Chapter20: Accounting Changes and Error Corrections

Exercises

An alternate exercise and problem set is available on the text website: www.mhhe.com/spiceland6e

E 20-1

Change in principle; change in inventory methods

● LO2

During 2009 (its first year of operations) and 2010, Batali Foods used the FIFO inventory costing method for both financial reporting and tax purposes. At the beginning of 2011, Batali decided to change to the average method for both financial reporting and tax purposes.

Income components before income tax for 2011, 2010, and 2009 were as follows ($ in millions):

Dividends of $20 million were paid each year. Batali's fiscal year ends December 31.

p. 1163

Required:

1.		Prepare the journal entry at the beginning of 2011 to record the change in accounting principle. (Ignore income taxes.)
2.		Prepare the 2011–2010 comparative income statements.
3.		Determine the balance in retained earnings at January 1, 2010, as Batali reported previously using the FIFO method.
4.		Determine the adjustment to the January 1, 2010, balance in retained earnings that Batali would include in the 2011–2010 comparative statements of retained earnings or retained earnings column of the statements of shareholders' equity to revise it to the amount it would have been if Batali had used the average method.

E 20-2

Change in principle; change in inventory methods

● LO2

Aquatic Equipment Corporation decided to switch from the LIFO method of costing inventories to the FIFO method at the beginning of 2011. The inventory as reported at the end of 2010 using LIFO would have been $60,000 higher using FIFO. Retained earnings at the end of 2010 was reported as $780,000 (reflecting the LIFO method). The tax rate is 40%.

Required:

1.		Calculate the balance in retained earnings at the time of the change (beginning of 2011) as it would have been reported if FIFO had been used in prior years.
2.		Prepare the journal entry at the beginning of 2011 to record the change in accounting principle.

E 20-3

Change from the treasury stock method to retired stock

● LO2

In keeping with a modernization of corporate statutes in its home state, UMC Corporation decided in 2011 to discontinue accounting for reacquired shares as treasury stock. Instead, shares repurchased will be viewed as having been retired, reassuming the status of unissued shares. As part of the change, treasury shares held were reclassified as retired stock. At December 31, 2010, UMC's balance sheet reported the following shareholders' equity:

Required:

Identify the type of accounting change this decision represents and prepare the journal entry to effect the reclassification of treasury shares as retired shares.

E 20-4

Change in principle; change to the equity method

● LO2

The Trump Companies, Inc., has ownership interests in several public companies. At the beginning of 2011, the company's ownership interest in the common stock of Milken Properties increased to the point that it became appropriate to begin using the equity method of accounting for the investment. The balance in the investment account was $31 million at the time of the change. Accountants working with company records determined that the balance would have been $48 million if the account had been adjusted to reflect the equity method.

Required:

1.		Prepare the journal entry to record the change in accounting principle. (Ignore income taxes.)
2.		Briefly describe other steps Trump should take to report the change.
3.		Suppose Trump is changing from the equity method rather than to the equity method. How would your answers to requirements 1 and 2 differ?

E 20-5

FASB codification research; change in accounting for investments

● LO2

Companies often invest in the common stock of other corporations. The way we report these investments depends on the nature of the investment and the investor's motivation for the investment. The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles.

Required:

1.		Obtain the relevant authoritative literature on accounting for a change from the cost method to the equity method for investments in common stock using the FASB's Codification Research System at the FASB website (www.fasb.org).
2.		What is the specific citation that describes how to account for a change from the cost method to the equity method for investments in common stock?
3.		What are the specific requirements?

E 20-6

FASB codification research

● LO2

Access the FASB's Codification Research System at the FASB website (www.fasb.org). Determine the specific citation for accounting for each of the following items:

1.		Reporting most changes in accounting principle.
2.		Disclosure requirements for a change in accounting principle.
3.		Illustration of the application of a retrospective change in the method of accounting for inventory.

p. 1164

E 20-7

Change in principle; change to the percentage-of completion method

● LO2

The Long Island Construction Company has used the completed contract method of accounting for construction contracts. At the beginning of 2011, the company decides to change to the percentage-of-completion method for financial reporting purposes, but will continue to use the completed contract method for tax reporting. The following table presents information concerning the change. The income tax rate for all years is 40%.

