Question & Answer

On January 1, 2011, Jackson Company purchased a building and equipment that have the following useful lives, salvage values, and costs. Building, 40-year estimated useful life, $50,000 salvage value, $800,000 cost Equipment, 12-year estimated useful life, $10,000 salvage value, $100,000 cost The building has been depreciated under the double-declining-balance method through 2014. In 2015, thecompany decided to switch to the straight-line method of depreciation. Jackson also decided to change the total useful life of the equipment to 9 years, with a salvage value of $5,000 at the end of that time. The equipment is depreciated using the straight-line method.

Instructions

(a) Prepare the journal entry(ies) necessary to record the depreciation expense on the building in 2015.

(b) Compute depreciation expense on the equipment for 2015.

Joy Cunningham Co. purchased a machine on January 1, 2012, for $550,000. At that time, it was estimated that the machine would have a 10-year life and no salvage value. On December 31, 2015, the firm’s accountant found that the entry for depreciation expense had been omitted in 2013. In addition, management has informed the accountant that the company plans to switch to straight-line depreciation, starting with the year 2015. At present, the company uses the sum-of-the-years’-digits method for depreciating equipment.

Instructions

Prepare the general journal entries that should be made at December 31, 2015, to record these events.

(Ignore tax effects.)

Listed below are various types of accounting changes and errors.

______ 1. Change in a plant asset’s salvage value.

______ 2. Change due to overstatement of inventory.

______ 3. Change from sum-of-the-years’-digits to straight-line method of depreciation.

______ 4. Change from presenting unconsolidated to consolidated financial statements.

______ 5. Change from LIFO to FIFO inventory method.

______ 6. Change in the rate used to compute warranty costs.

______ 7. Change from an unacceptable accounting principle to an acceptable accounting principle.

______ 8. Change in a patent’s amortization period.

______ 9. Change from completed-contract to percentage-of-completion method on construction contracts.

______ 10. Change from FIFO to average-cost inventory method.

Instructions

For each change or error, indicate how it would be accounted for using the following code letters:

(a) Accounted for prospectively.

(b) Accounted for retrospectively.

(c) Neither of the above.

Presented below are the comparative income and retained earnings statements for Denise Habbe Inc. for the years 2014 and 2015.

LIFO Basis FIFO Basis

2014 2013 2014 2013

Sales $3,000 $3,000 $3,000 $3,000

Cost of goods sold 1,130 1,000 1,100 940

Operating expenses 1,000 1,000 1,000 1,000

Income before profi t-sharing 870 1,000 900 1,060

Profi t-sharing expense 87 100 96 100

Net income $ 783 $ 900 $ 804 $ 960

2015 2014

Sales $340,000 $270,000

Cost of sales 200,000 142,000

Gross profi t 140,000 128,000

Expenses 88,000 50,000

Net income $ 52,000 $ 78,000

Retained earnings (Jan. 1) $125,000 $ 72,000

Net income 52,000 78,000

Dividends (30,000) (25,000)

Retained earnings (Dec. 31) $147,000 $125,000

The following additional information is provided:

1. In 2015, Denise Habbe Inc. decided to switch its depreciation method from sum-of-the-years’-digits to the straight-line method. The assets were purchased at the beginning of 2014 for $100,000 with an estimated useful life of 4 years and no salvage value. (The 2015 income statement contains depreciation expense of $30,000 on the assets purchased at the beginning of 2014.)

2. In 2015, the company discovered that the ending inventory for 2014 was overstated by $24,000; ending inventory for 2015 is correctly stated.

Instructions

Prepare the revised retained earnings statement for 2014 and 2015, assuming comparative statements.

(Ignore income taxes.)

