1Williams-Santana, inc. is a manufacturer of high-tech industrial parts that was
ID: 2471625 • Letter: 1
Question
1Williams-Santana, inc. is a manufacturer of high-tech industrial parts that was started in 1977 by two talented engineers with little business training. on 2011, the company was aquired by one of its major customers. As part of an internal audit, the following facts were prepared. The income tax rate is 40% for all years.
a. A five-year casualtyinsurance policy was purchased at the beginning of 2009 for $ 35,000. The full amount was debited to insurance expense a the time.
b. On Decemeber 31, 2010 merchandise inventory was overstated by $25,000 due to a mistake in the physial inventory count using the periodic inventory system.
c. The company changed inventory cost method to FIFO from LIFO at the end fo 2011 for both financial statement and income tax purposes. The change will cause a $960,000 increase in the begining inventory at january 1, 2010.
d. At the end of 2010, the company failed to accrue $15,500 of sales commissions earned by employees during 2010. the expense recorded when the commisions wre paid in early 2011.
e. At the begining of 2009, the company purchased a machine at a cost of $720,000. 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, 2010, was $460,800. On january 1, 2011 the company changed to the straight-line method.
f. Additonal industrial robots were aquired at the begining of 2008 and added to the company's assebly process. The $1,000,000 cost of the equipment was inadvertently recorded as repair expense. Robots have 10 year useful lives and no salvage value. this class of equipment by the straight-line method for both financial reporting and income tax reporting.
required:
1) Identify whether it represents an accoutanting change or an error. If an accounting change, identify the type of change.
2) Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2011 related to the situation described. Any tax effects should be adjusted for through the deferred tax liability account.
3) Breifly describe any other step that should be taken to appropriately report the situation.
Explanation / Answer
a.
This is an accounting error that requires retrospective restatement. The amount that should be charged to expense every year is $7,000 ($35,000 ÷ 5)
2009: Expense Overstated = Net Income Understated = Retained Earnings Understated by $28,000 ($35,000 - $7,000)
2010: Expense understated Net income overstated by $7,000 Retained earnings is now Understated by $21,000
Correcting entry
Prepaid Insurance (3 * $7,000)
$21,000
Retained earnings
$21,000
Adjusting entry
Insurance expense
$7,000
Prepaid insurance
$7,000
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.
b.
This is an accounting error that requires retrospective restatement.
2010: EI O/S = COGS U/S = NI O/S = R/E O/S; also the asset inventory is overstated.
R/E 25,000 Debit
Inventory 25,000 Credit
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.
c.
This is a change in accounting principle that is reported retrospectively.
2011: EI U/S = COGS O/S = NI U/S = R/E U/S; also, the asset inventory is understated
Inventory 960,000 Debit
Retained earnings 960,000 Credit
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.
d.
This is an accounting error that requires retrospective restatement.
2010: Expense U/S = NI O/S = R/E O/S
2011: Expense O/S
R/E 15,500 Debit
Sales Commission Expense 15,500 Credit
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.
e.
This is treated as a change in estimate that is handled prospectively.
2011 Book value = $460,800
Residual value = $0
Remaining life = 8 years (10 – 2)
New depreciation = $460,800 ÷ 8 = $57,600
Depreciation expense 57,600 Debit
Accumulated depreciation 57,600 Credit
Previous financial statements are not restated. Rather, the company simply utilizes the straight-line method from this point on.
Correcting entry
Prepaid Insurance (3 * $7,000)
$21,000
Retained earnings
$21,000
Adjusting entry
Insurance expense
$7,000
Prepaid insurance
$7,000
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