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Chapter20: Accounting Changes and Error Corrections

Problems

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An alternate exercise and problem set is available on the text website: www.mhhe.com/spiceland6e

P 20-1  Change in inventory costing methods; comparative income statements  
 LO2


The Cecil-Booker Vending Company changed its method of valuing inventory from the average cost method to the FIFO cost method at the beginning of 2011. At December 31, 2010, inventories were $120,000 (average cost basis) and were $124,000 a year earlier. Cecil-Booker's accountants determined that the inventories would have totaled $155,000 at December 31, 2010, and $160,000 at December 31, 2009, if determined on a FIFO basis. A tax rate of 40% is in effect for all years.

   One hundred thousand common shares were outstanding each year. Income from continuing operations was $400,000 in 2010 and $525,000 in 2011. There were no extraordinary items either year.

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Required:

1.

 

Prepare the journal entry to record the change in accounting principle. (All tax effects should be reflected in the deferred tax liability account.)

2.

 

Prepare the 2011–2010 comparative income statements beginning with income from continuing operations. Include per share amounts.

P 20-2  Change in principle; change in method of accounting for long-term construction  
 LO2


The Pyramid Construction Company has used the completed-contract method of accounting for construction contracts during its first two years of operation, 2009 and 2010. At the beginning of 2011, Pyramid decided to change to the percentage-of-completion method for both tax and financial reporting purposes. The following table presents information concerning the change for 2009–2011. The income tax rate for all years is 40%.

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Pyramid issued 50,000 $1 par, common shares for $230,000 when the business began, and there have been no changes in paid-in capital since then. Dividends were not paid the first year, but $10,000 cash dividends were paid in both 2010 and 2011.

Required:

1.

 

Prepare the journal entry to record the change in accounting principle. (All tax effects should be reflected in the deferred tax liability account.)

2.

 

Prepare the 2011–2010 comparative income statements beginning with income before income taxes.

3.

 

Prepare the 2011–2010 comparative statements of shareholders' equity. (Hint: The 2009 statements reported retained earnings of $36,000. This is $60,000 − [$60,000 × 40%].

P 20-3  Change in inventory costing methods; comparative income statements  
 LO2 LO3


p. 1171

Shown below are net income amounts as they would be determined by Weihrich Steel Company by each of three different inventory costing methods ($ in 000s).

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Required:

1.

 

Assume that Weihrich used FIFO before 2011, and then in 2011 decided to switch to average cost. Prepare the journal entry to record the change in accounting principle and briefly describe any other steps Weihrich should take to appropriately report the situation. (Ignore income tax effects.)

2.

 

Assume that Weihrich used FIFO before 2011, and then in 2011 decided to switch to LIFO. Assume accounting records are inadequate to determine LIFO information prior to 2011. Therefore, the 2010 ($540) and pre-2010 ($2,280) data are not available. Prepare the journal entry to record the change in accounting principle and briefly describe any other steps Weihrich should take to appropriately report the situation. (Ignore income tax effects.)

3.

 

Assume that Weihrich used FIFO before 2011, and then in 2011 decided to switch to LIFO cost. Weihrich's records of inventory purchases and sales are not available for several previous years. Therefore, the pre-2010 LIFO information ($2,280) is not available. However, Weihrich does have the information needed to apply LIFO on a prospective basis beginning in 2010. Prepare the journal entry to record the change in accounting principle and briefly describe any other steps Weihrich should take to appropriately report the situation. (Ignore income tax effects.)

P 20-4  Change in inventory methods  
 LO2

The Rockwell Corporation uses a periodic inventory system and has used the FIFO cost method since inception of the company in 1974. In 2011, the company decided to change to the average cost method. Data for 2011 are as follows:

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Additional information:

1.

 

The company's effective income tax rate is 40% for all years.

2.

 

If the company had used the average cost method prior to 2011, ending inventory for 2010 would have been $130,000.

