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Chapter 22: Q2CE (page 1325)
When a company has to restate its financial statements to correct an error, what information must the company disclose?
The business should disclose two things in the case of restatement of financial statements due to error.
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Define a change in estimate and provide an illustration. When is a change in accounting estimate effected by a change in accounting principle?
On March 5, 2018, you were hired by Hemingway Inc., a closely held company, as a staff member of its newly created internal auditing department. While reviewing the company’s records for 2016 and 2017, you discover that no adjustments have yet been made for the following items. Items
1. Interest income of \(14,100 was not accrued at the end of 2016. It was recorded when received in February 2017.
2. A computer costing \)4,000 was expensed when purchased on July 1, 2016. It is expected to have a 4-year life with no salvage value. The company typically uses straight-line depreciation for all fixed assets.
3. Research and development costs of \(33,000 were incurred early in 2016. They were capitalized and were to be amortized over a 3-year period. Amortization of \)11,000 was recorded for 2016 and \(11,000 for 2017.
4. On January 2, 2016, Hemingway leased a building for 5 years at a monthly rental of \)8,000. On that date, the company paid the following amounts, which were expensed when paid. Security deposit \(20,000 First month’s rent 8,000 Last month’s rent 8,000 \)36,000
5. The company received \(36,000 from a customer at the beginning of 2016 for services that it is to perform evenly over a 3-year period beginning in 2016. None of the amount received was reported as unearned revenue at the end of 2016.
6. Merchandise inventory costing \)18,200 was in the warehouse at December 31, 2016, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method.
Instructions
Indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2016, and the retained earnings figure reported on the balance sheet at December 31, 2017. Assume all amounts are material, and ignore income tax effects. Using the following format, enter the appropriate dollar amounts in the appropriate columns. Consider each item independent of the other items. It is not necessary to total the columns on the grid.
Analysis of Various Accounting Changes and Errors) Various types of accounting changes can affect the financial statements of a business enterprise differently. Assume that the following list describes changes that have a material effect on the financial statements for the current year of your business enterprise.
1. A change from the completed-contract method to the percentage-of-completion method of accounting for long-term construction-type contracts.
2. A change in the estimated useful life of previously recorded fixed assets as a result of newly acquired information.
3. A change from deferring and amortizing preproduction costs to recording such costs as an expense when incurred because future benefits of the costs have become doubtful. The new accounting method was adopted in recognition of the change in estimated future benefits.
4. A change from including the employer share of FICA taxes with payroll tax expenses to including it with “Retirement benefits” on the income statement.
5. Correction of a mathematical error in inventory pricing made in a prior period.
6. A change from presentation of statements of individual companies to presentation of consolidated statements.
7. A change in the method of accounting for leases for tax purposes to conform with the financial accounting method. As a result, both deferred and current taxes payable changed substantially.
8. A change from the FIFO method of inventory pricing to the LIFO method of inventory pricing.
Instructions Identify the type of change that is described in each item above and indicate whether the prior year’s financial statements should be recast when presented in comparative form with the current year’s financial statements
On January 1, 2017, Millay Inc. paid \(700,000 for 10,000 shares of Genso Company’s voting common stock, which was a 10% interest in Genso. At that date, the net assets of Gensototaled \)6,000,000. The fair values of all of Genso’s identifiable assets and liabilities were equal to their book values. Millay does not have the ability to exercise significant influence over the operating and financial policies of Genso. Millay received dividends of \(1.50 per share from Genso on October 1, 2017. Genso reported net income of \)550,000 for the year ended December 31, 2017.
On July 1, 2018, Millay paid \(2,325,000 for 30,000 additional shares of Genso Company’s voting common stock which represents a 30% investment in Genso. The fair values of all of Genso’s identifiable assets net of liabilities were equal to their book values of \)6,550,000. As a result of this transaction, Millay has the ability to exercise significant influence over the operating and financial policies of Genso. Millay received dividends of \(2.00 per share from Genso on April 1, 2018, and \)2.50 per share on October 1, 2018. Genso reported net income of \(650,000 for the year ended December 31, 2018, and \)350,000 for the 6 months ended December 31, 2018.
Instructions (For both purchases, assume any excess of cost over book value is due to goodwill.)
(a) Prepare a schedule showing the income or loss before income taxes for the year ended December 31, 2017, that Millay should report from its investment in Genso in its income statement issued in March 2018.
(b) During March 2019, Millay issues comparative financial statements for 2017 and 2018. Prepare schedules showing the income or loss before income taxes for the years ended December 31, 2017 and 2018, that Millay should report from its investment in Genso.
Question: (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?
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