3a. Anderson Company\'s December 31 year-end financial statements contained the
ID: 2591412 • Letter: 3
Question
3a. Anderson 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 covering 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.
3a-1. What is the total net effect of the errors on Anderson's 2018 net income?
3a-2. Write the necessary prior period adjustment for December 31, 2018. Show your labelled work to support each amount.
3b. The following information is available for Reich Company for its 2017 operations:
Accounts receivable, January 1, 2017
$ 40,000
Accounts receivable collected during 2017
84,000
Cash sales during 2017
20,000
Inventory, January 1, 2017
48,000
Inventory, December 31, 2017
44,000
Purchases of inventory during 2017
80,000
Gross profit on sales
42,000
What is Reich’s accounts receivable balance at December 31, 2017?
3c. Lema Inc. issued $500,000 of 6% bonds that mature in 10 years. These bonds pay interest every January 1 and July 1. The yield on these bonds at issuance was 7%.
3c-1. How much cash did Lema receive from the sale of its bonds?
3c-2. Explain why (in simple English) the price you computed was the same, more or less than the face amount of the bonds.
Accounts receivable, January 1, 2017
$ 40,000
Accounts receivable collected during 2017
84,000
Cash sales during 2017
20,000
Inventory, January 1, 2017
48,000
Inventory, December 31, 2017
44,000
Purchases of inventory during 2017
80,000
Gross profit on sales
42,000
Explanation / Answer
3a1) What is the net effect of error on Anderson 2018 net income
i) 2017 ending inventory understated by $37,500 and in turns the COGS being understated by $37,500 and net income being overstated for 2018 by $37,500.
In 2018 ending inventory being overstated by $55,000 which impact the COGS being understated by $55,000 and net income being overstated by $55,000
ii) Depreciation expense being understated by $10,000 in 2017 however it does not have any impact on the net income in 2018 as no correction entry was done.
iii) Insurance expense of $30,000 was understated in 2018 which in turns impact the net income being overstated by $30,000. ($30,000 belongs to the year 2018 i.e 90,000/3)
iv) Forget to record sale of full depreciated machinery. Hence, $47,500 gain on sale was not recorded in 2017 which in turns impact the net income being understated by $47,500
Total impact on net income in2018 = $37500 (O)+55000 (O)+30000(O)-47,500 (U)=$75,000 being overstated due to errors in 2018 net income
3a2) Prior period adjustment
i) 2017 inventory being understated = so the adjustment entry would be debiting the inventory account and crediting the retained earning account by $37,500. Since now we are bringing the inventory to the correct level and increase the retained earning.
2018 inventory being overstated= Incorrectly overstated the inventory by $55,000 hence the adjustment would be to reduce the inventory. so the adjustment entry would be debiting the cash account and crediting the inventory by $55,000.
ii) Depreciation expense understated by $10,000=
Retained earning account Dr $10,000
Cr Asset Account $10000
iii) Prepaid expense was debited to insurance expense account in 2017. Hence retained earning was understated by $60,000 in 2017 as expense of $30,000 was related to 2017 as against $90,000 debited.
So entry would be by
Dr Expense account $30,000
Dr Prepaid expense $ 30,000
Cr Retained earning $60,000
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