Question

(Analysis of Various Accounting Changes and Errors) Katherine Irving, controller of Lotan Corp., is aware of a pronouncement on accounting changes. After reading the pronouncement, she is confused about what action should be taken on the following items related to Lotan Corp. for the year 2017.

1. In 2017, Lotan decided to change its policy on accounting for certain marketing costs. Previously, the company had chosen to defer and amortize all marketing costs over at least 5 years because Lotan believed that a return on these expenditures did not occur immediately. Recently, however, the time differential has considerably shortened, and Lotan is now expensing the marketing costs as incurred.

2. In 2017, the company examined its entire policy relating to the depreciation of plant equipment. Plant equipment had normally been depreciated over a 15-year period, but recent experience has indicated that the company was incorrect in its estimates and that the assets should be depreciated over a 20-year period.

3. One division of Lotan Corp., Hawthorne Co., has consistently shown an increasing net income from period to period. On closer examination of its operating statement, it is noted that bad debt expense and inventory obsolescence charges are much lower than in other divisions. In discussing this with the controller of this division, it has been learned that the controller has increased his net income each period by knowingly making low estimates related to the write-off of receivables and inventory.

4. In 2017, the company purchased new machinery that should increase production dramatically. The company has decided to depreciate this machinery on an accelerated basis, even though other machinery is depreciated on a straight-line basis.

5. All equipment sold by Lotan is subject to a 3-year warranty. It has been estimated that the expense ultimately to be incurred on these machines is 1% of sales. In 2017, because of a production breakthrough, it is now estimated that ½ of 1% of sales is sufficient. In 2015 and 2016, warranty expense was computed as \(64,000 and \)70,000, respectively. The company now believes that these warranty costs should be reduced by 50%.

6. In 2017, the company decided to change its method of inventory pricing from average-cost to the FIFO method. The effect of this change on prior years is to increase 2015 income by \(65,000 and increase 2016 income by \)20,000.

Instructions Katherine Irving has come to you, as her CPA, for advice about the situations above. Prepare a report, indicating the appropriate accounting treatment that should be given for each of these situations.

Short answer

Report is prepared as per the appropriate accounting treatment.

Step-by-step solution

part 1

Id the marketing costs are no more capitalized, nothing to do. It will charged to the accounting in which they relate. If there are any unamortized marketing costs, this can be amortized over the current period.

Part 2

The depreciation should be calculated up to the period used in the business based on 20 years life. The over absorption of depreciation should be deducted in the amount from the actual overhead absorbed using 15 years of life.

Part 3

The Lotan corp must identify the doubtful debts and obsolete inventories and the calculate the amount of write off them immediately.

Part 4

The machinery in the part 4, estimated production units or machine hours over its useful life can be calculated for each unit of production or machine hours.

Part 5

Nothing should be done in the case of change in estimates. Generally, expenses are recorded when accrued or paid during accounting period.

Part 6

Increase in income for the year 2015 and 2016 must be taken as income of 2017 which will increase the income for 2017 by the amount $85,000.

Accounting year 2015 and 2016 has been closed and we cannot change previous years account. Effects of change in accounting policy must be taken into 2017 accounting, then continue with changes policy.