3.

 

7,000 units remained in inventory at the end of 2011.

Required:

1.

 

Prepare the journal entry at the beginning of 2011 to record the change in principle.

2.

 

In the 2011–2009 comparative financial statements, what will be the amounts of cost of goods sold and inventory reported for 2011?

P 20-5  Change in inventory methods  
 LO2

Fantasy Fashions had used the LIFO method of costing inventories, but at the beginning of 2011 decided to change to the FIFO method. The inventory as reported at the end of 2010 using LIFO would have been $20 million higher using FIFO.

   Retained earnings reported at the end of 2009 and 2010 was $240 million and $260 million, respectively (reflecting the LIFO method). Those amounts reflecting the FIFO method would have been $250 million and $272 million, respectively. 2010 net income reported at the end of 2010 was $28 million (LIFO method) but would have been $30 million using FIFO. After changing to FIFO, 2011 net income was $36 million. Dividends of $8 million were paid each year. The tax rate is 40%.

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Required:

1.

 

Prepare the journal entry at the beginning of 2011 to record the change in accounting principle.

2.

 

In the 2011–2010 comparative income statements, what will be the amounts of net income reported for 2010 and 2011?

3.

 

Prepare the 2011–2010 retained earnings column of the comparative statements of shareholders' equity.

P 20-6  Change in principle; change in depreciation methods  
 LO3

p. 1172

During 2009 and 2010, Faulkner Manufacturing used the sum-of-the-years'-digits (SYD) method of depreciation for its depreciable assets, for both financial reporting and tax purposes. At the beginning of 2011, Faulkner decided to change to the straight-line method for both financial reporting and tax purposes. A tax rate of 40% is in effect for all years.

   For an asset that cost $21,000 with an estimated residual value of $1,000 and an estimated useful life of 10 years, the depreciation under different methods is as follows:

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Required:

1.

 

Describe the way Faulkner should account for the change described. Include in your answer any journal entry Faulkner will record in 2011 related to the change and any required footnote disclosures.

2.

 

Suppose instead that Faulkner previously used straight-line depreciation and changed to sum-of-the-years'-digits in 2011. Describe the way Faulkner should account for the change. Include in your answer any journal entry Faulkner will record in 2011 related to the change and any required footnote disclosures.

P 20-7  Depletion; change in estimate  
 LO4

In 2011, the Marion Company purchased land containing a mineral mine for $1,600,000. Additional costs of $600,000 were incurred to develop the mine. Geologists estimated that 400,000 tons of ore would be extracted. After the ore is removed, the land will have a resale value of $100,000.

   To aid in the extraction, Marion built various structures and small storage buildings on the site at a cost of $150,000. These structures have a useful life of 10 years. The structures cannot be moved after the ore has been removed and will be left at the site. In addition, new equipment costing $80,000 was purchased and installed at the site. Marion does not plan to move the equipment to another site, but estimates that it can be sold at auction for $4,000 after the mining project is completed.

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   In 2011, 50,000 tons of ore were extracted and sold. In 2012, the estimate of total tons of ore in the mine was revised from 400,000 to 487,500. During 2012, 80,000 tons were extracted.

Required:

1.

 

Compute depletion and depreciation of the mine and the mining facilities and equipment for 2011 and 2012. Marion uses the units-of-production method to determine depreciation on mining facilities and equipment.

2.

 

Compute the book value of the mineral mine, structures, and equipment as of December 31, 2012.

P 20-8  Accounting changes; six situations  
 LO1 LO3 LO4

Described below are six independent and unrelated situations involving accounting changes. Each change occurs during 2011 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years. Any tax effects should be adjusted through the deferred tax liability account.

a.

