Question

Watson Co. is a specialty fabrics manufacturer and retailer who operates mainly in the Carolinas. A partial trial balance showing Watson’s equity, revenue and expense balances as of its December 31, 2019 year-end follows:

    Debits              Credits

Dividends                                                                     $   321,960

Retained earnings (1/1/19)                                                                     $   859,265

Unrealized holding loss – ECM bonds (1/1/19)                      53,710

Interest revenue                                                                                         17,805

Sales revenue                                                                                        9,147,540

Advertising expense                                                           116,385

Cost of goods sold                                                         5,947,660

Depreciation expense                                                         241,195

Interest expense                                                                 108,470

Salaries and wages expense                                           1,859,255

Utilities expense                                                                212,090

In addition, the following information is available for the company for 2019. Unless indicated otherwise, this information has not yet been reflected in the company’s accounts. All of the dollar amounts are stated on a before-tax basis.

1. In early January 2016, Watson purchased certain equipment at a price of $81,750. Watson began depreciating the equipment using the straight-line method and estimates of 10 years for useful life and $16,350 for salvage value. Watson depreciated the equipment on this basis through 2018 (actually 2019 – see the Note below). In early January 2019, the company determined that its initial estimates needed to be revised. Watson increased the useful life from 10 to 15 years and decreased the salvage value from $16,390 to $5,250.

Note – Watson mistakenly computed depreciation on this equipment for 2019 using the original estimates (10 years and $16,350). The depreciation expense of $241,195 shown in the partial trial balance above reflects use of the original estimates for this equipment.

2. In March 2019, Watson extinguished bonds payable having a book value of $429,350. Watson paid the investors $392,675 to retire these bonds.

3. In November 2019, Watson discovered that it understated the sales revenue reported in its 2018 financial statements. As a result, the company’s 2018 sales revenue was understated by $74,290. Watson plans to record the correcting entry before year-end 2019 and report the correction as required by GAAP in its 2019 financial statements.

Note – The discovery and correction of the 2018 error will not change the sales revenue for 2019. The $9,147,540 figure in the partial trial balance above is correct.

4. In preparing its 2019 financial statements, Watson has determined that it must write down certain inventory items by a total of $46,310.

5. In 2015, Watson purchased bonds issued by ECM Co., which it continues to hold as an available-for-sale investment. The fair value of Watson’s investment increased in 2019, from $283,415 to $369,185.

Note – The $53,710 Unrealized holding loss – ECM bonds (1/1/19) in the partial trial balance above relates to this item and, of course, is stated net of income taxes.

6. In September 2019, the government of South Africa expropriated a manufacturing facility that Watson owned in the country. The South African government informed Watson that it does not intend to compensate the company for this action. Watson’s accounts show a book value for the manufacturing plant at the time of expropriation of $239,850. This event satisfies the conditions of unusual and infrequent.

7. At year-end 2019, Watson decided to change its inventory cost flow method from First-in, First-out (FIFO) to Average Cost. The effect of the change on 2019 and prior years is as follows:

     2019            Prior Years

Cost of goods sold – FIFO                                 $5,947,660        $14,732,000

Cost of goods sold – Average Cost                     6,081,390           15,316,000

Note – The cost of goods sold figure in Watson’s partial trial balance above reflects use of the old method (FIFO) for 2019.

8. In April 2019, Watson shifted its business strategy, resulting in the August 2019 sale of a component of the company considered a separate major line of business. The sale produced a loss on disposal of $71,920. The operations of the component, prior to the sale in August, produced an income of $22,070.

Assume the above amounts are material. Also, assume the income tax rate applicable to all years and all income items is 30%. Finally, note that Watson uses the multiple-step format for the reporting of income items and the two-income statement approach for the display of other comprehensive income items.

– Instructions –

Prepare the financial statements for the year ended December 31, 2019 to show the proper reporting of Watson’s:

Prepare an Income statement and retained earnings statement from the informantion above.

Prepare these statements in good form, according to GAAP requirements.

Answer 1