Question

Described below are six independent and unrelated situations involving accounting changes. Each change occurs during 2018 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years. Any tax effects should be adjusted through the deferred tax liability account.

A) Fleming Home Products introduced a new line of commercial awnings in 2017 that carry a one-year warranty against manufacturer’s defects. Based on industry experience, warranty costs were expected to approximate 4% of sales. Sales of the awnings in 2017 were $4,000,000. Accordingly, warranty expense and a warranty liability of $160,000 were recorded in 2017. In late 2018, the company’s claims experience was evaluated and it was determined that claims were far fewer than expected: 3% of sales rather than 4%. Sales of the awnings in 2018 were $4,500,000, and warranty expenditures in 2018 totaled $102,375.

B) On December 30, 2014, Rival Industries acquired its office building at a cost of $1,100,000. It was depreciated on a straight-line basis assuming a useful life of 40 years and no salvage value. However, plans were finalized in 2018 to relocate the company headquarters at the end of 2022. The vacated office building will have a salvage value at that time of $750,000.

C) Hobbs-Barto Merchandising, Inc., changed inventory cost methods to LIFO from FIFO at the end of 2018 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2018, is $740,000.

D)At the beginning of 2015, the Hoffman Group purchased office equipment at a cost of $385,000. Its useful life was estimated to be 10 years with no salvage value. The equipment was depreciated by the sum-of-the-years’-digits method. On January 1, 2018, the company changed to the straight-line method.

E) In November 2016, the State of Minnesota filed suit against Huggins Manufacturing Company, seeking penalties for violations of clean air laws. When the financial statements were issued in 2017, Huggins had not reached a settlement with state authorities, but legal counsel advised Huggins that it was probable the company would have to pay $250,000 in penalties. Accordingly, the following entry was recorded:

Loss—litigation 250,000 Liability—litigation 250,000 Late in 2018, a settlement was reached with state authorities to pay a total of $405,000 in penalties.

Loss-Litigation	250,000
Liability-Litigation		250,000

F) At the beginning of 2018, Jantzen Specialties, which uses the sum-of-the-years’-digits method, changed to the straight-line method for newly acquired buildings and equipment. The change increased current year net earnings by $500,000.

Required: For each situation:

1. Identify the type of change.

2. Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2018 related to the situation described.

Answer 1

Part A

It is a change in estimate.

Entry would be to record warranty liability.

Warranty Expenses (4500000x3%) $ 135,000

Estimated Warranty Liability $ 135,000

Part B

It is change in estimate of salvage value. Entry to record new depreciation expenses would be

Depreciation Expenses A.c $ 53500

Acc. Depreciation Expenses A/c $ 53500

(to record depreciation expenses)

Cost	$ 1100000
Less: Acc Dep	$ 82500
Book Value	$ 1017500
Less: Salvage Value	$ 750000
Book Value	$ 267500
New Dep Expenses	$ 53500

3. A change in accounting principle from LIFO to FIFO

No entry would be required

4. Change in depreciation method is change in accounting estimate. Entry for new depreciatio would be

Depreciation Expenses A.c $ 28000

Acc. Depreciation Expenses A/c $ 28000

(to record depreciation expenses)

Cost	$ 385000
Less: Acc Dep	$ 189000
Book Value	$ 196000
Less: Salvage Value	0
Book Value	$ 196000
New Dep Expenses	$ 28000

e. It is a change in accounting estimate and following entry must be passed to record loss-liability on the basis of new estimate.

Loss Litigation A.c Debit $ 155000

Liability Litigation A.c Credit $ 155000

(405000-250000 = $ 155000)

f. It is a change in accounting principle and is accounted prospectively as the asset is put to use after the date of change.

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