In: Accounting
AACTG 4650
Assignment 3
Due February 21
A) Company A has the following income statement information for the years 2015-2017:
2015 Income 2016 Income 2017 Income
Statement as Statement as Statement
Reported Reported Totals
Construction Rev 10,000,000 12,500,000 17,000,000
Construction Costs 6,200,000 7,250,000 10,260,000
Gross Profit 3,800,000 5,250,000 6,740,000
Operating Expenses 2,100,000 2,835,000 3,219,000
Income from
Operations 1,700,000 2,415,000 3,521,000
Non-Operating Items (220,000) (171,000) (249,000)
Income from
Continuing Operations 1,480,000 2,244,000 3,272,000
Income Tax Expense 370,000 561,000 818,000
Net Income 1,110,000 1,683,000 2,454,000
During 2017, Company A changed its method of accounting for long-term contracts from completed contract to percentage of completion. This change brought Hogan’s accounting into line with other companies in the industry and was made due to improvements in Hogan’s abilities to project future costs. Company A will continue to use completed contract for tax purposes. Construction revenues and costs for 2015 and 2016 under percentage of completion would have been:
2015 2016
Construction Revenues 13,000,000 14,300,000
Construction Costs 7,650,000 8,715,000
For years prior to 2015, the change would have increased income from continuing operations by a total of $3,200,000. Company A is a calendar year company. Assume a tax rate of 25% for all years.
Required: Prepare in good form the 2017 Income Statement showing 2015 and 2016 Income Statements for comparative purposes. Additionally, prepare the retained earnings portion of the Statement of Stockholder’s equity for these comparative statements. (The retained earnings balance on January 1, 2015 was $3,654,000) Assume Company A declared and paid $100,000 of cash dividends each year 2015-2017.
B) Francis, Inc. is in the process of preparing their 2017 financial statements. During 2017, the following items occurred:
The company changed its method of depreciating its plant assets from double-declining balance to straight-line. This change brings Francis into line with most companies in the industry.
The company discovered an error in the 2014 ending inventory balance. The error resulted in 2014 ending inventory being understated.
The company sold a significant portion of their investment in Stout Corp. during 2017. Prior to this sale and for the previous 5 years, Francis owned 80% of the voting stock of Stout. After the sale, Francis owns 35% of the voting stock of Stout.
During 2017, the company changed its inventory method from weighted-average to FIFO. FIFO is consistent with the actual flow of goods and also with other companies in the industry.
Required: Prepare a report for the company controller explaining how each of these items should be accounted for on the 2017 books and how they will affect the 2017 financial statements and any prior statements shown for comparative purposes. The company generally reports the current year and two prior years in their annual financial statements.
Company A | |||||||
2015 | 2015 (Revised) | Effect of changes in methods | 2016 | 2016 (Revised) | Effect of changes in methods | 2017 | |
Construction revenue | 10000000 | 13000000 | 3000000 | 12500000 | 14300000 | 1800000 | 17000000 |
Construction costs | 6200000 | 7650000 | 1450000 | 7250000 | 8715000 | 1465000 | 10260000 |
Gross profit | 3800000 | 5350000 | 1550000 | 5250000 | 5585000 | 335000 | 6740000 |
Operating expense | 2100000 | 2100000 | 0 | 2835000 | 2835000 | 0 | 3219000 |
Income from operations | 1700000 | 3250000 | 1550000 | 2415000 | 2750000 | 335000 | 3521000 |
Non-operating items | 220000 | 220000 | 0 | 171000 | 171000 | 0 | 249000 |
Income from continuing operations | 1480000 | 3030000 | 1550000 | 2244000 | 2579000 | 335000 | 3272000 |
Income tax expense | 370000 | 757500 | 387500 | 561000 | 644750 | 83750 | 818000 |
Net income | 1110000 | 2272500 | 1162500 | 1683000 | 1934250 | 251250 | 2454000 |
If the company made a change in charging depreciation from double declining to straight line method, this is a change in accounting principle. It requires retrospective effects. This approach requires the reporting of the cumulative effect of the impact on the carrying amounts of assets and liabilities as if the new method had been used all along with an offsetting adjustment to the opening balance of retained earnings as of the beginning balance of the first period presented.
The company discovers an error in inventory balance which resulted an understatement. Understatement in the closing inventory means opening inventory in the next year is also understated. Current year profit is also understated. And next year’s profit is overstated. At the end of two years, the adjustment in retained earnings or the profit gets adjusted automatically with similar effect in the inventory balance.
Changes in reporting entities also require retrospective application. Prior period financial statements are reflected to show the financial information for the new reporting entity as if the entity had existed in that form all along. Cumulative earnings differences are reported through beginning retained earnings as of the beginnings of the first period presented.