Question

(Reporting the Financial Effects of Varied Transactions) In an examination of Arenes Corporation as of 31 Dec, 2017, you have learned that the following situations exist. No entries have been made in the accounting records for these items.

1. The corporation erected its present factory building in 2001. Depreciation was calculated by the straight-line method, using an estimated life of 35 years. Early in 2017, the board of directors conducted a careful survey and estimated that the factory building had a remaining useful life of 25 years as of 1 Jan, 2017.

2. An additional assessment of 2016 income taxes was levied and paid in 2017.

3. When calculating the accrual for officers’ salaries at 31 Dec, 2017, it was discovered that the accrual for officers’ salaries for 31 Dec, 2016, had been overstated.

4. On 15 Dec, 2017, Arenes Corporation declared a cash dividend on its common stock outstanding, payable 1 Feb, 2018, to the common stockholders of record 31 Dec, 2017.

Instructions

Describe fully how each of the items above should be reported in the financial statements of Arenes Corporation for the year 2017.

Short answer

1. Retrospective reporting is not required to change the asset’s useful life.

2. Retrospective adjustments are not required. The additional assessment will be included in the current year’s taxes.

3. Adjustments must be made to the beginning balance of the retained earnings.

4. A journal entry will be made for the declaration of dividends.

Step-by-step solution

Definition of Useful Life

Useful life is the estimate made by the business entity in respect of the number of years for which the respective asset will be used.Such an estimate is used for calculating the depreciation expenses.

Reporting Change in Financial Statements

1. The change in the asset’s useful life is considered a change in the estimates of the financial reporting that are not reported retrospectively. Therefore, the depreciation for the current year and future period will be calculated considering new useful life. The disclosure must be made in the notes to the financial statement.
2. The additional assessment for the income taxes does not require any adjustments to the previous periods' financial statements. It must be reflected in the income statement of the current year. It will be separately represented if it is material. Otherwise, it must be included in the tax expenses of the current year.
3. The error made on 31 Dec 2016 must be reported in the statement of retained earnings and adjusted against the beginning balance of the retained earnings in the year 2017. The business entity must adjust the expenses of the year 2017.
4. The business entity will make a journal entry to record the dividend declaration. The retained earnings will be debited, and the dividend payable account will be credited with the same amount.