Question

The accountant preparing the income statement for Bakersfield, Inc. had some doubts about the appropriate accounting treatment of the seven items listed below during the fiscal year ending December 31, 2014. Assume a tax rate of 40 percent.
1. The corporation experienced an uninsured flood loss of $70,000 before taxes. While this loss meets the criteria of an unusual item, it has not been recorded.
2. The corporation disposed of its sporting goods division during 2014. This disposal meets the criteria for discontinued operations. The division correctly calculated income from operating this division of $110,000 before taxes and a loss of $12,000 before taxes on the disposal of the division. All of these events occurred in 2014 and have not been recorded.

3. The company recorded advances of $10,000 to employees made December 31, 2014 as Salaries and Wages Expense.

4. Dividends of $10,000 during 2014 were recorded as an operating expense.

5. In 2014, Bakersfield changed its method of accounting for inventory from the first-in-first-out method to the average cost method. Inventory in 2014 was correctly recorded using the average cost method. The new inventory method would have resulted in an additional $125,000 of cost of goods sold (before taxes) being reported on prior years' income statement.

6. Office equipment purchased January 1, 2014 for $60,000 was incorrectly charged to Supplies Expense at the time of purchase. The office equipment has an estimated three-year service life with no expected salvage value. Bakersfield uses the straight-line method to depreciate office equipment for financial reporting purposes. This error has not been recorded.

7. On January 1, 2010, Bakersfield bought a building that cost $85,000, had an estimated useful life of ten years, and had a salvage value of $5,000. Bakersfield uses the
straight-line depreciation method to depreciate the building. In 2014, it was estimated that the remaining useful life was eight years and the salvage value was zero. Depreciation expense reported on the 2014 income statement was correctly calculated based on the new estimates. No adjustment for prior years' depreciation estimates was made.

Required:
1.For each item, record corrections to income from continuing operations before taxes, if any. Denote any negative numbers by using brackets < >.

2.At January 1, 2014, Bakersfield, Inc.'s retained earnings balance was $200,000. Assume that income from continuing operations (before taxes) and after correctly considering any of the seven additional items was $1,400,000. Prepare the income statement and retained earnings statement. Denote negative numbers by using brackets < >. Do not disclose earnings per share data.

Answer 1

1)
Number Item	Description	Increase (Decrease) to Income from Continuing Operations
1. The corporation experienced an uninsured flood loss of $70,000 before taxes. While this loss meets the criteria of an unusual item, it has not been recorded.	Extraordinary items reported after Income from Continuing Operations (ICO)	No Effect
2. The corporation disposed of its sporting goods division during 2014. This disposal meets the criteria for discontinued operations. The division correctly calculated income from operating this division of $110,000 before taxes and a loss of $12,000 before taxes on the disposal of the division. All of these events occurred in 2014 and have not been recorded.	Discontinued Items reported afterIncome from Continuing Operations	No Effect
3. The company recorded advances of $10,000 to employees made December 31, 2014 as Salaries and Wages Expense.	Correct journal entry Dr: Prepaid Salary debited  Salaries/ wages Expense credited	$10,000
4. Dividends of $10,000 during 2014 were recorded as an operating expense.	Dividends are not reported on the Income Statement; should be on R/E Statement.	$10,000
5. In 2014, Bakersfield changed its method of accounting for inventory from the first-in-first-out method to the average cost method. Inventory in 2014 was correctly recorded using the average cost method. The new inventory method would have resulted in an additional $125,000 of cost of goods sold (before taxes) being reported on prior years' income statement.	Change in inventory method: Current year reported correctly on income statement, need to adjust beginning R/E.	No Effect
6. Office equipment purchased January 1, 2014 for $60,000 was incorrectly charged to Supplies Expense at the time of purchase. The office equipment has an estimated three-year service life with no expected salvage value. Bakersfield uses the straight-line method to depreciate office equipment for financial reporting purposes. This error has not been recorded.	To correct, need to put back all $60,000 of equipment into Equipment account and take out of Supplies Expense account. Also take depreciation of $20,000 for the year. Net effect is to increase income by $40,000.	$40,000
7. On January 1, 2010, Bakersfield bought a building that cost $85,000, had an estimated useful life of ten years, and had a salvage value of $5,000. Bakersfield uses the straight-line depreciation method to depreciate the building. In 2014, it was estimated that the remaining useful life was eight years and the salvage value was zero. Depreciation expense reported on the 2014 income statement was correctly calculated based on the new estimates. No adjustment for prior years' depreciation estimates was made.	Current year is correct. Change in estimate does not need retroactive action.	No Effect
b)
Bakersfield Incorporated
Partial Income Statement
For the Year Ending December 31, 2014
Income from continuing operations before income taxes	$                                                   1,400,000
Less: Income tax expense ($1,400,000 × 40%)	$                                                    (560,000)
Income from continuing operations	$                                                      840,000
Discontinued operations
Add: Income from discontinued operations, net of tax ($110,000 × .6)	$                                                        66,000
Less: Loss on disposal of discontinued operations, net of tax ($12,000 × .6)	$                                                        (7,200)
Income before extraordinary item	$                                                      898,800
Less: Loss due to extraordinary item, net of tax ($70,000 × .6)	$                                                      (42,000)
Net income	$                                                      856,800
Bakersfield Incorporated
Retained Earnings Statement
For the Year Ending December 31, 2014
Beginning Retained earnings as of January 1, 2014	200,000
Adjustment for change in inventory method ($125,000 × .6)	-75000
Beginning Retained earnings adjusted	125,000
Add: Net Income	856,800
Less: Dividends	-10000
Ending Retained earnings	971,800