Kathleen Cole Inc. acquired the following assets in January of 2012. Equipment, estimated service life, 5 years; salvage value, $15,000 $525,000 Building, estimated service life, 30 years; no salvage value $693,000 The equipment has been depreciated using the sum-of-the-years’-digits method for the first 3 years for financial reporting purposes. In 2015, the company decided to change the method of computing depreciation to the straight-line method for the equipment, but no change was made in the estimated service life or salvage value. It was also decided to change the total estimated service life of the building from 30 years to 40 years, with no change in the estimated salvage value. The building is depreciated on the straight-line method.

Instructions

(a) Prepare the general journal entry to record depreciation expense for the equipment in 2015.

(b) Prepare the journal entry to record depreciation expense for the building in 2015. (Round all computations to two decimal places.)

Presented below are income statements prepared on a LIFO and FIFO basis for Kenseth Company, which started operations on January 1, 2013. The company presently uses the LIFO method of pricing its inventory and has decided to switch to the FIFO method in 2014. The FIFO income statement is computed in accordance with the requirements of GAAP. Kenseth’s profit-sharing agreement with its employees indicates that the company will pay employees 10% of income before profit-sharing.

Income taxes are ignored.

LIFO Basis FIFO Basis

2014 2013 2014 2013

Sales $3,000 $3,000 $3,000 $3,000

Cost of goods sold 1,130 1,000 1,100 940

Operating expenses 1,000 1,000 1,000 1,000

Income before profi t-sharing 870 1,000 900 1,060

Profi t-sharing expense 87 100 96 100

Net income $ 783 $ 900 $ 804 $ 960

Instructions

Answer the following questions.

(a) If comparative income statements are prepared, what net income should Kenseth report in 2013 and 2014?

(b) Explain why, under the FIFO basis, Kenseth reports $100 in 2013 and $96 in 2014 for its profit-sharing expense.

(c) Assume that Kenseth has a beginning balance of retained earnings at January 1, 2014, of $8,000 using the LIFO method. The company declared and paid dividends of $500 in 2014. Prepare the retained earnings statement for 2014, assuming that Kenseth has switched to the FIFO method.

Gordon Company started operations on January 1, 2009, and has used the FIFO method of inventory valuation since its inception. In 2015, it decides to switch to the average-cost method. You are provided with the following information. Net Income Retained Earnings (Ending Balance) Under FIFO Under Average-Cost Under FIFO

2009 $100,000 $ 90,000 $100,000

2010 70,000 65,000 160,000

2011 90,000 80,000 235,000

2012 120,000 130,000 340,000

2013 300,000 290,000 590,000

2014 305,000 310,000 780,000

Instructions

(a) What is the beginning retained earnings balance at January 1, 2011, if Gordon prepares comparative financial statements starting in 2011?

(b) What is the beginning retained earnings balance at January 1, 2014, if Gordon prepares comparative financial statements starting in 2014?

(c) What is the beginning retained earnings balance at January 1, 2015, if Gordon prepares singleperiod financial statements for 2015?

(d) What is the net income reported by Gordon in the 2014 income statement if it prepares comparative financial statements starting with 2012?

Taveras Co. decides at the beginning of 2014 to adopt the FIFO method of inventory valuation. Taveras had used the LIFO method for financial reporting since its inception on January 1, 2012, and had maintained records adequate to apply the FIFO method retrospectively. Taveras concluded that FIFO is the preferable inventory method because it reflects the current cost of inventory on the balance sheet. The following table presents the effects of the change in accounting principles on inventory and cost of goods sold.

Inventory Determined by Cost of Goods Sold Determined by

Date LIFO Method FIFO Method LIFO Method FIFO Method

January 1, 2012 $ 0 $ 0 $ 0 $ 0

December 31, 2012 100 80 800 820

December 31, 2013 200 240 1,000 940

December 31, 2014 320 390 1,130 1,100

Other information:

1. For each year presented, sales are $3,000 and operating expenses are $1,000.

2. Taveras provides two years of financial statements. Earnings per share information is not required.

Instructions

(a) Prepare income statements under LIFO and FIFO for 2012, 2013, and 2014.

(b) Prepare income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method for 2014 and 2013.

