Question

You are an internal auditor for Shannon Supplies, Inc., and are reviewing the company’s preliminary financial statements. The statements, prepared after making the adjusting entries, but before closing entries for the year ended December 31, 2021, are as follows:

SHANNON SUPPLIES, INC. Balance Sheet December 31, 2021 ($ in thousands)

Assets

Cash $ 2,350

Investment in equity securities 225

Accounts receivable, net 760

Inventory 1,010

Equipment 1,190

Less: Accumulated depreciation (610 )

Total assets $ 4,925

Liabilities and Shareholders’ Equity

Accounts payable and accrued expenses $ 3,270

Income tax payable 170

Common stock, $1 par 150

Additional paid-in capital 700

Retained earnings 635

Total liabilities and shareholders’ equity $ 4,925

SHANNON SUPPLIES, INC. Income Statement For the Year Ended December 31, 2021 ($ in thousands)

Sales revenue $ 3,850

Operating expenses:

Cost of goods sold $ 1,090

Selling and administrative 891

Depreciation 89 2,070

Income before income tax $ 1,780

Income tax expense (445 )

Net income $ 1,335

Shannon’s income tax rate was 25% in 2021 and previous years. During the course of the audit, the following additional information (not considered when the above statements were prepared) was obtained:

a. Shannon’s investment portfolio consists of blue chip stocks held for long-term appreciation. To raise working capital, some of the shares with an original cost of $175,000 were sold in May 2021. Shannon accountants debited cash and credited investment in equity securities for the $210,000 proceeds of the sale.

b. At December 31, 2021, the fair value of the remaining equity securities in the investment portfolio was $246,500.

c. The state of Alabama filed suit against Shannon in October 2019, seeking civil penalties and injunctive relief for violations of environmental regulations regulating emissions. Shannon’s legal counsel previously believed that an unfavorable outcome of this litigation was not probable, but based on negotiations with state attorneys in 2021, now believes eventual payment to the state of $125,000 is probable, most likely to be paid in 2024.

d. The $1,010,000 inventory total, which was based on a physical count at December 31, 2021, was priced at cost. Based on your conversations with company accountants, you determined that the inventory cost was overstated by $127,000.

e. Electronic counters costing $110,000 were added to the equipment on December 29, 2020. The cost was charged to repairs.

f. Shannon’s equipment, on which the counters were installed, had a remaining useful life of four years on December 29, 2020, and is being depreciated by the straight-line method for both financial and tax reporting.

g. A new tax law was enacted in 2021 which will cause Shannon’s income tax rate to change from 25% to 20% beginning in 2022.

Required: Prepare journal entries to record the effects on Shannon’s accounting records at December 31, 2021, for each of the items described above. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Do not round intermediate calculations. Enter your answers in whole dollars not in thousands of dollars.)

• a1

  Record the gain on sale of investment with an original cost of $175,000 for $210,000.

• a2

  Record the adjustment of equity securities for the investment of $210,000 as on the date of sale.

• b

  Record the fair value adjustment.

• c

  Record the loss-lawsuit.

• d

  Record correction of inventory error.

• e

  Record correct assets that were incorrectly expensed.

• f

  Record the 2021 adjusting entry for depreciation.

• g

  Record the income tax expense.

Answer 1

Prepare journal entries to record the effects as follows:

		($ in thousands)
Trn.	General journal	Debit	Credit
a)	Investments [$210,000 - $175,000]	$35
	Gain on sale of investment		$35
	(To record the gain on sale of investment)
b)	Investments [$246,500 - ($225,000 - $175,000)]	$196.5
	Unrealized Gain on Investment		$196.5
	[Unrealized gain = Fair value of remaining securities - Book value of remaining securities]
c)	No entry journalized because payment to be made in 2019	-	-
d)	Retained Earnings	$127
	Inventory		$127
	(To record correction of inventory error)
e)	Equipment	$110
	Repairs		$110
	(To record corect asset that were incorrectly expensed)
f)	Depreciation expense [$110,000/4 years]	$27.50
	Accumulated depreciation		$27.50
	(To record the 2021 adjusting entry for deprciation)
g)	No entry journalized