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Chapter 22: 22-2BE (page 1306)

Refer to the accounting change by Wertz Construction Company in BE22-1. Wertz has a profit-sharing plan, which pays all employees a bonus at year-end based on 1% of pre-tax income. Compute the indirect effect of Wertz’s change in accounting principle that will be reported in the 2017 income statement, assuming that the profit-sharing contract explicitly requires adjustment for changes in income numbers.

Short Answer

Expert verified

Pre-tax income is income before tax, and the indirect effect will be $400.

Step by step solution

01

Definition of pre-tax Income

Pre-tax income is defined as the income shown in the income statement after deducting all the expenses and before income tax.

02

Computation of Indirect Effect

Indirect Effect

= (Pre tax income percentage of completion - Pre tax income cost recovery ) x Bonus rate

=(120,000 - 80,000) x 1%

=$400

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Most popular questions from this chapter

(Change in Principle—Long-Term Contracts) Cullen Construction Company, which began operations in 2017, changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during 2018. For tax purposes, the company employs the completed-contract method and will continue this approach in the future. The appropriate information related to this change is as follows.

Pretax Income Percentage-of-Completion Completed-Contract Difference 2017 \(880,000 \)590,000 $290,000 2018 900,000 480,000 420,000

Instructions (a) Assuming that the tax rate is 40%, what is the amount of net income that would be reported in 2018? (b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?

(Change in Estimate) Mike Crane is an audit senior of a large public accounting firm who has just been assigned to the Frost Corporation’s annual audit engagement. Frost has been a client of Crane’s firm for many years. Frost is a fastgrowing business in the commercial construction industry. In reviewing the fixed asset ledger, Crane discovered a series of unusual accounting changes, in which the useful lives of assets, depreciated using the straight-line method, were substantially lowered near the midpoint of the original estimate. For example, the useful life of one dump truck was changed from 10 to 6 years during its fifth year of service. Upon further investigation, Mike was told by Kevin James, Frost’s accounting manager, “I don’t really see your problem. After all, it’s perfectly legal to change an accounting estimate. Besides, our CEO likes to see big earnings!”

Instructions Answer the following questions.

(a) What are the ethical issues concerning Frost’s practice of changing the useful lives of fixed assets?

(b) Who could be harmed by Frost’s unusual accounting changes?

(c) What should Crane do in this situation?

Parsons Inc. has proposed a change from one inventory accounting method to another for financial reporting purposes. The auditor indicates that a change would be permitted only if it is to a preferable method. What difficulties develop in assessing preferability?

You have been engaged to review the financial statements of Gottschalk Corporation. In the course of your examination, you conclude that the bookkeeper hired during the current year is not doing a good job. You notice a number of irregularities as follows.

1. Year-end wages payable of \(3,400 were not recorded because the bookkeeper thought that “they were immaterial.”

2. Accrued vacation pay for the year of \)31,100 was not recorded because the bookkeeper “never heard that you had to do it.”

3. Insurance for a 12-month period purchased on November 1 of this year was charged to insurance expense in the amount of \(2,640 because “the amount of the check is about the same every year.” 4. Reported sales revenue for the year is \)2,120,000. This includes all sales taxes collected for the year. The sales tax rate is 6%. Because the sales tax is forwarded to the state’s Department of Revenue, the Sales Tax Expense account is debited. The bookkeeper thought that “the sales tax is a selling expense.” At the end of the current year, the balance in the Sales Tax Expense account is $103,400.

Instructions Prepare the necessary correcting entries, assuming that Gottschalk uses a calendar-year basis.

Indicate the effect—Understate, Overstate, No Effect—that each of the following errors has on 2017 net income and 2018 net income. 2017 2018 (a) Equipment (with a useful life of 5 years) was purchased and expensed in 2015. (b) Wages payable were not recorded at 12/31/17. (c) Equipment purchased in 2017 was expensed. (d) 2017 ending inventory was overstated. (e) Patent amortization was not recorded in 2018.
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