Question

In: Accounting

Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was started in 2006 by two...

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 adjusting entries or closing entries were prepared. The income tax rate is 40% for all years.

A five-year casualty insurance policy was purchased at the beginning of 2016 for $33,000. The full amount was debited to insurance expense at the time.

Effective January 1, 2018, the company changed the salvage values used in calculating depreciation for its office building. The building cost $604,000 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 $120,000. Declining real estate values in the area indicate that the salvage value will be no more than $30,000.

On December 31, 2017, merchandise inventory was overstated by $23,000 due to a mistake in the physical inventory count using the periodic inventory system.

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 $940,000 increase in the beginning inventory at January 1, 2019.

At the end of 2017, the company failed to accrue $15,100 of sales commissions earned by employees during 2017. The expense was recorded when the commissions were paid in early 2018.

At the beginning of 2016, the company purchased a machine at a cost of $680,000. Its useful life was estimated to be ten years with no salvage value. The machine has been depreciated by the double-declining balance method. Its book value on December 31, 2017, was $435,200. On January 1, 2018, the company changed to the straight-line method.

Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.70% is a better indication of the actual cost. Management effects the change in 2018. Credit sales for 2018 are $3,600,000; in 2017 they were $3,300,000.


Required:
For each situation:
1. Identify whether it represents an accounting change or an error. If an accounting change, identify the type of change. For accounting errors, choose "Not applicable".
2. Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2018 related to the situation described. Any tax effects should be adjusted for through Income tax payable or Refund income tax.

Solutions

Expert Solution

Event Type of change
a. An error NA
b. An accounting change Change in estimate
c. An error NA
d. An accounting change Change in accounting principle
e. An error NA
f. An accounting change Change in estimate resulting from a change in accounting principle
g. An accounting change Change in estimate
Transaction General Journal Debit Credit
a(1) Prepaid insurance ($33,000 ÷ 5 yrs x 3 yrs: 2016-2018) $        19,800
Income tax payable ($19,800 x 40%) $          7,920
Retained earnings $        11,880
a(2) Insurance expense ($33,000 ÷ 5 yrs) $          6,600
Prepaid insurance $          6,600
b(1) No journal entry required
b(2) Depreciation expense* $        15,100
Accumulated depreciation $        15,100
c(1) Retained earnings $        13,800
Refund—Income tax (23000 x 40%) $          9,200
Inventory $        23,000
c(2) No journal entry required
d(1) Inventory $     940,000
Income tax payable(940000 x 40%) $     376,000
Retained earnings $     564,000
d(2) No journal entry required
e(1) Retained earnings $          9,060
Refund—Income tax (15100 x 40%) $          6,040
Compensation expense $        15,100
e(2) No journal entry required
f(1) No journal entry required
f(2) Depreciation expense** $        54,400
Accumulated depreciation $        54,400
g(1) No journal entry required
g(2) Warranty expense (3600000 x 0.70%) $        25,200
Warranty liability $        25,200
*Calculation of annual depreciation after the change:
$604,000 Cost
$12,100 Old depreciation ([$604,000 – $120,000] ÷ 40 years)
x 10 yrs -121,000 Depreciation to date (2008-2017)
$483,000 Undepreciated cost
-30,000 New estimated salvage value
$453,000 To be depreciated
      ÷   30 Estimated remaining life (40 years – 10 years used)
$15,100 New annual depreciation
** Undepreciated cost, Jan. 1, 2018 (given) $435,200
Estimated residual value 0
To be depreciated over remaining 8 years $435,200
8 years
Annual straight-line depreciation 2018-2025 $54,400

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