Question

Neilson Tool Corporation's December 31 year-end financial statements contained the following errors:

.........................................December 31, 2016 ...............December 31, 2017

Ending Inventory ..........$9,600 overstated ..................$8,100 understated

Depreciation Expense ..$2,300 overstated ............................-

An insurance premium of $66,000 covering the years 2016, 2017, and 2018 was prepaid in 2016, with the entire amount charged to expense that year. In addition, on December 31, 2017, fully depreciated machinery was sold for $15,000 cash, but the entry was not recorded until 2018. There were no other errors during 2016 or 2017, and no corrections have been made for any of the errors. Neilson follows ASPE.
Instructions
Answer the following, ignoring income tax considerations.

(a) Calculate the total effect of the errors on 2017 net income.

(b) Calculate the total effect of the errors on the amount of Neilson's working capital at December 31, 2017.

(c) Calculate the total effect of the errors on the balance of Neilson's retained earnings at December 31, 2017.

(d) Assume that the company has retained earnings on January 1, 2016 and 2017 of $1,250,000 and $1,607,000, respectively; net income for 2016 and 2017 of $422,000 and $375,000, respectively; and cash dividends declared for 2016 and 2017 of $65,000 and $45,000, respectively, before adjustment for the above items. Prepare a revised statement of retained earnings for 2016 and 2017.

(e) Outline the accounting treatment required by ASPE in this situation and explain how these requirements help investors.

Answer 1

(a)           Effect of errors on 2017 net income: 

           $10,700 understatement

  Calculations – Effect on 2017 net income:

		Over (under) statement
Overstatement of 2016 ending inventory(and 2017 beginning inventory) Understatement of 2017 ending inventory Expensing of insurance premium in 2016   ($66,000 ÷ 3) Failure to record gain on disposal of fully depreciated machine in 2017 Total effect of errors on net income   (understated)		$ (9,600))                        (8,100) 22,000                        (15,000)                              $(10,700))

(b)      Effect of errors on working capital: $45,100 understatement

  Calculations – Effect on working capital:

		Over (under) statement
Understatement of 2017 ending inventory Expensing of insurance premium in 2016   (prepaid insurance) Cash from sale of fully depreciated machine unrecorded Total effect on working capital (understated)		$( (8,100))  (22,000)  (15,000) $(45,100)

(c)      Effect of errors on retained earnings: 

          $47,400 understatement

  Calculations – Effect on retained earnings:

		Over (under) statement
Understatement of 2017 ending inventory Overstatement of depreciation expense in   2016 Expensing of insurance premium applicable   to 2018 in 2016 Failure to record sale of fully depreciated   machine in 2017 Total effect on retained earnings (understated)		$( (8,100))  (  (2,300))   (22,000)  (15,000) $(47,400)

(d)

NEILSON TOOL CORPORATION

Statement of Retained Earnings

For the Years 2017 and 2016

		2017		2016 (restated)
Retained earnings, January 1,           as previously reported Less: Effect of error in           inventory in previous year Add: Depreciation error in           previous year Add: Error in insurance Retained earnings, January 1,           as restated Net income Dividends Retained earnings, December 31		$1,607,000 (9,600) 2,300    44,000                       1,643,700 * 385,700   (45,000) $1,984,400		$1,250,000         _ 1,250,000 ** 458,700    (65,000) $1,643,700

*Net income for 2017 = $375,000 + $10,700 understatement.

**Net income for 2016 = $422,000 – $9,600 + $2,300 + $44,000

(e)             Correction of error: The financial statements must be restated for all prior periods. Opening retained earnings are adjusted.

           The required disclosure includes a description of the errors, the effect of the correction of the errors on the financial statements of the current and prior periods; and the fact that the financial statements of prior periods that are presented for comparative purposes are restated. More specifically, the amounts of the corrections to each line of the financial statements presented for comparative purposes, as well as the amounts of the corrections made at the beginning of the earliest prior period are presented.

            Retrospective restatement enhances the consistency and more specifically, the comparability of the financial statements.