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Chapter 22: Q20E. (page 1313)

The before-tax income for Lonnie Holdiman Co. for 2017 was \(101,000 and \)77,400 for 2018. However, the accountant noted that the following errors had been made:

1. Sales for 2017 included amounts of \(38,200 which had been received in cash during 2017, but for which the related products were delivered in 2018. Title did not pass to the purchaser until 2018.

2. The inventory on December 31, 2017, was understated by \)8,640.

3. The bookkeeper in recording interest expense for both 2017 and 2018 on bonds payable made the following entry on an annual basis. Interest Expense 15,000 Cash 15,000

The bonds have a face value of \(250,000 and pay a stated interest rate of 6%. They were issued at a discount of \)15,000 on January 1, 2017, to yield an effective-interest rate of 7%. (Assume that the effective-yield method should be used.)

4. Ordinary repairs to equipment had been erroneously charged to the Equipment account during 2017 and 2018. Repairs in the amount of \(8,500 in 2017 and \)9,400 in 2018 were so charged. The company applies a rate of 10% to the balance in the Equipment account at the end of the year in its determination of depreciation charges.

Instructions

Prepare a schedule showing the determination of corrected income before taxes for 2017 and 2018

Short Answer

Expert verified

Depreciation is the allocation of the cost to its useful life, and corrected income before tax for 2017 is $62,340 and for 2018 is $96,949

Step by step solution

01

Definition of Depreciation

Depreciation is defined as the accounting process which allocates the cost of an asset to its estimated useful life.

02

Schedule showing corrected Income

2017 ($)

2018 ($)

Incorrect Income before tax

101,000

77,400

Unearned Revenue, earned in 2018

-38,200

38,200

Understated Inventory

8,640

-8,640

Short Interest Booked

-1,450

Short interest Booked

-1,551

Repairs Booked

-8,500

-9,400

Excess Depreciation

850

Excess Depreciation

940

Correct Income before tax

62,340

96,949

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Most popular questions from this chapter

On December 31, 2017, before the books were closed, the management and accountants of Madrasa Inc. made the following determinations about three pieces of equipment.

1. Equipment A was purchased January 2, 2014. It originally cost \(540,000 and, for depreciation purposes, the straight-line method was originally chosen. The asset was originally expected to be useful for 10 years and have a zero salvage value. In 2017, the decision was made to change the depreciation method from straight-line to sum-of-the-years’-digits, and the estimates relating to useful life and salvage value remained unchanged.

2. Equipment B was purchased January 3, 2013. It originally cost \)180,000 and, for depreciation purposes, the straight-line method was chosen. The asset was originally expected to be useful for 15 years and have a zero residual value. In 2017, the decision was made to shorten the total life of this asset to 9 years and to estimate the residual value at \(3,000.

3. Equipment C was purchased January 5, 2013. The asset’s original cost was \)160,000, and this amount was entirely expensed in 2013. This particular asset has a 10-year useful life and no residual value. The straight-line method was chosen for depreciation purposes.

Additional data:

1. Income in 2017 before depreciation expense amounted to \(400,000.

2. Depreciation expense on assets other than A, B, and C totaled \)55,000 in 2017.

3. Income in 2016 was reported at \(370,000.

4. Ignore all income tax effects.

5. 100,000 shares of common stock were outstanding in 2016 and 2017.

Instructions

(a) Prepare all necessary entries in 2017 to record these determinations.

(b) Prepare comparative retained earnings statements for Madrasa Inc. for 2016 and 2017. The company had retained earnings of \)200,000 at December 31, 2015.

(Analysis of Various Accounting Changes and Errors) Mathys Inc. has recently hired a new independent auditor, Karen Ogleby, who says she wants “to get everything straightened out.” Consequently, she has proposed the following accounting changes in connection with Mathys Inc.’s 2017 financial statements.

1. At December 31, 2016, the client had a receivable of \(820,000 from Hendricks Inc. on its balance sheet. Hendricks Inc. has gone bankrupt, and no recovery is expected. The client proposes to write off the receivable as a prior period item.

2. The client proposes the following changes in depreciation policies.

(a) For office furniture and fixtures, it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2016, would have been \)250,000 less. The effect of the change on 2017 income alone is a reduction of \(60,000.

(b) For its new equipment in the leasing division, the client proposes to adopt the sum-of-the-years’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2017. If straight-line depreciation were used, 2017 income would be \)110,000 greater.

3. In preparing its 2016 statements, one of the client’s bookkeepers overstated ending inventory by \(235,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment.

4. In the past, the client has spread preproduction costs in its furniture division over 5 years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize preproduction costs on a per-unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction. If the new accounting method had been used prior to 2017, retained earnings at December 31, 2016, would have been \)375,000 less.

5. For the nursery division, the client proposes to switch from FIFO to LIFO inventories because it believes that LIFO will provide a better matching of current costs with revenues. The effect of making this change on 2017 earnings will be an increase of \(320,000. The client says that the effect of the change on December 31, 2016, retained earnings cannot be determined.

6. To achieve an appropriate recognition of revenues and expenses in its building construction division, the client proposes to switch from the completed-contract method of accounting to the percentage-of-completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2016, would have been \)1,075,000 greater.

Instructions

(a) For each of the changes described above, decide whether:

(1) The change involves an accounting principle, accounting estimate, or correction of an error.

(2) Restatement of opening retained earnings is required.

(b) What would be the proper adjustment to the December 31, 2016, retained earnings?

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?

Equipment was purchased on January 2, 2017, 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 2017? What entry is necessary to correct for this error, assuming that the books are not closed for 2017?

Taveras Co. decides at the beginning of 2017 to adopt the FIFO method of inventory valuation. Taveras had used the LIFO method for financial reporting since its inception on January 1, 2015, 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, 2015 \( 0 \) 0 \( 0 \) 0 December 31, 2015 100 80 800 820 December 31, 2016 200 240 1,000 940 December 31, 2017 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 2015, 2016, and 2017. (b) Prepare income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method for 2017 and 2016. (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 2017 and 2016 that were affected by the change in accounting principle. (d) Prepare comparative retained earnings statements for 2016 and 2017 under FIFO. Retained earnings reported under LIFO are as follows: Retained Earnings Balance December 31, 2015 $1,200 December 31, 2016 2,200 December 31, 2017 3,070
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