Question

Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was started in 2006 by two talented engineers with little business training. In 2018, the company was acquired by one of its major customers. As part of an internal audit, the following facts were discovered. The audit occurred during 2018 before any adjusting entries or closing entries were prepared. The income tax rate is 40% for all years.

A five-year casualty insurance policy was purchased at the beginning of 2016 for $37,500. The full amount was debited to insurance expense at the time.

Effective January 1, 2018, the company changed the salvage values used in calculating depreciation for its office building. The building cost $640,000 on December 29, 2007, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $120,000. Declining real estate values in the area indicate that the salvage value will be no more than $30,000.

On December 31, 2017, merchandise inventory was overstated by $27,500 due to a mistake in the physical inventory count using the periodic inventory system.

The company changed inventory cost methods to FIFO from LIFO at the end of 2018 for both financial statement and income tax purposes. The change will cause a $985,000 increase in the beginning inventory at January 1, 2019.

At the end of 2017, the company failed to accrue $16,000 of sales commissions earned by employees during 2017. The expense was recorded when the commissions were paid in early 2018.

At the beginning of 2016, the company purchased a machine at a cost of $770,000. Its useful life was estimated to be ten years with no salvage value. The machine has been depreciated by the double-declining balance method. Its book value on December 31, 2017, was $492,800. On January 1, 2018, the company changed to the straight-line method.

Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.70% is a better indication of the actual cost. Management effects the change in 2018. Credit sales for 2018 are $4,500,000; in 2017 they were $4,200,000.

Required:
For each situation:
1. Identify whether it represents an accounting change or an error. If an accounting change, identify the type of change. For accounting errors, choose "Not applicable".
2. Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2018 related to the situation described. Any tax effects should be adjusted for through Income tax payable or Refund income tax.

Answer 1

2.)

Salvage Value changed w.e.f. 1^st Jan,2018

Just a Accounting Change of Estimate.

Purchased at the end of 2007, so, till end of 2017, 10 years has elapsed, with estimated salvage value of $120,000 and SLM Depreciation.

i.e Depreciable value = 640,000 - 120,000 = 520,000

Life = 40 years and elapsed 10 years so, 25% has been depreciated

WDV by 1-Jan-2018 = 640,000 - 25%(520,000) = $510,000

New Salvage Value = $30,000

New Depreciable Value = $480,000

Life Remaining = 30 years

Annual Depreciation = $16,000

No Journal Entry Change Required. Just the Amount is changed from $13,000 to $16,000

3.)

4.)

5.)

6.)

Depreciation Method changed w.e.f. 1^st Jan,2018

Just a Accounting Change of Estimate.

Purchased at the start of 2016,

WDV by 31-Dec-2017 = $492,800

Life Remaining = 8 years

Annual Depreciation = $61,600

No Journal Entry Change Required. Just the Amount is changed.

7.)