 

Fleming Home Products introduced a new line of commercial awnings in 2010 that carry a one-year warranty against manufacturer's defects. Based on industry experience, warranty costs were expected to approximate 3% of sales. Sales of the awnings in 2010 were $3,500,000. Accordingly, warranty expense and a warranty liability of $105,000 were recorded in 2010. In late 2011, the company's claims experience was evaluated and it was determined that claims were far fewer than expected: 2% of sales rather than 3%. Sales of the awnings in 2011 were $4,000,000 and warranty expenditures in 2011 totaled $91,000.

b.

 

On December 30, 2007, Rival Industries acquired its office building at a cost of $1,000,000. It was depreciated on a straight-line basis assuming a useful life of 40 years and no salvage value. However, plans were finalized in 2011 to relocate the company headquarters at the end of 2015. The vacated office building will have a salvage value at that time of $700,000.

c.

 

Hobbs-Barto Merchandising, Inc., changed inventory cost methods to LIFO from FIFO at the end of 2011 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2012, is $690,000.

d.

 

At the beginning of 2008, the Hoffman Group purchased office equipment at a cost of $330,000. Its useful life was estimated to be 10 years with no salvage value. The equipment was depreciated by the sum-of-the-years'-digits method. On January 1, 2011, the company changed to the straight-line method.

e.

 

In November 2009, the State of Minnesota filed suit against Huggins Manufacturing Company, seeking penalties for violations of clean air laws. When the financial statements were issued in 2010, Huggins had not reached a settlement with state authorities, but legal counsel advised Huggins that it was probable the company would have to pay $200,000 in penalties. Accordingly, the following entry was recorded:

Loss—litigation ................................................

200,000

 Liability—litigation ........................................

200,000

Late in 2011, a settlement was reached with state authorities to pay a total of $350,000 in penalties.

p. 1173

f.

 

At the beginning of 2011, Jantzen Specialties, which uses the sum-of-the-years'-digits method, changed to the straight-line method for newly acquired buildings and equipment. The change increased current year net earnings by $445,000.

Required:

For each situation:

1.

 

Identify the type of change.

2.

 

Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2011 related to the situation described.

3.

 

Briefly describe any other steps that should be taken to appropriately report the situation.

P 20-9 Accounting changes; identify type and reporting approach 
 LO1  through  LO4


At the beginning of 2011, Wagner Implements undertook a variety of changes in accounting methods, corrected several errors, and instituted new accounting policies.

Required:

On a sheet of paper numbered from 1 to 10, indicate for each item below the type of change and the reporting approach Wagner would use.

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Change:

1.

 

By acquiring additional stock, Wagner increased its investment in Wise, Inc., from a 12% interest to 25% and changed its method of accounting for the investment from an available-for-sale investment to the equity method.

2.

 

Wagner instituted a postretirement benefit plan for its employees in 2011. Wagner did not previously have such a plan.

3.

 

Wagner changed its method of depreciating computer equipment from the SYD method to the straight-line method.

4.

 

Wagner determined that a liability insurance premium it both paid and expensed in 2010 covered the 2010–2012 period.

5.

 

Wagner custom-manufactures farming equipment on a contract basis. Wagner switched its accounting for these long-term contracts from the completed-contract method to the percentage-of-completion method.

6.

 

Due to an unexpected relocation, Wagner determined that its office building, previously depreciated using a 45-year life, should be depreciated using an 18-year life.

7.

 

Wagner offers a three-year warranty on the farming equipment it sells. Manufacturing efficiencies caused Wagner to reduce its expectation of warranty costs from 2% of sales to 1% of sales.

8.

 

Wagner changed from LIFO to FIFO to account for its materials and work-in-process inventories.

9.

 

Wagner changed from FIFO to average cost to account for its equipment inventory.

10.

 

Wagner sells extended service contracts on some of its equipment sold. Wagner performs services related to these contracts over several years, so in 2011 Wagner changed from recognizing revenue from these service contracts on a cash basis to the accrual basis.

P 20-10 Inventory errors 
 LO6

You have been hired as the new controller for the Ralston Company. Shortly after joining the company in 2011, you discover the following errors related to the 2009 and 2010 financial statements:

a.

