Question

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Starbucks Company's December 31 year-end financial statements contained the following errors: Dec. 31, 2017 Dec. 31, 2018 Ending inventory $37,500 understated $55,000 overstated Depreciation expense 10,000 understated An insurance premium of $90,000 was prepaid in 2017 for the years 2017, 2018, and 2019. The prepayment was recorded with a debit to insurance expense. In addition, on December 31, 2018, fully depreciated machinery was sold for $47,500 cash, but the sale was not recorded until 2019. There were no other errors during 2018 or 2019 and no corrections have been made for any of the errors. The effective income tax rate is 27% in all years. What is the total net effect of the errors on Starbuck's 2018 net income? Write the necessary prior period adjustment for December 31, 2018. Label work on each item. How would Prior period adjustment be reported in the financial statements at December 31, 2018.

Answer 1

ANSWER

Impacts: + Overstatement of profits - Understatement of profits
Starbucks Company
Particulars	2017	2018	2019
Ending Inventory Overstated		55,000.00
Ending Inventory Understated	(37,500.00)
Opening Inventory Overstated			(55,000.00)
Opening Inventory Understated		37,500.00
Prepaid Insurance expensed out: (It is assumed that insurance premium is equal year on year basis for all 3 years	(60,000.00)	30,000.00	30,000.00
Profit on sale of machinery not recorded		(47,500.00)
Net Impact	(97,500.00)	75,000.00	(25,000.00)
Tax Amount - at Rate (27%)	(26,325.00)	20,250.00	(6,750.00)
Prior period items refer to misstament of financial numbers as a result of errors or omissions occurred during the prior period i.e. previous period.
	Positive - Debit, Negative - Credit amounts
Prior Period Adjustment:	Amount
Ending Inventory overstated	Not a prior period item
Opening Inventory Understated	37,500.00
Insurance Expenses Understated	30,000.00
Profit on Sale of machinery not recorded	Not a prior period item
Net Prior Period Impact	67,500.00
Reporting of prior period Items:
Prior period items shall be shown in statement of Profit and as a separate line item - "Prior Period items" and shall be shown on the face of statement of Income and Expenditure.
Illustrative reporting in above situation
Statement of Profit and Loss
Particulars	Note No.	Amount
Income
Revenue from Operations
Other Income
Total
Expenses
Cost of goods sold
Employee Benefit Expenses
Finance Costs
Depreciation and amortization
Other Expenses
Prior period Items		67,500.00

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