Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was

Question

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 a. A five-year casualty insurance policy was purchased at the beginning of 2016 for $32,500. The full amount was debited to 2 points insurance expense at the time b. Effective January 1, 2018, the company changed the salvage value used in calculating depreciation for its office building. The building cost $580,000 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 $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, 2017, merchandise inventory was overstated by $22,500 due to a mistake in the physical inventory count using d. The company changed inventory cost methods to FIFO from LIFO at the end of 2018 for both financial statement and income tax e. At the end of 2017, the company failed to accrue $15,000 of sales commissions earned by employees during 2017. The expense f. At the beginning of 2016, the company purchased a machine at a cost of $670,000. Its useful life was estimated to be 10 years with eBook the periodic inventory system. purposes. The change will cause a $935,000 increase in the beginning inventory at January 1, 2019 was recorded when the commissions were paid in early 2018 Print no salvage value. The machine has been depreciated by the double-declining balance method. Its book value on December 31, 2017, was $428,800. 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 O.75% is a better indication of the actual cost. Management effects the change in 2018. Credit sales for 2018 are $3,500,000; in 2017 they were $3,200,000 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. (Ignore tax effects.) Complete this question by entering your answers in the tabs below Required 1 Required 2 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" Type of change ven a. b. C. d. e.

Explanation / Answer

a. A five-year casualty insurance policy was purchased at the beginning of

2016 for $35,000. The full amount was debited to insurance expense at

the time.

This is an accounting error that requires retrospective restatement.

The amount that should be charged to expense every year is $6,500

($32,500 ÷ 5)

2016: Expense O/S -> NI U/S -> R/E U/S by $26,000 ($32,500 - $6,500)

2017: Expense U/S -> NI O/S by $6,500 -> R/E is now U/S by $19,500

Correcting Entry:

Prepaid insurance (3 x $6,500) 19,500

R/E 19,500

Adjusting Entry:

Insurance expense 6,500

Prepaid insurance 6,500

A prior period adjustment to retained earnings would be reported, along with a disclosure note describing the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and EPS

b. Effective January 1, 2018, the company changed the salvage value used in
calculating depreciation for its office building. The building cost $580,000 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 $100,000. Declining real estate
values in the area indicate that the salvage value will be no more than $25,000.
This is a change in estimate that is handled prospectively.
Annual depreciation before the change = ($580,000 - $100,000) ÷ 40 = $12,000
2018 Book value = $580,000 – [(10 x $12,000)] = $460,000
New residual value = $25,000
Remaining life = 30 years (40 – 10)
New depreciation = ($460,000 - $25,000) ÷ 30 = $14,500

Depreciation expense 14,500
Accumulated depreciation 14,500
Disclosure is required describing the effect of the change in estimate on income
before extraordinary items, net income and EPS

c. On December 31, 2017, merchandise inventory was overstated by
$22,500 due to a mistake in the physical inventory count using the
periodic inventory system.
This is an accounting error that requires retrospective restatement.
2017: EI O/S -> COGS U/S -> NI O/S -> R/E O/S; also the asset
inventory is overstated.
R/E 22,500
Inventory 22,500
A prior period adjustment to retained earnings would be reported, along
with a disclosure note describing the nature of the error and the impact
of its correction on each year’s net income, income before extraordinary
items, and EPS.

d. 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 $935,000 increase in the beginning inventory at
January 1, 2019.
This is a change in accounting principle that is reported retrospectively.
2018: EI U/S -> COGS O/S -> NI U/S -> R/E U/S; also, the asset
inventory is understated.
Inventory 935,000
Retained earnings 935,000
Prior years’ financial statements would be restated to reflect the use of the
new accounting method. A disclosure note justifying the change and
describing the effect of the change on any financial statement line items
and EPS for all periods reported is required.

e. At the end of 2017, the company failed to accrue $15,000 of sales
commissions earned by employees during 2017. The expense was
recorded when the commissions were paid in early 2018.
This is an accounting error that requires retrospective restatement.
2017: Expense U/S -> NI O/S -> R/E O/S
2018: Expense O/S

R/E 15,000
Sales Commission Expense 15,000

A prior period adjustment to retained earnings would be reported, along
with a disclosure note describing the nature of the error and the impact
of its correction on each year’s net income, income before extraordinary
items, and EPS.

f. At the beginning of 2016, the company purchased a machine at a cost of
$670,000. 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, 2017 was
$428,800. On January 1, 2018, the company changed to the straight-line
method.
This is treated as a change in estimate that is handled prospectively.
2018 Book value = $428,800

Residual value = $0
Remaining life = 8 years (10 – 2)

New depreciation = $428,800 ÷ 8 = $53,600

Depreciation expense 53,600
Accumulated depreciation 53,600

Previous financial statements are not restated. Rather, the company simply
utilizes the straight-line method from this point on.

g. Warranty expense is determined each year as 1% of sales. Actual
payment experience of recent years indicates that 0.75% is a better
indication of the actual cost. Management effects the change in 2018.
Credit sales for 2018 are $3,500,000; in 2017, they were $3,200,000.
This is a change in estimate that is handled prospectively.
2018 Warranty expense = 0.75% x $3,500,000 = $26,250

Warranty expense 26,250
Warranty payable 26,250

If the impact of the change in estimate is material, then a disclosure note
should describe the effect of the change in estimate on income before
extraordinary items, net income and EPS for the current period.

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