 

Inventory at 12/31/09 was understated by $6,000.

b.

 

Inventory at 12/31/10 was overstated by $9,000.

c.

 

On 12/31/10, inventory was purchased for $3,000. The company did not record the purchase until the inventory was paid for early in 2011. At that time, the purchase was recorded by a debit to purchases and a credit to cash.

The company uses a periodic inventory system.

Required:

1.

 

Assuming that the errors were discovered after the 2010 financial statements were issued, analyze the effect of the errors on 2010 and 2009 cost of goods sold, net income, and retained earnings. (Ignore income taxes.)

2.

 

Prepare a journal entry to correct the errors.

3.

 

What other step(s) would be taken in connection with the error?

P 20-11 Error correction; change in depreciation method 
 LO6

p. 1174

The Collins Corporation purchased office equipment at the beginning of 2009 and capitalized a cost of $2,000,000. This cost included the following expenditures:

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   The company estimated an eight-year useful life for the equipment. No residual value is anticipated. The double-declining-balance method was used to determine depreciation expense for 2009 and 2010.

   In 2011, after the 2010 financial statements were issued, the company decided to switch to the straight-line depreciation method for this equipment. At that time, the company's controller discovered that the original cost of the equipment incorrectly included one year of annual maintenance charges for the equipment.

Required:

1.

 

Ignoring income taxes, prepare the appropriate correcting entry for the equipment capitalization error discovered in 2011.

2.

 

Ignoring income taxes, prepare any 2011 journal entry(s) related to the change in depreciation methods.

P 20-12 

Accounting changes and error correction; eight situations; tax effects ignored

 
 LO1  through  LO4 LO6


Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was started in 1999 by two talented engineers with little business training. In 2011, the company was acquired by one of its major customers. As part of an internal audit, the following facts were discovered. The audit occurred during 2011 before any adjusting entries or closing entries were prepared.

a.

 

A five-year casualty insurance policy was purchased at the beginning of 2009 for $35,000. The full amount was debited to insurance expense at the time.

b.

 

Effective January 1, 2011, the company changed the salvage value used in calculating depreciation for its office building. The building cost $600,000 on December 29, 2000, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $100,000. Declining real estate values in the area indicate that the salvage value will be no more than $25,000.

c.

 

On December 31, 2010, merchandise inventory was overstated by $25,000 due to a mistake in the physical inventory count using the periodic inventory system.

d.

 

The company changed inventory cost methods to FIFO from LIFO at the end of 2011 for both financial statement and income tax purposes. The change will cause a $960,000 increase in the beginning inventory at January 1, 2012.

e.

 

At the end of 2010, the company failed to accrue $15,500 of sales commissions earned by employees during 2010. The expense was recorded when the commissions were paid in early 2011.

f.

 

At the beginning of 2009, the company purchased a machine at a cost of $720,000. Its useful life was estimated to be 10 years with no salvage value. The machine has been depreciated by the double-declining balance method. Its carrying amount on December 31, 2010, was $460,800. On January 1, 2011, the company changed to the straight-line method.

g.

 

Bad debt expense is determined each year as 1% of credit sales. Actual collection experience of recent years indicates that 0.75% is a better indication of uncollectible accounts. Management effects the change in 2011. Credit sales for 2011 are $4,000,000; in 2010 they were $3,700,000.

Required:

For each situation:

1.

 

Identify whether it represents an accounting change or an error. If an accounting change, identify the type of change.

2.

 

Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2011 related to the situation described. (Ignore tax effects.)

3.

 

Briefly describe any other steps that should be taken to appropriately report the situation.

P 20-13 Accounting changes and error correction; eight situations; tax effects considered 
 LO1  through  LO4 LO6


(Note: This problem is a variation of the previous problem, modified to consider income tax effects.) Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was started in 1999 by two talented engineers with little business training. In 2011, the company was acquired by one of its major customers. As part of an internal audit, the following facts were discovered. The audit occurred during 2011 before any adjusting entries or closing entries were prepared. The income tax rate is 40% for all years.

a.

