P22-3 Penn Company is in the process of adjusting and correcting its books at the end of 2010. In reviewing its records, the following information was compiled. 1. Pen has failed to accrue sales commissions playable at the end of the last 2 years, as follows December 31, 2009 $16,000 December 31, 2010 $2,5000 2. In reviewing the December 31, 2011, inventory, Penn discovered errors in its inventory-taking procedures that have caused inventories for the last 3 years to be incorrect, as follows December 31, 2008 understated $16,000 December 31, 2009 understated $19,000 December 31, 2010 overstated $6,7000 Penn has already made an entry that established the incorrect December 31, 2010, inventory amount. 3. At December 31, 2010, Penn decided to change the depreciation method on its office equipment from double-declining balance to straight-line. The equipment had an original cost of $100,000 when purchased on January 1, 2008. It has a 10-year useful life and no salvage value. Depreciation recorded 2010 $12,800 using the double-declining balance method. 4. Before 2010, Penn accounted for its income from long-term construction contracts on the completed contract basis. Early in 2010, Penn changed to percentage- of- completion basis for accounting purposes. It continues to use the completed-contract method for tax purposes. Income for 2010 has been recorded using the percentage-of-completion method. The following information is available. Pretax income Percentage-of-completion completed-contract Prior to 2010 $150,000 $105,000 2010 60,000 20,000 Instructions Prepare the journal entries necessary at December 31, 2010, to record the above corrections and changes. The books are still open for 2010. The income tax rate is 40%. Penn has not yet recorded its 2010 income tax expense and playable amounts so current-year tax effects may be ignored. Prior-year tax effects must be considered in item 4.
1.Retained Earnings...... 3,500
Sales Commissions Payable...... 2,500
Sales Commissions Expense...... 1,000
2.Cost of Goods Sold ($19,000 + $6,700)...... 25,700
Retained Earnings...... 19,000
Inventory...... 6,700
Income Overstated (Understated)2008 / 2009 / 2010
Beginning inventory / $ 16,000 / $19,000
Ending inventory / $(16,000) / (19,000) / 6,700
$(16,000) / $ (3,000) / $25,700
3.Accumulated Depreciation—Equipment...... 4,800
Depreciation Expense...... 4,800*
*Equipment cost...... $100,000
Depreciation before 2010...... (36,000)
Book value...... $ 64,000
Depreciation to be taken ($64,000/8)...... $ 8,000
Depreciation recorded...... 12,800
Difference...... $ 4,800
4.Construction in Process...... 45,000
Deferred Tax Liability...... 18,000*
Retained Earnings...... 27,000
*($150,000 – $105,000) X 40%
P22-2 Botticelli inc. was organized in late 2008 to manufacture and sell hosiery. At the end of its fourth year of operation, the company has been fairly successful , as indicated by the following reported net incomes 2008 $140,000(a) 2010 $205,000 20009 160,000(b) 2011 276,000 a. Includes a $10,000 increase because of change in bad debt experience rate b. Includes extraordinary gain of $30,000. The company has decided to expand operations and has applied for a sizeable bank loan. The bank officer has indicated that the records should be audited and presented in comparative statements to facilitate analysis by the bank. Botticelli inc. therefore hired the auditing firm check and Doublecheck co. and has provided the following additional information. 1. In early 2009, Botticelli inc. changed its estimate from 2% to 1% on the amount of bad credit expense to be charged to operation. Bad debt expense for 2008, if a 1% rate has been used, would have been $10,000. The company The Company therefore restated its net income for 2008. 2. In 2011, the auditor discovered that company had changed its method of inventory pricing for LIFO to FIFO. The effect on the income statements for previous years is as follows. Net income unadjusted-LIFO basis 2010 2009 2010 2011 Net income unadjusted-FIFO basis $140,000 $160,000 $205,000 $276,000 155,000 165,000 215,000 260,000 $ 15,000 $ 5,000 $ 10,000 ($ 16,000) 3. In 2011 the auditor discovered that: a. The company incorrectly overstated the ending inventory by $14,000 in 2010 b. A dispute developed in 2009 with the internal revenue service over deductibility of entertainment expenses. In 2008, the company was not permitted these deductions, but a tax settlement was reached in 2011 were reduced by $60,000. Instructions (a) Indicate how each of these changes or corrections should be handled in accounting records. (b) Present comparative income statements for the year 2008 to 2011, starting with income before extraordinary items. Ignore income tax considerations.
(a)1.Bad debt expense for 2008 should not have been reduced by $10,000. A change in the experience rate is considered a change in estimate, which should be handled prospectively.
2.A change from LIFO to FIFO is considered a change in accounting principle, which must be handled retrospectively.
3.(a)The inventory error in 2010 is a prior period adjustment and the 2010 and 2011 financial statements should be restated.
(b)The lawsuit settlement is correctly treated.
(b)BOTTICELLI INC.
Comparative Income Statements
For the Years 2008 through 2011
2008 / 2009 / 2010 / 2011Income before extraordinary item /
$145,000 /
$135,000* /
$201,000 /
$274,000
Extraordinary gain / 30,000
Net income (see below) / $145,000 / $165,000 / $201,000 / $274,000
2008 / 2009 / 2010 / 2011
Net income (unadjusted) / $140,000 / $160,000 / $205,000 / $276,000
1.Bad debt expense
adjustment /
(10,000)
2.Inventory adjustment
(FIFO) /
15,000 /
5,000 /
10,000 /
(16,000)
3.Inventory
overstatement /
(14,000) /
14,000
Net income (adjusted) / $145,000 / $165,000* / $201,000 / $274,000
*The income before extraordinary item in 2009 is $135,000 ($165,000 – $30,000).