $9,600 understated $8,100 overstated
Depreciation expense $2,300 understated —
An insurance premium of $66,000 was prepaid in 2014 covering the years 2014, 2015, and 2016. The entire amount was charged to expense in 2014. In addition, on December 31, 2015, fully depreciated machinery was sold for $15,000 cash, but the entry was not recorded until 2016. There were no other errors during 2014 or 2015, and no corrections have been made for any of the errors. (Ignore income tax considerations.)
(a) Compute the total effect of the errors on 2015 net income.
(b) Compute the total effect of the errors on the amount of Henning’s working capital at December 31,
(c) Compute the total effect of the errors on the balance of Henning’s retained earnings at December 31,
E22-19 (Error Analysis; Correcting Entries) A partial trial balance of Julie Hartsack Corporation is as follows on December 31, 2015.
Additional adjusting data:
1. A physical count of supplies on hand on December 31, 2015, totaled $1,100.
2. Through oversight, the Salaries and Wages Payable account was not changed during 2015. Accrued salaries and wages on December 31, 2015, amounted to $4,400.
3. The Interest Receivable account was also left unchanged during 2015. Accrued interest on investments amounts to $4,350 on December 31, 2015.
4. The unexpired portions of the insurance policies totaled $65,000 as of December 31, 2015.
5. $28,000 was received on January 1, 2015, for the rent of a building for both 2015 and 2016. The entire amount was credited to rent revenue.
6. Depreciation on equipment for the year was erroneously recorded as $5,000 rather than the correct figure of $50,000.
7. A further review of depreciation calculations of prior years revealed that equipment depreciation of $7,200 was not recorded. It was decided that this oversight should be corrected by a prior period adjustment.
Supplies $ 2,700
Salaries and wages payable $ 1,500
Interest receivable 5,100
Prepaid insurance 90,000
Unearned rent –0–
Interest payable 15,000
(a) Assuming that the books have not been closed, what are the adjusting entries necessary at December 31, 2015? (Ignore income tax considerations.)
(b) Assuming that the books have been closed, what are the adjusting entries necessary at December 31,
2015? (Ignore income tax considerations.)
(c) Repeat the requirements for items 6 and 7, taking into account income tax effects (40% tax rate) and assuming that the books have been closed.
E22-20 (Error Analysis) The before-tax income for Lonnie Holdiman Co. for 2014 was $101,000 and $77,400 for 2015. However, the accountant noted that the following errors had been made:
1. Sales for 2014 included amounts of $38,200 which had been received in cash during 2014, but for which the related products were delivered in 2015. Title did not pass to the purchaser until 2015.
2. The inventory on December 31, 2014, was understated by $8,640.
3. The bookkeeper in recording interest expense for both 2014 and 2015 on bonds payable made the following entry on an annual basis.
Interest Expense 15,000
The bonds have a face value of $250,000 and pay a stated interest rate of 6%. They were issued at a discount of $15,000 on January 1, 2014, to yield an effective-interest rate of 7%. (Assume that the effective-yield method should be used.)
4. Ordinary repairs to equipment had been erroneously charged to the Equipment account during
2014 and 2015. Repairs in the amount of $8,500 in 2014 and $9,400 in 2015 were so charged. The company applies a rate of 10% to the balance in the Equipment account at the end of the year in its determination of depreciation charges.
Prepare a schedule showing the determination of corrected income before taxes for 2014 and 2015.
E22-21 (Error Analysis) When the records of Debra Hanson Corporation were reviewed at the close of
2015, the errors listed below were discovered. For each item, indicate by a check mark in the appropriate column whether the error resulted in an overstatement, an understatement, or had no effect on net income for the years 2014 and 2015.
Over- Under- No Over- Under- No
Item statement statement Effect statement statement Effect
1. Failure to record amortization of patent in 2015.
2. Failure to record the correct amount of ending 2014 inventory. The amount was understated because of an error in calculation.
3. Failure to record merchandise purchased in 2014.
Merchandise was also omitted from ending inventory in 2014 but was not yet sold.
4. Failure to record accrued interest on notes payable in
2014; that amount was recorded when paid in 2015.
5. Failure to refl ect supplies on hand on balance sheet at end of 2014.
*E22-22 (Change from Fair Value to Equity) On January 1, 2014, Beyonce Co. purchased 25,000 shares
(a 10% interest) in Elton John Corp. for $1,400,000. At the time, the book value and the fair value of John’s net assets were $13,000,000.
On July 1, 2015, Beyonce paid $3,040,000 for 50,000 additional shares of John common stock, which represented a 20% investment in John. The fair value of John’s identifiable assets net of liabilities was equal to their carrying amount of $14,200,000. As a result of this transaction, Beyonce owns 30% of John and can exercise significant influence over John’s operating and financial policies.
John reported the following net income and declared and paid the following dividends.
Net Income Dividend per Share
Year ended 12/31/14 $700,000 None
Six months ended 6/30/15 500,000 None
Six months ended 12/31/15 815,000 $1.55
(Any excess fair value is attributed to goodwill.)
Determine the ending balance that Beyonce Co. should report as its investment in John Corp. at the end of
*E22-23 (Change from Equity to Fair Value) Dan Aykroyd Corp. was a 30% owner of Steve Martin
Company, holding 210,000 shares of Martin’s common stock on December 31, 2013. The investment account had the following entries.
On January 2, 2014, Aykroyd sold 126,000 shares of Martin for $3,440,000, thereby losing its significant influence. During the year 2014, Martin experienced the following results of operations and paid the following dividends to Aykroyd.
At December 31, 2014, the fair value of Martin shares held by Aykroyd is $1,570,000. This is the first reporting date since the January 2 sale.
(a) What effect does the January 2, 2014, transaction have upon Aykroyd’s accounting treatment for its investment in Martin?
(b) Compute the carrying amount of the investment in Martin as of December 31, 2014 (prior to any fair value adjustment).
(c) Prepare the adjusting entry on December 31, 2014, applying the fair value method to Aykroyd’s long-term investment in Martin Company securities.