Question

Described below are six independent and unrelated situations involving accounting changes. Each change occurs during 2018 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years. Any tax effects should be adjusted through the deferred tax liability account. Fleming Home Products introduced a new line of commercial awnings in 2017 that carry a one-year warranty against manufacturer’s defects. Based on industry experience, warranty costs were expected to approximate 4% of sales. Sales of the awnings in 2017 were $2,800,000. Accordingly, warranty expense and a warranty liability of $112,000 were recorded in 2017. In late 2018, the company’s claims experience was evaluated and it was determined that claims were far fewer than expected: 3% of sales rather than 4%. Sales of the awnings in 2018 were $3,300,000, and warranty expenditures in 2018 totaled $75,075. On December 30, 2014, Rival Industries acquired its office building at a cost of $860,000. It was depreciated on a straight-line basis assuming a useful life of 40 years and no salvage value. However, plans were finalized in 2018 to relocate the company headquarters at the end of 2022. The vacated office building will have a salvage value at that time of $630,000. Hobbs-Barto Merchandising, Inc., changed inventory cost methods to LIFO from FIFO at the end of 2018 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2018, is $620,000. At the beginning of 2015, the Hoffman Group purchased office equipment at a cost of $253,000. Its useful life was estimated to be 10 years with no salvage value. The equipment was depreciated by the sum-of-the-years’-digits method. On January 1, 2018, the company changed to the straight-line method. In November 2016, the State of Minnesota filed suit against Huggins Manufacturing Company, seeking penalties for violations of clean air laws. When the financial statements were issued in 2017, Huggins had not reached a settlement with state authorities, but legal counsel advised Huggins that it was probable the company would have to pay $130,000 in penalties. Accordingly, the following entry was recorded: Loss—litigation 130,000 Liability—litigation 130,000 Late in 2018, a settlement was reached with state authorities to pay a total of $273,000 in penalties. At the beginning of 2018, Jantzen Specialties, which uses the sum-of-the-years’-digits method, changed to the straight-line method for newly acquired buildings and equipment. The change increased current year net earnings by $368,000. Required: For each situation: 1. Identify the type of change. 2. Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2018 related to the situation described.

Answer 1

a. 1. This is a change in accounting estimate. Therefore no retrospective restatement is required. No journal entry for the change.

2. Adjusting entry for 2018:

Date	General Journal	Debit	Credit
		$	$
December 31, 2018	Warranty Expense ( $ 3,300,000 x 3 % )	99,000
	Estimated Warranty Liability		99,000

b. 1. This is a change in accounting estimate. No journal entry is required for restatement.

2. Adjusting entry for 2018:

Date	General Journal	Debit	Credit
		$	$
December 31, 2018	Depreciation Expense	33,100
	Accumulated Depreciation		33,100

Accumulated depreciation of building as of January 1, 2018 = $ 860,000 / 40 * 3 = $ 64,500.

Book value as of January 1, 2018 = $ 860,000 - $ 64,500 = $ 795,500

Prospective annual depreciation charge = ($ 795,500 - $ 630,000) / 5 = $ 33,100

d. 1. This is a change in accounting estimate, and no journal entry required as a result of change.

2. Adjusting entry for 2018:

Date	General Journal	Debit	Credit
		$	$
December 31, 2018	Depreciation Expense	18,400
	Accumulated Depreciation		18,400

Total depreciation provided over three years = ( 10 + 9 + 8 ) / 55 * $ 253,000 = $ 124,200

Book value as of January 1, 2018 = $ 253,000 - $ 124,200 = $ 128,800

For the remaining 7 years, annual depreciation using straight-line method = $ 128,800 / 7 = $ 18,400.