 

A five-year casualty insurance policy was purchased at the beginning of 2009 for $35,000. The full amount was debited to insurance expense at the time.

p. 1175

b.

 

Effective January 1, 2011, the company changed the salvage values used in calculating depreciation for its office building. The building cost $600,000 on December 29, 2000, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $100,000. Declining real estate values in the area indicate that the salvage value will be no more than $25,000.

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c.

 

On December 31, 2010, merchandise inventory was overstated by $25,000 due to a mistake in the physical inventory count using the periodic inventory system.

d.

 

The company changed inventory cost methods to FIFO from LIFO at the end of 2011 for both financial statement and income tax purposes. The change will cause a $960,000 increase in the beginning inventory at January 1, 2012.

e.

 

At the end of 2010, the company failed to accrue $15,500 of sales commissions earned by employees during 2010. The expense was recorded when the commissions were paid in early 2011.

f.

 

At the beginning of 2009, the company purchased a machine at a cost of $720,000. Its useful life was estimated to be ten years with no salvage value. The machine has been depreciated by the double-declining balance method. Its carrying amount on December 31, 2010, was $460,800. On January 1, 2011, the company changed to the straight-line method.

g.

 

Bad debt expense is determined each year as 1% of credit sales. Actual collection experience of recent years indicates that 0.75% is a better indication of uncollectible accounts. Management effects the change in 2011. Credit sales for 2011 are $4,000,000; in 2010 they were $3,700,000.

Required:

For each situation:

1.

 

Identify whether it represents an accounting change or an error. If an accounting change, identify the type of change.

2.

 

Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2011 related to the situation described. Any tax effects should be adjusted for through the deferred tax liability account.

3.

 

Briefly describe any other steps that should be taken to appropriately report the situation.

P 20-14 Errors; change in estimate; change in principle; restatement of previous financial statements 
 LO1 LO3 LO4 LO6


Whaley Distributors is a wholesale distributor of electronic components. Financial statements for the years ended December 31, 2009 and 2010, reported the following amounts and subtotals ($ in millions):

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In 2011 the following situations occurred or came to light:

a.

 

Internal auditors discovered that ending inventories reported on the financial statements the two previous years were misstated due to faulty internal controls. The errors were in the following amounts:

        2009 inventory

Overstated by $12 million

        2010 inventory

Understated by $10 million

b.

 

A liability was accrued in 2009 for a probable payment of $7 million in connection with a lawsuit ultimately settled in December 2011 for $4 million.

c.

 

A patent costing $18 million at the beginning of 2009, expected to benefit operations for a total of six years, has not been amortized since acquired.

d.

 

Whaley's conveyer equipment was depreciated by the sum-of-the-years'-digits (SYD) basis since it was acquired at the beginning of 2009 at a cost of $30 million. It has an expected useful life of five years and no expected residual value. At the beginning of 2011, Whaley decided to switch to straight-line depreciation.

Required:

For each situation:

1.

 

Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2011 related to the situation described. (Ignore tax effects.)

2.

 

Determine the amounts to be reported for each of the five items shown above from the 2009 and 2010 financial statements when those amounts are reported again in the 2009–2011 comparative financial statements.

P 20-15 Correction of errors; six errors 
 LO6

Conrad Playground Supply underwent a restructuring in 2011. The company conducted a thorough internal audit, during which the following facts were discovered. The audit occurred during 2011 before any adjusting entries or closing entries are prepared.

p. 1176

a.

 

Additional computers were acquired at the beginning of 2009 and added to the company's office network. The $45,000 cost of the computers was inadvertently recorded as maintenance expense. Computers have five-year useful lives and no material salvage value. This class of equipment is depreciated by the straight-line method.

b.

