Question

Described below are six independent and unrelated situations involving accounting changes. Each change occurs during 2018 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.

1. Fleming Home Products introduced a new line of commercial awnings in 2017 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 2017 were $4,400,000. Accordingly, warranty expense and a warranty liability of $132,000 were recorded in 2017. In late 2018, 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 2018 were $4,900,000, and warranty expenditures in 2018 totaled $111,475.
2. On December 30, 2014, Rival Industries acquired its office building at a cost of $1,180,000. It was depreciated on a straight-line basis assuming a useful life of 40 years and no salvage value. However, plans were finalized in 2018 to relocate the company headquarters at the end of 2022. The vacated office building will have a salvage value at that time of $790,000.
3. Hobbs-Barto Merchandising, Inc., changed inventory cost methods to LIFO from FIFO at the end of 2018 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2018, is $780,000.
4. At the beginning of 2015, the Hoffman Group purchased office equipment at a cost of $429,000. 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, 2018, the company changed to the straight-line method.
5. In November 2016, 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 2017, Huggins had not reached a settlement with state authorities, but legal counsel advised Huggins that it was probable the company would have to pay $290,000 in penalties. Accordingly, the following entry was recorded:

Loss—litigation	290,000
Liability—litigation		290,000

Late in 2018, a settlement was reached with state authorities to pay a total of $449,000 in penalties.

6. At the beginning of 2018, 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 $544,000.

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 2018 related to the situation described.
  

Answer 1

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Part a.	Change in Estimate
	No Entry needed for correction
Adjusting Entry
	Warranty expense (1% x $4,400,000)	$      44,000
	Estimated warranty liability		$         44,000
If effect is Material:	Disclosure note should show the effect of chang ein estimate on:
	a. Income before extraordinary items.
	b. Net Income
Part b.	Change in Estimate
	No Entry needed for correction
Adjusting Entry	Depreciation Expense	$      60,300
	Accumulated Depreciation		$         60,300
	Cost		$   1,180,000
	Annual Depreciation ($1,180,000/40 Years)	$      29,500
	Depreciation for Three years		$         88,500
	Book value at start of Year 2018		$   1,091,500
	Less: Salvage Value		$     -790,000
			$       301,500
	Remaining Life (2022-2018)		5 Years
	New Depreciation		$         60,300
If effect is Material:	Disclosure note should show the effect of chang ein estimate on:
	a. Income before extraordinary items.
	b. Net Income
Part c.	Change in accounting principal
	No Entry needed for change
	Company will report beginning inventory as $650,000 as base year inventory for all LIFO calculations in future.
	Disclosure required the nature of and justification for the change.
Part d.	Change in Accounting estimated, resulting due to change in principal
	No Entry needed for change
Adjusting Entry	Depreciation Expense	$      31,200
	Accumulated Depreciation		$         31,200
	Cost		$       429,000
	Depreciation till date		$     -210,600
	(10+9+8)/55*$429,000
	Book Value at start of Year 2018		$       218,400
	Life Remaining		7 Years
	Depreciation onwards 2018		$         31,200
Part e.	Change in estimates
	Loss-Litigation ($449,000-$290,000)	$   159,000
	Liability-Litigation		$       159,000
	Disclosure note should show the effect of chang ein estimate on:
	a. Income before extraordinary items.
	b. Net Income
Part f.	Change in accounting principle.
	To be accounted prospectively
	Disclosure required the nature of and justification for the change.
	Effect of change in current year financial statement shoul be disclosed