(c) Prepare the note to the financial statements describing the change in method of inventory valuation.

In the note, indicate the income statement line items for 2014 and 2013 that were affected by the change in accounting principle.

(d) Prepare comparative retained earnings statements for 2013 and 2014 under FIFO. Retained earnings reported under LIFO are as follows:

Holder-Webb Company began operations on January 1, 2012, and uses the average-cost method of pricing inventory. Management is contemplating a change in inventory methods for 2015. The following information is available for the years 2012–2014.

Net Income Computed Using

Average-Cost Method FIFO Method LIFO Method

2012 $15,000 $19,000 $12,000

2013 18,000 23,000 14,000

2014 20,000 25,000 17,000

Instructions

(Ignore all tax effects.)

(a) Prepare the journal entry necessary to record a change from the average-cost method to the FIFO method in 2015.

(b) Determine net income to be reported for 2012, 2013, and 2014, after giving effect to the change in accounting principle.

(c) Assume Holder-Webb Company used the LIFO method instead of the average-cost method during the years 2012–2014. In 2015, Holder-Webb changed to the FIFO method. Prepare the journal entry necessary to record the change in principle.

Pam Erickson Construction Company changed from the completed-contract to the percentage-of completion method of accounting for long-term construction contracts during 2015. For tax purposes, the company employs the completed-contract method and will continue this approach in the future. (Hint: Adjust all tax consequences through the Deferred Tax Liability account.) The appropriate information related to this change is as follows. Pretax Income from:

Percentage-of-Completion Completed-Contract Difference

2014 $780,000 $590,000 $190,000

2015 700,000 480,000 220,000

Instructions

(a) Assuming that the tax rate is 35%, what is the amount of net income that would be reported in 2015?

(b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?

Oliver Corporation has owned stock of Conrad Corporation since 2011. At December 31, 2014, its balances related to this investment were: Equity Investments $185,000 Fair Value Adjustment (AFS) 34,000 Dr. Unrealized Holding Gain or Loss—Equity 34,000 Cr. On January 1, 2015, 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 2011–2014, Oliver’s share of income would have been $33,000 greater than dividends received. Prepare Oliver’s journal entries to record th purchase of the investment and the change to the equity method.

Simmons Corporation owns stock of Armstrong, Inc. Prior to 2014, the investment was accounted for using the equity method. In early 2014, Simmons sold part of its investment in Armstrong, and began using the fair value method. In 2014, Armstrong earned net income of $80,000 and paid dividends of $95,000. Prepare Simmons’s entries related to Armstrong’s net income and dividends, assuming Simmons now owns 10% of Armstrong’s stock.

Palmer Co. is evaluating the appropriate accounting for the following items.

1. Management has decided to switch from the FIFO inventory valuation method to the LIFO inventory valuation method for all inventories.

2. When the year-end physical inventory adjustment was made for the current year, the controller discovered that the prior year’s physical inventory sheets for an entire warehouse were mislaid and excluded from last year’s count.

3. Palmer’s Custom Division manufactures large-scale, custom-designed machinery on a contract basis. Management decided to switch from the completed-contract method to the percentage-ofcompletion method of accounting for long-term contracts. Identify and explain whether each of the above items is a change in accounting principle, a change in estimate, or an error.

Roundtree Manufacturing Co. is preparing its year-end financial statements and is considering the accounting for the following items.

1. The vice president of sales had indicated that one product line has lost its customer appeal and will be phased out over the next 3 years. Therefore, a decision has been made to lower the estimated lives on related production equipment from the remaining 5 years to 3 years.

2. The Hightone Building was converted from a sales office to offices for the Accounting Department at the beginning of this year. Therefore, the expense related to this building will now appear as an administrative expense rather than a selling expense on the current year’s income statement.

3. Estimating the lives of new products in the Leisure Products Division has become very difficult because of the highly competitive conditions in this market. Therefore, the practice of deferring and amortizing preproduction costs has been abandoned in favor of expensing such costs as they are incurred.