Required:

1.		Prepare the journal entry to record the change in accounting principle. (All tax effects should be reflected in the deferred tax liability account.)
2.		Determine the net income to be reported in the 2011–2010 comparative income statements.
3.		Which other 2010 amounts would be reported differently in the 2011–2010 comparative income statements and 2011–2010 comparative balance sheets than they were reported the previous year?
4.		How would the change be reflected in the 2011–2010 comparative statements of shareholders' equity? Cash dividends were $1 million each year.

E 20-8

Change in inventory methods; incomplete information

● LO3

Moulton Foods has always used the FIFO inventory costing method for both financial reporting and tax purposes. At the beginning of 2011, Moulton decided to change to the LIFO method. As a result of the change, net income in 2011 was $80 million. If the company had used LIFO in 2010, its cost of goods sold would have been higher by $6 million that year. Moulton's records of inventory purchases and sales are not available for 2009 and several previous years. Last year, Moulton reported the following net income amounts in its comparative income statements:

Required:

1.		Prepare the journal entry at the beginning of 2011 to record the change in accounting principle. (Ignore income taxes.)
2.		Briefly describe other steps Moulton will take to report the change.
3.		What amounts will Moulton report for net income in its 2011–2009 comparative income statements?

E 20-9

Change in inventory methods; incomplete information

● LO3

Wolfgang Kitchens has always used the FIFO inventory costing method for both financial reporting and tax purposes. At the beginning of 2011, Wolfgang decided to change to the LIFO method. Net income in 2011 was correctly stated as $90 million. If the company had used LIFO in 2010, its cost of goods sold would have been higher by $7 million that year. Company accountants are able to determine that the cumulative net income for all years prior to 2010 would have been lower by $23 million if LIFO had been used all along, but have insufficient information to determine specific effects of using LIFO in 2009. Last year, Wolfgang reported the following net income amounts in its comparative income statements:

Required:

1.		Prepare the journal entry at the beginning of 2011 to record the change in accounting principle. (Ignore income taxes.)
2.		Briefly describe other steps Wolfgang will take to report the change.
3.		What amounts will Wolfgang report for net income in its 2011–2009 comparative income statements?

E 20-10

Change in depreciation methods

● LO3

For financial reporting, Clinton Poultry Farms has used the declining-balance method of depreciation for conveyor equipment acquired at the beginning of 2008 for $2,560,000. Its useful life was estimated to be six years with a $160,000 residual value. At the beginning of 2011, Clinton decides to change to the straight-line method. The effect of this change on depreciation for each year is as follows ($ in 000s):

p. 1165

Required:

1.		Briefly describe the way Clinton should report this accounting change in the 2010–2011 comparative financial statements.
2.		Prepare any 2011 journal entry related to the change.

E 20-11

Change in depreciation methods

● LO3

The Canliss Milling Company purchased machinery on January 2, 2009, for $800,000. A five-year life was estimated and no residual value was anticipated. Canliss decided to use the straight-line depreciation method and recorded $160,000 in depreciation in 2009 and 2010. Early in 2011, the company changed its depreciation method to the sum-of-the-years'-digits (SYD) method.

Required:

1.		Briefly describe the way Canliss should report this accounting change in the 2010–2011 comparative financial statements.
2.		Prepare any 2011 journal entry related to the change.

E 20-12

Book royalties

● LO4

Dreighton Engineering Group receives royalties on a technical manual written by two of its engineers and sold to William B. Irving Publishing, Inc. Royalties are 10% of net sales, receivable on October 1 for sales in January through June and on April 1 for sales in July through December of the prior year. Sales of the manual began in July 2010, and Dreighton accrued royalty revenue of $31,000 at December 31, 2010, as follows:

Dreighton received royalties of $36,000 on April 1, 2011, and $40,000 on October 1, 2011. Irving indicated to Dreighton on December 31 that book sales subject to royalties for the second half of 2011 are expected to be $500,000.

Required:

1.		Prepare any journal entries Dreighton should record during 2011 related to the royalty revenue.
2.		What adjustments, if any, should be made to retained earnings or to the 2010 financial statements? Explain.

E 20-13

Loss contingency

● LO4

The Commonwealth of Virginia filed suit in October 2009, against Northern Timber Corporation seeking civil penalties and injunctive relief for violations of environmental laws regulating forest conservation. When the financial statements were issued in 2010, Northern had not reached a settlement with state authorities, but legal counsel advised Northern Timber that it was probable the ultimate settlement would be $1,000,000 in penalties. The following entry was recorded:

Late in 2011, a settlement was reached with state authorities to pay a total of $600,000 to cover the cost of violations.

