Question

Botticelli Inc. was organized in late 2015 to manufacture and sell hosiery. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes.

2015 \(140,000a 2017 \)205,000

2016 160,000b 2018 276,000

a Includes a \(10,000 increase because of change in bad debt experience rate.

bIncludes a gain of \)30,000.

The company has decided to expand operations and has applied for a sizable bank loan. The bank officer has indicated that the records should be audited and presented in comparative statements to facilitate analysis by the bank. Botticelli Inc. therefore hired the auditing firm of Check & Doublecheck Co. and has provided the following additional information.

1. In early 2016, Botticelli Inc. changed its estimate from 2% of sales to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2015, if a 1% rate had been used, would have been \(10,000. The company therefore restated its net income for 2015.

2. In 2018, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. The effect on the income statements for the previous years is as follows.

2015 2016 2017 2018

Net income unadjusted—LIFO basis \)140,000 \(160,000 \)205,000 \(276,000

Net income unadjusted—FIFO basis 155,000 165,000 215,000 260,000

\) 15,000 \( 5,000 \) 10,000 \( (16,000)

3. In 2018, the auditor discovered that:

(a) The company incorrectly overstated the ending inventory (under both LIFO and FIFO) by \)14,000 in 2017.

(b) A dispute developed in 2016 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2015, the company was not permitted these deductions, but a tax settlement was reached in 2018 that allowed these expenses. As a result of the court’s finding, tax expenses in 2018 were reduced by $60,000.

Instructions

(a) Indicate how each of these changes or corrections should be handled in the accounting records. (Ignore income tax considerations.)

(b) Present net income as reported in comparative income statements for the years 2015 to 2018

Short answer

All the changes and corrections are handled, and the comparative statement is prepared.

Step-by-step solution

Handling of changes and correction

1. Bad debt expenses will be added to the unadjusted net income.
2. The gain is abnormal; it will be reduced to the unadjusted net income.
3. Inventory of the prior years should be adjusted per FIFO
4. Inventory overstatement will be adjusted to 2017 ending inventory and 2018 opening inventory
5. Tax expense adjustment will be adjusted in 2018 net income

Comparative income Statement

Particulars	2015 ($)	2016 ($)	2017 ($)	2018 ($)
Net Income (unadjusted)	140,000	160,000	205,000	276,000
Adjustments:
Bad debt expense	10,000
Gain		-30,000
Inventory (FIFO)	15,000	5,000	10,000
Inventory Overstatement			-14,000	14,000
Tax expense				-60,000
Net Income (adjusted)	165,000	135,000	201,000	230,000