Identify and explain whether each of the above items is a change in principle, a change in estimate, or an error.

Indicate the effect—Understate, Overstate, No Effect—that each of the following errors has on 2014 net income and 2015 net income.

2014 2015

(a) Equipment purchased in 2012 was expensed.

(b) Wages payable were not recorded at 12/31/14.

(c) Equipment purchased in 2014 was expensed.

(d) 2014 ending inventory was overstated.

(e) Patent amortization was not recorded in 2015.

At January 1, 2014, Beidler Company reported retained earnings of $2,000,000. In 2014, Beidler discovered that 2013 depreciation expense was understated by $400,000. In 2014, net income was $900,000 and dividends declared were $250,000. The tax rate is 40%. Prepare a 2014 retained earnings statement for Beidler Company.

In 2014, Bailey Corporation discovered that equipment purchased on January 1, 2012, for $50,000 was expensed at that time. The equipment should have been depreciated over 5 years, with no salvage value. The effective tax rate is 30%. Prepare Bailey’s 2014 journal entry to correct the error.

Sesame Company purchased a computer system for $74,000 on January 1, 2013. It was depreciated based on a 7-year life and an $18,000 salvage value. On January 1, 2015, Sesame revised these estimates to a total useful life of 4 years and a salvage value of $10,000. Prepare Sesame’s entry to record 2015 depreciation expense.

Tedesco Company changed depreciation methods in 2014 from double-declining-balance to straight-line. Depreciation prior to 2014 under double-declining-balance was $90,000, whereas straight-line depreciation prior to 2014 would have been $50,000. Tedesco’s depreciable assets had a cost of $250,000 with a $40,000 salvage value, and an 8-year remaining useful life at the beginning of 2014. Prepare the 2014 journal entries, if any, related to Tedesco’s depreciable assets.

Shannon, Inc., changed from the LIFO cost flow assumption to the FIFO cost flow assumption in 2014. The increase in the prior year’s income before taxes is $1,200,000. The tax rate is 40%. Prepare Shannon’s 2014 journal entry to record the change in accounting principle.

Refer to the accounting change by Wertz Construction Company in BE22-1. Wertz has a profitsharing plan, which pays all employees a bonus at year-end based on 1% of pretax income. Compute the indirect effect of Wertz’s change in accounting principle that will be reported in the 2014 income statement, assuming that the profit-sharing contract explicitly requires adjustment for changes in income numbers.

Wertz Construction Company decided at the beginning of 2014 to change from the completedcontract method to the percentage-of-completion method for financial reporting purposes. The company will continue to use the completed-contract method for tax purposes. For years prior to 2014, pretax income under the two methods was as follows: percentage-of-completion $120,000, and completed-contract $80,000. The tax rate is 35%. Prepare Wertz’s 2014 journal entry to record the change in accounting principle.

Equipment was purchased on January 2, 2014, for $24,000, but no portion of the cost has been charged to depreciation. The corporation wishes to use the straight-line method for these assets, which have been estimated to have a life of 10 years and no salvage value. What effect does this error have on net income in 2014? What entry is necessary to correct for this error, assuming that the books are not closed for 2014?

An entry to record Purchases and related Accounts Payable of $13,000 for merchandise purchased on December 23, 2015, was recorded in January 2016. This merchandise was not included in inventory at December 31, 2015. What effect does this error have on reported net income for 2015? What entry should be made to correct for this error, assuming that the books are not closed for 2015?

On January 2, 2014, $100,000 of 11%, 10-year bonds were issued for $97,000. The $3,000 discount was charged to Interest Expense. The bookkeeper, Mark Landis, records interest only on the interest payment dates of January 1 and July 1. What is the effect on reported net income for 2014 of this error, assuming straight-line amortization of the discount? What entry is necessary to correct for this error, assuming that the books are not closed for 2014?