Question

Question: As audit partner for Grupo and Rijo, you are in charge of reviewing the classification of unusual items that have occurred during the current year. The following material items have come to your attention.

1. A merchandising company incorrectly overstated its ending inventory 2 years ago. Inventory for all other periods is correctly computed.

2. An automobile dealer sells for \(137,000 an extremely rare 1930 S type Invicta which it purchased for \)21,000 10 years ago. The Invicta is the only such display item the dealer owns.

3. A drilling company during the current year extended the estimated useful life of certain drilling equipment from 9 to 15 years. As a result, depreciation for the current year was materially lowered.

4. A retail outlet changed its computation for bad debt expense from 1% to ½ of 1% of sales because of changes in its customer clientele. Concepts for Analysis 191 192 Chapter 4 Income Statement and Related Information.

5. A mining concern sells a foreign subsidiary engaged in uranium mining, although it (the seller) continues to engage in uranium mining in other countries.

6. A steel company changes from the average-cost method to the FIFO method for inventory costing purposes.

7. A construction company, at great expense, prepared a major proposal for a government loan. The loan is not approved.

8. A water pump manufacturer has had large losses resulting from a strike by its employees early in the year.

9. Depreciation for a prior period was incorrectly understated by $950,000. The error was discovered in the current year.

10. A large sheep rancher suffered a major loss because the state required that all sheep in the state be killed to halt the spread of a rare disease. Such a situation has not occurred in the state for 20 years.

11. A food distributor that sells wholesale to supermarket chains and to fast-food restaurants (two distinguishable classes of customers) decides to discontinue the division that sells to one of the two classes of customers. This represents a strategic shift in the company business.

Instructions

From the foregoing information, indicate in what section of the income statement or retained earnings statement these items should be classified. Provide a brief rationale for your position.

Short answer

The given material items should be bifurcated and recorded in the statement of retained earnings and income statement in accordance with the Generally Accepted Accounting Principles(GAAP) to obtain accurate outcomes.

Step-by-step solution

Meaning of Audit

The term audit refers to the process of independent examination of the financial statements of a business entity by licensed professionals called auditors to ensure the accuracy of the financial information reported.

Classification of the items

1. Overstating theinventory was done by the company in the previous years, but the correction for the same is required to be done in the current year’s income statement.

2. The sale of a rare Invicta should be reported under theextraordinary itemsection of the income statement because such an income is non-operational and non-recurring for the business.

3. The alternation in theaccounting methodof charging depreciation will be reflected in the income statement. The change in the accounting method should be disclosed in the notes section of the financial statements.

4. The change in accounting method forbad debt computation must be disclosed in the notes section of the financial statements for the users.

5. The sale of thesubsidiary should be reported in the income statement under continuing operations section along with the loss incurred or profit earned.

6. The change in the inventory valuation method must be reflected in the income statement with the net effect of the same. The respective modification should be disclosed to the users offinancial information.

7. The cost incurred for raising the loan should be recorded as an expense in theincome statement.

8. Loss due to strike must be reported in the extraordinary items section of the income statement.

9. Understatement ofdepreciation should be adjusted in the opening balances of the retained earnings in the statement of retained earnings.

10. The loss due to the modification in thegovernment policiesshould be recorded in the extraordinary items.

The sale of a business division must be reported in the income statement in the discontinued operations section of the income statement.