Question

O’Brien Company is in the process of closing its books at the end of 2020. The company's preliminary income statement for 2020 and its reported income statement for 2019 are given below.

			2020		2019
Sales Revenues			675,000		660,000
Cost of Goods Sold			(427,500)		(428,750)
Gross Profit			247,500		231,250
Depreciation			(56,250)		(53,750)
Other Expenses			(81,020)		(76,520)
Net Income			110,230		100,980

                

       

O’Brien's records reveal the following information:

1. In examining the preliminary financial statements, O’Brien realized that it failed to accrue sales commissions at the end of each of the last two years. O’Brien should have accrued $3,500 at the end of 2019 and $2,500 at the end of 2020.

2. O’Brien purchased equipment on January 2, 2017, that cost $70,000 and had a useful life of 10 years and zero salvage value. The straight-line method of depreciation was originally chosen. However, in reviewing the preliminary financial statements, O’Brien decided to change the depreciation method from straight-line to sum-of-the-years'-digits; the estimates relating to useful life and salvage value remained unchanged.

3. At the end of 2020, O’Brien decided to change its inventory costing method from FIFO cost to the Average method. An analysis of the accounting records provides the following cost of goods sold amounts under average cost and FIFO:

                                    Year                     FIFO             Average

                                    2018                 426,500            428,000

                                    2019                 428,750            430,000

                                    2020                 427,500            432,000

O’Brien purchased equipment on July 2, 2016. The asset's original cost was $30,000, and this amount was entirely expensed in 2016. This particular asset has a 10-year useful life and a $5,000 residual value. The straight-line method was chosen for depreciation purposes.

Required:

1. Prepare the necessary journal entries at December 31, 2020, to record the above information.

2. Prepare new comparative income statements to reflect the adjustments required (1) through (4) above. You may ignore income taxes.

3. Retained earnings reported for the end of 2019 was $696,380 and at the end of 2018 was $625,400. Dividends of $30,000 were declared in each year. Prepare comparative statements of retained earnings for O’Brien Company for 2020 and 2019, reflecting appropriate adjustments from items (1)-(4) above, ignoring income taxes.

Answer 1

a) Journal Entries: -

1.1) Retained Earnings A/c ___________ Dr $3,500

To Sales Commission Payable A/c $3,500

(Being sales commission of FY 2019 recorded which was failed to accrue)

1.2) Sales Commission A/c ___________ Dr $2,500

To Sales Commission Payable A/c $2,500

(Being sales commission of FY 2020 accrued)

2.1) Retained Earnings A/c ____________ Dr $5,727

To Equipment A/c $5,727

(Being shortfall of depreciation owing to change in method of depreciation from Straight Line Method to Sum of Years' Digits Method for the year 2017 has been charged) [Note 1]

2.2) Retained Earnings A/c ____________ Dr $4,455

To Equipment A/c $4,455

(Being shortfall of depreciation owing to change in method of depreciation from Straight Line Method to Sum of Years' Digits Method for the year 2018 has been charged) [Note 1]

2.3) Retained Earnings A/c ____________ Dr $3,182

To Equipment A/c $3,182

(Being shortfall of depreciation owing to change in method of depreciation from Straight Line Method to Sum of Years' Digits Method for the year 2019 has been charged) [Note 1]

2.4) Depreciation A/c ____________ Dr $1,909

To Equipment A/c $1,909

(Being shortfall of depreciation owing to change in method of depreciation from Straight Line Method to Sum of Years' Digits Method for the year 2020 has been charged) [Note 1]

3.1) Retained Earnings A/c ___________ Dr $250

To Change in Inventory A/c (under Cost of Goods Sold) $ 250

(Being overvaluation of stock in the year 2019 owing to change in method of valuation of inventory has been recorded) [Note 2]

3.2) Change in Inventory A/c (under Cost of Goods Sold) A/c ___________ Dr $3,250

To Profit & Loss (Income) A/c $3,250

(Being undervaluation of stock in the year 2020 owing to change in method of valuation of inventory has been recorded) [Note 2]

4.1) Equipment A/c ___________ Dr $30,000

To Retained Earnings $30,000

(Being Equipment which should have been capitalized but expensed out in the year 2016 now capitalized)

4.2) Retained Earnings ____________ Dr $2,500

To Equipment A/c $2,500

(Being depreciation on Equipment which expensed out in the year 2016 recorded)

4.3) Retained Earnings ____________ Dr $2,500

To Equipment A/c $2,500

(Being depreciation on Equipment which expensed out in the year 2017 recorded)

4.4) Retained Earnings ____________ Dr $2,500

To Equipment A/c $2,500

(Being depreciation on Equipment which expensed out in the year 2018 recorded)

4.5) Retained Earnings ____________ Dr $2,500

To Equipment A/c $2,500

(Being depreciation on Equipment which expensed out in the year 2019 recorded)

4.6) Depreciation A/c ____________ Dr $2,500

To Equipment A/c $2,500

(Being depreciation on Equipment which expensed out in the year 2020 recorded)

b) Revised Comparative Income Statements: -

Particulars	2020	2019
Sales	6,75,000	6,60,000
Cost of Goods Sold	4,28,750	4,30,000
Depreciation	60,659	53,750
Other Expenses	83,520	76,520
Net Income	1,02,071	99,730

Note1: - Depreciation as per the Sum of Years' Digits Method: -

Year	Remaining Life	Base Amount	Depreciation as per Sum of Years' Digit	Depreciation as per Straight Line	Short Depreciation Charged
2017	10	70,000	12,727	7,000	5,727
2018	9	70,000	11,455	7,000	4,455
2019	8	70,000	10,182	7,000	3,182
2020	7	70,000	8,909	7,000	1,909

Note 2 : - Impact of Stock Valuation Method Change: -

	Opening Stock	Closing Stock	(Decrease)/Increase in Income (Opening stock)	(Decrease)/Increase in Income (Closing stock)	(Decrease)/Increase in Income (Net)
Year	Org	Rev	Org	Rev
2018			4,26,500	4,28,000
2019	4,26,500	4,28,000	4,28,750	4,30,000	-1,500	1,250	-250
2020	4,28,750	4,30,000	4,27,500	4,32,000	-1,250	4,500	3,250