Question

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.

1. A five-year casualty insurance policy was purchased at the beginning of 2016 for $35,500. The full amount was debited to insurance expense at the time.
2. Effective January 1, 2018, the company changed the salvage value used in calculating depreciation for its office building. The building cost $614,000 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 $110,000. Declining real estate values in the area indicate that the salvage value will be no more than $27,500.
3. On December 31, 2017, merchandise inventory was overstated by $25,500 due to a mistake in the physical inventory count using the periodic inventory system.
4. 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 $965,000 increase in the beginning inventory at January 1, 2019.
5. At the end of 2017, the company failed to accrue $15,600 of sales commissions earned by employees during 2017. The expense was recorded when the commissions were paid in early 2018.
6. At the beginning of 2016, the company purchased a machine at a cost of $730,000. Its useful life was estimated to be 10 years with no salvage value. The machine has been depreciated by the double-declining balance method. Its book value on December 31, 2017, was $467,200. On January 1, 2018, the company changed to the straight-line method.
7. Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.80% is a better indication of the actual cost. Management effects the change in 2018. Credit sales for 2018 are $4,100,000; in 2017 they were $3,800,000.

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. (Ignore tax effects.)

Answer 1

Requirement 1.

S.no.	Event	Type of change
a.	Accounting error	NA
b	Accounting change	Change in estimate
c	Accounting error	NA
d.	Accounting change	Change in accounting principle
e.	Accounting error	NA
f.	Accounting change	Change in estimate resulting from change in accounting principle
g.	Accounting change	Change in estimate

Requirement 2

a

The amount that should be charged to expense every year is $7,000 ($35,000 ÷ 5)

2016 : expense outstanding = 35500-7100 = 28400

2017: expense outstanding = 28400-7100 =21300

2018: Correcting entry shall be:

Prepaid insurance (7000*3)……Dr              21300

               Retained earnings                                            21300

Adjusting entry would be:

Insurance expense….Dr                                 7100

                Prepaid insurance                                            7100

b.

Annual depreciation before the change = ($614,000 - $110,000) ÷ 40 = $12600

2018 Book value = $614,000 – [(10 x $12,600)] = $488,000

New residual value = $275,00 Remaining life = 30 years (40 – 10)

New depreciation = ($488,000 - $27,500) ÷ 30 = $15350

The requisite journal entry would be

Depreciation expense    15,350

Accumulated depreciation          15,350

c.

The inventory has been overstated in 2017. Hence, the entry in 2018 would be

Retained Earnings....Dr 25500

Inventory 25500

d.

As a result of change, inventory has been understated in 2018.

Inventory...... Dr 965000

Retained earnings 965000

e.

Retained Earnings........Dr 15600

Sales commission expenses 15600

f.

2018 Book value = $467200

Residual value = $0

Remaining life = 8 years (10 – 2)

New depreciation = $467,200 ÷ 8 = $58400

Depreciation expense.....Dr 58400

Accumulated depreciation          58400

g.

2018 Warranty expense = 0.8% x $4,100,000 = $32,800

warranty expense.....Dr 32800

warranty payable 32800

KINDLY UPVOTE