Question

Whaley Distributors is a wholesale distributor of electronic components. Financial statements for the years ended December 31, 2019 and 2020, reported the following amounts and subtotals ($ in millions): 

 

In 2021, the following situations occurred or came to light: 

a. Internal auditors discovered that ending inventories reported on the financial statements the two previous years were misstated due to faulty internal controls. The errors were in the following amounts: 

2019 inventory................Overstated by $12 million 

2020 inventory...............Understated by $10 million 

b. A liability was accrued in 2019 for a probable payment of $7 million in connection with a lawsuit ultimately settled in December 2021 for $4 million. 

c. A patent costing $18 million at the beginning of 2019, expected to benefit operations for a total of six years, has not been amortized since acquired. 

d. Whaley’s conveyer equipment was depreciated by the sum-of-the-years’-digits (SYD) basis since it was acquired at the beginning of 2019 at a cost of $30 million. It has an expected useful life of five years and no expected residual value. At the beginning of 2021, Whaley decided to switch to straight-line depreciation. 

 

Required: 

For each situation 

1. Prepare any journal entry necessary as a direct result of the change or error correction, as well as any adjusting entry for 2021 related to the situation described. (Ignore tax effects.) 

2. Determine the amounts to be reported for each of the five items shown above from the 2019 and 2020 financial statements when those amounts are reported again in the 2019–2021 comparative financial statements.

Answer 1

1)	Figures in $ millions.
a)	Inventory (understated of 2021 opening inventory)	$10
	Retained Earnings (understated of 2020 income)	$10
	2019 error requires nothing adjustment as it will be self corrected in 2021.
b)	Liability -litigation (estimated originally)	$7
	Gain Litigation ($7-$4)	$3
	Cash (actual settlement)	$4
c)	Retained earnings (2019-2020 patent amortization)	$6
	Patent ($18/6 years*2)	$6
	2021 Adjusting entry
	Patent -amortization expenses ($18/6 yrs)	$3
	Patent	$3
d)	No entry required for change.
	2021 Adjusting entry
	Depreciation expenses (calculated below*)	$4
	Accumulated Depreciation	$4
	Annual depreciation *
	Cost	$30
	Previous depreciation (as calculated below**)	($18)
	Undepreciated cost	$12
	Estimated residual value	$0
	To be depreciated	$12
	Estimated remaining life	3 years
	Annual depreciation new ($12/3)	$4
	**SYD
	Depreciation -2019 ($30*5/15)	$10
	Depreciation -2020 ($30*4/15)	$8
	Accumulated depreciation	$18

 

2)

	Asset	Liability	Shareholders\' Equity	Net Income	Expenses
2019	$740	$330	$410	$210	$150
2019 Inventory	($12)		($12)	($12)	$12
Loss Contingency	No adjustment in prior years
Patent Amortization	($3)		($3)	($3)	$3
Depreciation	No adjustment in prior years
	$725	$330	$395	$195	$165
2020	$820	$400	$420	$230	$175
2019 Inventory				$12	($12)
2020 Inventory	$10		$10	$10	($10)
Loss Contingency	No adjustment in prior years
Patent Amortization	($6)		($6)	($3)	$3
Depreciation	No adjustment in prior years
	$824	$400	$424	$249	$156