Required:

1.		Prepare any journal entries related to the change.
2.		Briefly describe other steps Northern should take to report the change.

E 20-14

Warranty expense

● LO4

Woodmier Lawn Products introduced a new line of commercial sprinklers in 2010 that carry a one-year warranty against manufacturer's defects. Because this was the first product for which the company offered a warranty, trade publications were consulted to determine the experience of others in the industry. Based on that experience, warranty costs were expected to approximate 2% of sales. Sales of the sprinklers in 2010 were $2,500,000. Accordingly, the following entries relating to the contingency for warranty costs were recorded during the first year of selling the product:

In late 2011, the company's claims experience was evaluated and it was determined that claims were far more than expected—3% of sales rather than 2%.

p. 1166

Required:

1.		Assuming sales of the sprinklers in 2011 were $3,600,000 and warranty expenditures in 2011 totaled $88,000, prepare any journal entries related to the warranty.
2.		Assuming sales of the sprinklers were discontinued after 2010, prepare any journal entry(s) in 2011 related to the warranty.

E 20-15

Deferred taxes; change in tax rates

● LO4

Bronson Industries reported a deferred tax liability of $8 million for the year ended December 31, 2010, related to a temporary difference of $20 million. The tax rate was 40%. The temporary difference is expected to reverse in 2012 at which time the deferred tax liability will become payable. There are no other temporary differences in 2010–2012. Assume a new tax law is enacted in 2011 that causes the tax rate to change from 40% to 30% beginning in 2012. (The rate remains 40% for 2011 taxes.) Taxable income in 2011 is $30 million.

Required:

1.		Determine the effect of the change and prepare the appropriate journal entry to record Bronson's income tax expense in 2011.
2.		What adjustment, if any, is needed to revise retained earnings as a result of the change?

E 20-16

Accounting change

● LO4

The Peridot Company purchased machinery on January 2, 2009, for $800,000. A five-year life was estimated and no residual value was anticipated. Peridot decided to use the straight-line depreciation method and recorded $160,000 in depreciation in 2009 and 2010. Early in 2011, the company revised the total estimated life of the machinery to eight years.

Required:

1.		What type of change is this?
2.		Briefly describe the accounting treatment for this change.
3.		Determine depreciation for 2011.

E 20-17

Change in estimate; useful life and residual value of equipment

● LO4

Wardell Company purchased a mini computer on January 1, 2009, at a cost of $40,000. The computer has been depreciated using the straight-line method over an estimated five-year useful life with an estimated residual value of $4,000. On January 1, 2011, the estimate of useful life was changed to a total of 10 years, and the estimate of residual value was changed to $900.

Required:

1.		Prepare the appropriate adjusting entry for depreciation in 2011 to reflect the revised estimate.
2.		Repeat requirement 1 assuming that the company uses the sum-of-the-years'-digits method instead of the straight-line method.

E 20-18

Classifying accounting changes

● LO1 through LO5

Indicate with the appropriate letter the nature of each situation described below:

Type of Change

Change in principle reported retrospectively

Change in principle reported prospectively

Change in estimate

Change in estimate resulting from a change in principle

Change in reporting entity

Not an accounting change

_____

Change from declining balance depreciation to straight-line.

_____

Change in the estimated useful life of office equipment.

_____

Technological advance that renders worthless a patent with an unamortized cost of $45,000.

_____

Change from determining lower of cost or market for the inventories by the individual item approach to the aggregate approach.

_____

Change from LIFO inventory costing to the weighted-average inventory costing.

_____

Settling a lawsuit for less than the amount accrued previously as a loss contingency.

_____

Including in the consolidated financial statements a subsidiary acquired several years earlier that was appropriately not included in previous years.

_____

Change by a retail store from reporting bad debt expense on a pay-as-you-go basis to the allowance method.

_____

A shift of certain manufacturing overhead costs to inventory that previously were expensed as incurred to more accurately measure cost of goods sold. (Either method is generally acceptable.)

_____

10.

Pension plan assets for a defined benefit pension plan achieving a rate of return in excess of the amount anticipated.

