Accounting changes and error correction; seven situations; tax effects ignored
• LO20–1 through LO20–4, LO20–6
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
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.
b. Effective January 1, 2018, the company changed the salvage value used in calculating depreciation for its office building. The building cost $600,000 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 $25,000 due to a mistake in the physical inventory count using the periodic inventory system.
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 $960,000 increase in the beginning inventory at January 1, 2019.
e. At the end of 2017, the company failed to accrue $15,500 of sales commissions earned by employees during 2017. The expense was recorded when the commissions were paid in early 2018.
f. At the beginning of 2016, 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 book value on December 31, 2017, was $460,800. On January 1, 2018, the company changed to the straight-line method.
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 $4,000,000; in 2017 they were $3,700,000.
Required:
For each situation
1. Identify whether it represents an accounting change or an error. If an accounting change, identify the type of change.
2. Prepare any
3. Briefly describe any other steps that should be taken to appropriately report the situation.
Accounting changes:
Accounting changes are the alterations made to the accounting methods, accounting estimates, accounting principles (or) the reporting entity.
To identify: Accounting changes or an error.
Explanation of Solution
(a) This is a correction of an error:
Account title and Explanation | Debit ($) | Credit ($) |
Prepaid insurance (1) | 21,000 | |
Retained earnings (2) | 21,000 | |
(To record the correction of an error). | ||
Insurance expense (3) | 7,000 | |
Prepaid insurance | 7,000 | |
(To record 2018 adjusting entry). |
Table (1)
- Prepaid insurance is an asset. There is an increase in asset value. Therefore, it is debited.
- Retained earnings are liability. There is an increase in liability value. Therefore, it is credited.
- Insurance expense is an expense. There is an increase in liability value. Therefore, it is debited.
- Prepaid insurance is an asset. There is a decrease in assets value. Therefore, it is credited.
Working notes:
Calculate prepaid insurance:
Calculate retained earnings:
Calculate insurance expense:
- (a) This is a change in estimate:
Account title and explanations | Debit ($) | Credit ($) |
Depreciation expense (1) | 15,000 | |
Accumulated depreciation | 15,000 | |
(To record depreciation adjusting entry for 2018). |
Table (2)
- Depreciation expense is an expense. There is a decrease in liability value. Therefore, it is debited.
- Accumulated depreciation is a contra asset. There is a decrease in asset value.
Working notes:
Calculate annual depreciation after the estimate change:
Particulars | Amount ($) |
Cost | 600,000 |
Less: Depreciation to date
|
(125,000) |
Un depreciated cost | 475,000 |
Less: New estimated salvage value | (25,000) |
To be depreciated | 450,000 |
New annual depreciation
|
15,000 |
Table (3)
(c) This is a correction of an error:
Account title and Explanation | Debit ($) | Credit ($) |
Retained earnings | 25,000 | |
Inventory | 25,000 | |
(To record the correction of an error in inventory). |
Table (4)
- Retained earnings are liability. There is a decrease in liability value. Therefore, it is debited.
- Inventory is an asset. There is a decrease in asset value. Therefore, it is credited
- (d) This is a change in accounting principle and is reported retrospectively:
Account title and Explanation | Debit ($) | Credit ($) |
Inventory | 960,000 | |
Retained earnings | 960,000 | |
(To record a change in accounting principles in inventory). |
Table (5)
- Inventory is an asset. There is an increase in asset value. Therefore, it is debited.
- Retained earnings are liability. There is an increase in liability value. Therefore, it is credited.
- (e) This is a correction of an error:
Account title and Explanation | Debit ($) | Credit ($) |
Retained earnings | 15,500 | |
Compensation expense | 15,500 | |
(To record the compensation expense). |
Table (6)
- Retained earnings are liability. There is a decrease in liability value. Therefore, it is debited.
- Compensation expense is a liability. There is an increase in liability value. Therefore, it is credited.
- (f) This is a change in estimate resulting from a change in accounting principle and is accounted for prospectively.
Account title and Explanation | Debit ($) | Credit ($) |
Depreciation expense (1) | 57,600 | |
Accumulated depreciation | 57,600 | |
(To record depreciation). |
Table (7)
- Depreciation expense is an expense. There is a decrease in liability value. Therefore, it is debited.
- Accumulated depreciation is a contra asset. There is a decrease in asset value.
Working notes:
Particulars | Amount ($) |
Undepreciated cost | 460,800 |
Less: Residual value | (0) |
460,800 | |
Depreciated over remaining 8 years | |
Annual straight line depreciation 2018-2025 |
57,600 |
Table (8)
- (g) This is a change in estimate:
Account title and Explanation | Debit ($) | Credit ($) |
Warranty expense
|
30,000 | |
Warranty liability | 30,000 | |
(To record the change in estimate). |
Table (9)
- Warranty expense is an expense. There is an increase in liability value. Therefore, it is debited.
- Estimated warranty liability is a liability. There is an increase in liability value. Therefore, it is credited.
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Chapter 20 Solutions
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