Question

Described below are six independent and unrelated situations involving accounting changes. Each change occurs during 2021 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 25% 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 2020 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 2020 were $2,500,000. Accordingly, warranty expense and a warranty liability of $100,000 were recorded in 2020. In late 2021, 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 2021 were $3,000,000, and warranty expenditures in 2021 totaled $68,250.

b. On December 30, 2017, Rival Industries acquired its office building at a cost of $800,000. It was depreciated on a straight-line basis assuming a useful life of 40 years and no salvage value. However, plans were finalized in 2021 to relocate the company headquarters at the end of 2025. The vacated office building will have a salvage value at that time of $600,000.

c. Hobbs-Barto Merchandising, Inc., changed inventory cost methods to LIFO from FIFO at the end of 2021 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2021, is $590,000.

d. At the beginning of 2018, the Hoffman Group purchased office equipment at a cost of $220,000. 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, 2021, the company changed to the straight-line method.

e. In November 2019, 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 2020, Huggins had not reached a settlement with state authorities, but legal counsel advised Huggins that it was probable the company would have to pay $100,000 in penalties. Accordingly, the following entry was recorded:

Loss—litigation	100,000
Liability—litigation		100,000

Late in 2021, a settlement was reached with state authorities to pay a total of $240,000 in penalties.

f. At the beginning of 2021, 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 $335,000.

Required:
For each situation:
1. Identify the type of change, change in accounting estimates or change in accounting principle
2. Prepare any journal entry necessary as a direct result of the change or any adjusting entry for 2021 related to the situation described

Answer 1

Event An accounting change An accounting change An accounting change Type of change Change in estimate Change in estimate change in accounting principle that is normal reported prospectively Change in estimate resulting from a change in accounting principle Change in estimate Change in estimate resulting from a change in accounting principle An accounting change Change in estimate f. An accounting change Transaction Debit Credit at) General Journal No journal entry required (change in estimate is prospective) Warranty expense Warranty liability (3,000,000 x 3%) a(2) 90,000 90,000 b(1) No journal entry required (*No JE's are needed to correct any errors* (Prospective) b(2) 28,000 Depreciation expense Accumulated depreciation 28,000 800,000 Original depreciation factor (=800,000-0) 20,000 depreciation per year (800,000/40 years) 60,000 amount already depreciated (over 3 years) 740,000 Book value after 3 years (=800,000-60000) 140,000 New depreciation factor with new residual value (740000-600000) 28,000 New depreciation per year (140000/5 years remaining life) (1) No journal entry required 24,500 24,500 c(2) No journal entry required When switching to LIFO accounting records are usually not enough to report retrospectively. Therefore, the company needs to include footnotes on the financial statements explaining the need for the change in method and why the retrospective was not practical. LIFO base inventory would be beginning inventory in the year the company changed to LIFO method. (1) No journal entry required (2) 16,000 Depreciation expense Accumulated depreciation 16.000 Sum of digits method 220,000 Original depreciation factor (=220,000.-0) 108,000 amount already depreciated (over 3 years) 220000 x 27/55 112,000 Book value after 3 years (=220,000-108000) 16,000 New depreciation per year (112000/7 years remaining life) e(1) No journal entry required e(2) 140,000 140,000 Loss - Litigation Liability- Litigation (240,000-100,000) No journal entry required f(1) f(2) No journal entry required A disclosure note should also be written explaining any effects the change in estimate has on income for the current period