E 20-19

Error correction; inventory error

● LO6

p. 1167

During 2011, WMC Corporation discovered that its ending inventories reported on its financial statements were misstated by the following amounts:

WMC uses the periodic inventory system and the FIFO cost method.

Required:

1.		Determine the effect of these errors on retained earnings at January 1, 2011, before any adjustments. Explain your answer. (Ignore income taxes.)
2.		Prepare a journal entry to correct the error.
3.		What other step(s) would be taken in connection with the error?

E 20-20

Error corrections; investment

● LO6

On December 12, 2011, an investment costing $80,000 was sold for $100,000. The total of the sale proceeds was credited to the investment account.

Required:

1.		Prepare the journal entry to correct the error assuming it is discovered before the books are adjusted or closed in 2011. (Ignore income taxes.)
2.		Prepare the journal entry to correct the error assuming it is not discovered until early 2012. (Ignore income taxes.)

E 20-21

Error in amortization schedule

● LO6

Wilkins Food Products, Inc. acquired a packaging machine from Lawrence Specialists Corporation. Lawrence completed construction of the machine on January 1, 2009. In payment for the machine Wilkins issued a three-year installment note to be paid in three equal payments at the end of each year. The payments include interest at the rate of 10%. Lawrence made a conceptual error in preparing the amortization schedule which Wilkins failed to discover until 2011. As a result of the error, Wilkins understated interest expense by $45,000 in 2009 and $40,000 in 2010.

Required:

1.		Determine which accounts are incorrect as a result of these errors at January 1, 2011, before any adjustments. Explain your answer. (Ignore income taxes.)
2.		Prepare a journal entry to correct the error.
3.		What other step(s) would be taken in connection with the error?

E 20-22

Error correction; accrued interest on bonds

● LO6

At the end of 2010, Majors Furniture Company failed to accrue $61,000 of interest expense that accrued during the last five months of 2010 on bonds payable. The bonds mature in 2024. The discount on the bonds is amortized by the straight-line method. The following entry was recorded on February 1, 2011, when the semiannual interest was paid:

Required:

Prepare any journal entry necessary to correct the error as well as any adjusting entry for 2011 related to the situation described. (Ignore income taxes.)

E 20-23

Error correction; three errors

● LO6

Below are three independent and unrelated errors.

On December 31, 2010, Wolfe-Bache Corporation failed to accrue office supplies expense of $1,800. In January 2011, when it received the bill from its supplier, Wolfe-Bache made the following entry:

On the last day of 2010, Midwest Importers received a $90,000 prepayment from a tenant for 2011 rent of a building. Midwest recorded the receipt as rent revenue.

At the end of 2010, Dinkins-Lowery Corporation failed to accrue interest of $8,000 on a note receivable. At the beginning of 2011, when the company received the cash, it was recorded as interest revenue.

p. 1168

Required:

For each error:

1.		What would be the effect of each error on the income statement and the balance sheet in the 2010 financial statements?
2.		Prepare any journal entries each company should record in 2011 to correct the errors.

E 20-24

Inventory errors

● LO6

For each of the following inventory errors occurring in 2011, determine the effect of the error on 2011's cost of goods sold, net income, and retained earnings. Assume that the error is not discovered until 2012 and that a periodic inventory system is used. Ignore income taxes.

E 20-25

Classifying accounting changes and errors

● LO1 through LO6

Indicate with the appropriate letter the nature of each adjustment described below:

Type of Adjustment

Change in accounting principle (reported retrospectively)

Change in accounting principle (exception reported prospectively)

Change in estimate

Change in estimate resulting from a change in accounting principle

Change in reporting entity

Correction of an error

_____

Change from expensing extraordinary repairs to capitalizing the expenditures.

_____

Change in the residual value of machinery.

_____

Change from FIFO inventory costing to LIFO inventory costing.

_____

Change in the percentage used to determine bad debts.

_____

Change from LIFO inventory costing to FIFO inventory costing.

_____

Change from reporting an investment by the equity method due to a reduction in the percentage of shares owned.

_____

Change in the composition of a group of firms reporting on a consolidated basis.

_____

Change from sum-of-the-years'-digits depreciation to straight-line depreciation.

_____

Change from the percentage-of-completion method by a company in the long-term construction industry.

_____

10.

Change in actuarial assumptions for a defined benefit pension plan.

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Chapter20: Accounting Changes and Error Corrections

Exercises