 

Two weeks prior to the audit, the company paid $17,000 for assembly tools and recorded the expenditure as office supplies. The error was discovered a week later.

c.

 

On December 31, 2010, merchandise inventory was understated by $78,000 due to a mistake in the physical inventory count. The company uses the periodic inventory system.

d.

 

Two years earlier, the company recorded a 4% stock dividend (2,000 common shares, $1 par) as follows:

Retained earnings ........................................

2,000

Common stock ...........................................

2,000

The shares had a market price at the time of $12 per share.

e.

 

At the end of 2010, the company failed to accrue $104,000 of interest expense that accrued during the last four months of 2010 on bonds payable. The bonds, which were issued at face value, mature in 2015. The following entry was recorded on March 1, 2011, when the semiannual interest was paid:

Interest expense ........................................

156,000

Cash .........................................................

156,000

f.

 

A three-year liability insurance policy was purchased at the beginning of 2010 for $72,000. The full premium was debited to insurance expense at the time.

Required:

For each error, prepare any journal entry necessary to correct the error as well as any year-end adjusting entry for 2011 related to the situation described. (Ignore income taxes.)

P 20-16 Integrating problem; errors; deferred taxes; contingency; change in tax rates 
 LO6


You are internal auditor for Shannon Supplies, Inc., and are reviewing the company's preliminary financial statements. The statements, prepared after making the adjusting entries, but before closing entries for the year ended December 31, 2011, are as follows:

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p. 1177

   Shannon's income tax rate was 40% in 2011 and previous years. During the course of the audit, the following additional information (not considered when the above statements were prepared) was obtained:

a.

 

Shannon's investment portfolio consists of blue chip stocks held for long-term appreciation. To raise working capital, some of the shares with an original cost of $180,000 were sold in May 2011. Shannon accountants debited cash and credited investments for the $220,000 proceeds of the sale.

b.

 

At December 31, 2011, the fair value of the remaining securities in the portfolio was $274,000.

c.

 

The state of Alabama filed suit against Shannon in October 2009 seeking civil penalties and injunctive relief for violations of environmental regulations regulating emissions. Shannon's legal counsel previously believed that an unfavorable outcome was not probable, but based on negotiations with state attorneys in 2011, now believe eventual payment to the state of $130,000 is probable, most likely to be paid in 2014.

d.

 

The $1,060,000 inventory total, which was based on a physical count at December 31, 2011, was priced at cost. Based on your conversations with company accountants, you determined that the inventory cost was overstated by $132,000.

e.

 

Electronic counters costing $80,000 were added to the equipment on December 29, 2010. The cost was charged to repairs.

f.

 

Shannon's equipment on which the counters were installed had a remaining useful life of four years on December 29, 2010, and is being depreciated by the straight-line method for both financial and tax reporting.

g.

 

A new tax law was enacted in 2011 which will cause Shannon's income tax rate to change from 40% to 35% beginning in 2012.

Required:

Prepare journal entries to record the effects on Shannon's accounting records at December 31, 2011, for each of the items described above. Show all calculations.

P 20-17 Integrating problem; error; depreciation; deferred taxes 
 LO6

George Young Industries (GYI) acquired industrial robots at the beginning of 2008 and added them to the company's assembly process. During 2011, management became aware that the $1 million cost of the machinery was inadvertently recorded as repair expense on GYI's books and on its income tax return. The industrial robots have 10-year useful lives and no material salvage value. This class of equipment is depreciated by the straight-line method for financial reporting purposes and for tax purposes it is considered to be MACRS 7-year property (cost deducted over 7 years by the modified accelerated recovery system as follows):

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The tax rate is 40% for all years involved.

Required:

1.

 

Prepare any journal entry necessary as a direct result of the error described.

2.

 

Briefly describe any other steps GYI would take to appropriately report the situation.

3.

 

Prepare the adjusting entry for 2011 depreciation.

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