Question

Problem 20-13 Accounting changes and error correction; seven situations; tax effects considered [LO20-1, 20-2, 20-3, 20-4, 20-6]

Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was started in 2006 by two talented engineers with little business training. In 2018, 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 2018 before any adjusting entries or closing entries were prepared. The income tax rate is 40% for all years.

A five-year casualty insurance policy was purchased at the beginning of 2016 for $30,500. The full amount was debited to insurance expense at the time.

Effective January 1, 2018, the company changed the salvage values used in calculating depreciation for its office building. The building cost $574,000 on December 29, 2007, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $110,000. Declining real estate values in the area indicate that the salvage value will be no more than $27,500.

On December 31, 2017, merchandise inventory was overstated by $20,500 due to a mistake in the physical inventory count using the periodic inventory system.

The company changed inventory cost methods to FIFO from LIFO at the end of 2018 for both financial statement and income tax purposes. The change will cause a $915,000 increase in the beginning inventory at January 1, 2019.

At the end of 2017, the company failed to accrue $14,600 of sales commissions earned by employees during 2017. The expense was recorded when the commissions were paid in early 2018.

At the beginning of 2016, the company purchased a machine at a cost of $630,000. 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 book value on December 31, 2017, was $403,200. On January 1, 2018, the company changed to the straight-line method.

Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.80% is a better indication of the actual cost. Management effects the change in 2018. Credit sales for 2018 are $3,100,000; in 2017 they were $2,800,000.

Required:
For each situation:
1. Identify whether it represents an accounting change or an error. If an accounting change, identify the type of change. For accounting errors, choose "Not applicable".
2. Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2018 related to the situation described. Any tax effects should be adjusted for through Income tax payable or Refund income tax.

Answer 1

Situation

(a) A five-year casualty insurance policy was purchased at the beginning of 2016 for $30500. The full amount was debited to insurance expense at the time. this is accounting change. the same was treated retrospectively as the prior year's comparative statements are revised.

date	Particulars		debit($)	credit($)
correction	Prepaid insurance		18300
entry	Retained earnings			18300
	(record the amount understated by retained earning)
adjusted	Insurance expense		6100
entry	prepaid insurance			6100
	( adjustment made against the prepaid insurance)

(b) Due to change in estimate ,there is no need for a correction entry as this is a change in ESTIMATE and to be reported prospectively. The journal is as under..

date	Particulars		debit($)	credit($)
Adjusted	Depreciation Expenses		14350
entry 2018	Accumulated depreciation			14350

Depreciation is calculated as under-

Cost of Asset= $574000

salvage value = $110000

depreciation for each year = 574000-110000/40=$11600

Depreciation for 10 years = $11600*10=$116000

New Cost to be depreciated for the year 2018=$574000-$116000

                                                                                  = $458000

New estimated salvage value = $27500

Remaining useful life= 30years

Annual Depreciation = $458000-$27500 = $14350

(c) inventory was overstated by $20,500 due to a mistake . It is an accounting error and reported retrospectively as the error related to previous year and needs to be corrected .The closing inventory which was overstated in result is understated of retained earnings.

  Journal-

date	Particulars		debit($)	credit($)
2018	retained earnings		20500
	Inventory (adjust the overstated inventory to retained earning )			20500

     (adjust the overstated inventory to retained earning )

(d) The company changed inventory cost methods to FIFO from LIFO at the end of 2018 for both financial statement and income tax purposes. This is an account principle change and to be reported retrospectively.

Journal-

date	Particulars		debit($)	credit($)
2018	Inventory		915000
	Retained earnings ( adjust the increased inventory to retained earnings)			915000

(e) This is correction in error and reported retrospectively .As the expense is of   year, it will recast prior period income statement .

Journal-

date	Particulars		debit($)	credit($)
2018	retained earnings		14600
	sales commission (To adjust the sales commission to retained earnings)			14600

(To adjust the sales commission to retained earnings)

(f) ) Due to change in estimate ,there is no need for a correction entry as this is a change in ESTIMATE and to be reported prospectively. The journal is as under-

date	Particulars		debit($)	credit($)
Adjusted	Depreciation Expenses		50400
entry 2018	Accumulated depreciation			50400

future depriciation will be as under-

The carrying value of asset =$403200

salvage value=   0

remaining years=8 yrs

Annual depriciation using straight line method-

      $403200/8

    =$50400

(g) ) Due to change in estimate ,there is no need for a correction entry as this is a change in ESTIMATE and to be reported prospectively.

Journal-

date	Particulars		debit($)	credit($)
Adjusted	Bad debts Expenses		24800
entry 2018	unallocatable account allowance (record the bad debts expenses)			24800

Bad debts calculated as below-

Credit sales for the year 2018=3100000

Bad debt iexpense= .80%

bad debts for the year-

310000*.80%=$ 24800