Question

Exercise 22-18

Jasper Corp December 31 year-end financial statements contained the following errors.

		December 31, 2017		December 31, 2018
Ending inventory		$9,600 understated		$8,100 overstated
Depreciation expense		$2,300 understated		—

An insurance premium of $66,000 was prepaid in 2017 covering the years 2017, 2018, and 2019. The entire amount was charged to expense in 2017. In addition, on December 31, 2018, fully depreciated machinery was sold for $14,800 cash, but the entry was not recorded until 2019. There were no other errors during 2017 or 2018, and no corrections have been made for any of the errors, Jasper follows ASPE

1. Compute the total effect of the errors on 2018 net income.
2. Compute the total effect of the errors on the amount of Bonita’s working capital at December 31, 2018.
3. Compute the total effect of the errors on the balance of Bonita’s retained earnings at December 31, 2018.
4. Assume that the company has retained earnings on Jan 1, 2017 and 2018 of 1,250,000 and 1,607,000, respectively net income for 2017 and 2018 of 422,000 and 375,000 respectively and cash dividends declared for 2017 and 2018 of 65,0000 and 45,000, respectively, before adjustment for the above items. Prepare a revised statement of retained earnings for 2017 and 2018.
5. Outline the accounting treatment required by ASPE in this situation and explain how these requirements help investors.

Answer 1

A.Compute the total effect of the errors on 2018 net income.

Total Effect of the errors on 2018 Net Income:

The Net Income is overstated by $39,700 ($9,600 + $8,100 +$22,000). The Corrected Net Income for the Year 2018 is calculated as follows.

Particulars	Amount ($)	Amount ($)
Net Income before adjustment of the given errors		375,000
Less: Ending Inventory as on Dec31,2017 Understated (Opening Inventory for the year 2018)	9,600
Less: Ending Inventory as on Dec31,2018 Overstated	8,100
Less: Insurance Expense for the 2018	22,000
Total adjustments		39,700
Corrected Net Income for the year 2018		335,300

B.Compute the total effect of the errors on the amount of Bonita’s working capital at December 31, 2018.

1. On Dec 31,2018, fully depreciated asset was sold for $14,800 cash but no entry was made. The cash was understated by $14,800 as on Dec 31,2018

2. The Insurance paid for 2017,2018 and 2019 $66,000 was fully charges to income statement. But the prepaid expense to be shown as on Dec 31,2018 is $22,000 (prepaid for the Year 2019 is to be shown - $66,000/3). The current assets as on Dec 31,2018 is understated by $22,000.

Working capital = Current assets - Current Liabilities

Working capital was therefore understated by $36,800 ($14,800 + $22,000) due to the above errors.

C.Compute the total effect of the errors on the balance of Bonita’s retained earnings at December 31, 2018.

particulars	Amount ($)
Opening Retained Earnings - Jan 01,2018	1,607,000
Add: net income given (before rectification of errors)	375,000
tOTAL	1,982,000
Less: Dividends paid	45,000
Retained earnings before rectification of errors	1,937,000
Retained earnings after rectification of errors (Taken form the below computation)	1,948,600
Difference	11,600

The Retained earnings as on Dec 31,2018 was understated by $11,600 due to the given errors.

D.Prepare a revised statement of retained earnings for 2017 and 2018.

Particulars	Amount ($)	Amount ($)
Opening Balance (Jan 01,2017)		1,250,000
Net Income Given	422,000
Adjustments for errors
Add: Ending inventory understated	9,600
Less: Depreciation Expense Understated	2,300
Add: Prepaid Insurance wrongly charged to income ($66,000*2/3)	$44,000
Corrected Net Income		473,300
Total		1,723,300
less: Dividends paid *(wrongly given in the question as $65,0000 hence corrected and taken as $65,000)		65,000
Closing Retained Earnings as on Dec 31, 2017		1,658,300
Opening Balance as on Jan 01,2018		1,658,300
Add: Corrected Net Income for the Year 2018 (from Q.A)		335,300
Total		1,993,600
Less: Dividends paid		45,000
Closing retained earnings as on Dec 31,2018		1,948,600

E.Outline the accounting treatment required by ASPE in this situation and explain how these requirements help investors.

As per ASPE 1506 - Accounting changes

Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

1. Was available when financial statements for those periods were completed; and

2. Could reasonably be expected to have been obtained and taken into accounting in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud.

Material prior period errors must be corrected retrospectively in the first set of financial statements completed after their discovery by:

1. Restating the comparative amounts for the prior period(s) in which the error occurred; or

2. If the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

Disclosure Requirements are mandatory so that the Investors can easily understand:

In the period the error is corrected, the following must be disclosed:

1. The nature of the prior period error;

2. For each prior period presented, the amount of the correction for each financial statement line item affected; and

3. The amount of the correction at the beginning of the earliest prior period presented.