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Chapter 22: 8P (page 1319)

On March 5, 2018, you were hired by Hemingway Inc., a closely held company, as a staff member of its newly created internal auditing department. While reviewing the company’s records for 2016 and 2017, you discover that no adjustments have yet been made for the following items. Items

1. Interest income of \(14,100 was not accrued at the end of 2016. It was recorded when received in February 2017.

2. A computer costing \)4,000 was expensed when purchased on July 1, 2016. It is expected to have a 4-year life with no salvage value. The company typically uses straight-line depreciation for all fixed assets.

3. Research and development costs of \(33,000 were incurred early in 2016. They were capitalized and were to be amortized over a 3-year period. Amortization of \)11,000 was recorded for 2016 and \(11,000 for 2017.

4. On January 2, 2016, Hemingway leased a building for 5 years at a monthly rental of \)8,000. On that date, the company paid the following amounts, which were expensed when paid. Security deposit \(20,000 First month’s rent 8,000 Last month’s rent 8,000 \)36,000

5. The company received \(36,000 from a customer at the beginning of 2016 for services that it is to perform evenly over a 3-year period beginning in 2016. None of the amount received was reported as unearned revenue at the end of 2016.

6. Merchandise inventory costing \)18,200 was in the warehouse at December 31, 2016, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method.

Instructions

Indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2016, and the retained earnings figure reported on the balance sheet at December 31, 2017. Assume all amounts are material, and ignore income tax effects. Using the following format, enter the appropriate dollar amounts in the appropriate columns. Consider each item independent of the other items. It is not necessary to total the columns on the grid.

Short Answer

Expert verified

Retained earnings are the accumulated profits, and the effect of the error is shown

Step by step solution

01

Definition of Retained Earnings

The retained Earnings refer to the accumulated profit after distributing the dividends to the shareholders of the company.

02

The effect of errors

Net Income for 2016

Retained Earnings at 12/31/17

Item

Understated

Overstated

Understated

Overstated

1.

14,100


No effect

No effect

2.

3,500


2,500


3.

22,000


11,000

4.

28,000


28,000


5.

24,000


12,000

6.

18,200


No effect

No effect

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Most popular questions from this chapter

If a company registered with the SEC justifies a change in accounting method as preferable under the circumstances, and the circumstances change, can that company switch back to its prior method of accounting before the change? Why or why not?

Aston Corporation performs year-end planning in November of each year before its calendar year ends in December. The preliminary estimated net income is \(3 million. The CFO, Rita Warren, meets with the company president, J. B. Aston, to review the projected numbers. She presents the following projected information. ASTON CORPORATION PROJECTED INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2017 Sales \)28,995,000 Interest revenue 5,000 Cost of goods sold \(14,000,000 Depreciation 2,600,000 Operating expenses 6,400,000 23,000,000 Income before income tax 6,000,000 Income tax 3,000,000 Net income \) 3,000,000 ASTON CORPORATION SELECTED BALANCE SHEET INFORMATION AT DECEMBER 31, 2017 Estimated cash balance \( 5,000,000 Available-for-sale debt investments (at cost) 10,000,000 Fair value adjustment (1/1/17) —0— Estimated fair value at December 31, 2017: Security Cost Estimated Fair Value A \) 2,000,000 \( 2,200,000 B 4,000,000 3,900,000 C 3,000,000 3,100,000 D 1,000,000 1,800,000 Total \)10,000,000 \(11,000,000 Other information at December 31, 2017: Equipment \)3,000,000 Accumulated depreciation (5-year SL) 1,200,000 New robotic equipment (purchased 1/1/17) 5,000,000 Accumulated depreciation (5-year DDB) 2,000,000 The corporation has never used robotic equipment before, and Warren assumed an accelerated method because of the rapidly changing technology in robotic equipment. The company normally uses straight-line depreciation for production equipment. Aston explains to Warren that it is important for the corporation to show a \(7,000,000 income before taxes because Aston receives a \)1,000,000 bonus if the income before taxes and bonus reaches \(7,000,000. Aston also does not want the company to pay more than \)3,000,000 in income taxes to the government.

Instructions (a) What can Warren do within GAAP to accommodate the president’s wishes to achieve $7,000,000 in income before taxes and bonus? Present the revised income statement based on your decision. (b) Are the actions ethical? Who are the stakeholders in this decision, and what effect do Warren’s actions have on their interests?

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

Oliver Corporation has owned stock of Conrad Corporation since 2014. At December 31, 2017, its balances related to this investment were:

Equity Investments \(185,000

Fair Value Adjustment (AFS) 34,000 Dr.

Accumulated Unrealized Holding Gain or Loss—Income (recorded in Retained Earnings) 34,000 Cr.

On January 1, 2018, 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 2014–2017, 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.

Which of the following is not classified as an accounting change by IFRS?

(a) Change in accounting policy.

(b) Change in accounting estimate.

(c) Errors in financial statements.

(d) None of the above
See all solutions

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