Question

Arivat Inc. is preparing to do an IPO. As a result it now prepares its annual financial statements in accordance with IFRS. The senior accountant identified several items that were either overlooked or booked incorrectly in the past. He asks you for help with the following:

Required: i. Prepare the journal entries in 2014 to correct the accounting records where necessary, assuming that the 2014 accounts have not been closed. [Note: this means that any error/omission that relates only to the 2014 fiscal year can be corrected in the 2014 accounts]

ii. Identify the type of change for each item Accounting issues

a. At the beginning of 2012, the company purchased a machine for $450,000 (residual value of $45,000) that had a useful life of 6 years. The bookkeeper used straight-line depreciation but failed to deduct the residual value in calculating the depreciation base for 2012, 2013, and 2014

b. The December 31, 2013 accrual for salaries was overstated by $36,000. [Assume the accrual was not reversed on January 1, 2014]

c. A tax lawsuit that involved the year 2012 was settled late in 2014. It was determined that the company owed an additional $73,000 in taxes related to 2012. The company did not record a liability in 2012 or 2013, because the possibility of losing was considered remote. The company charged the $73,000 to retained earnings in 2014 as a correction of a prior year’s error.

d. Arivat Inc. purchased another company early in 2010 and recorded goodwill of $450,000. They amortized $22,500 of goodwill in 2010 and $45,000 in each of 2011, 2012, 2013 and 2014. During this period there was no indication that goodwill had been impaired.

e. In 2014 the company changed its basis of inventory costing from FIFO to weighted average cost. The cumulative effect of the change was to decrease net income of prior years by $39,000. The company debited this cumulative effect to Retained Earnings. The weighted average cost was used in calculating income for 2014. [Notes: assume the change can be justified as resulting in more relevant financial information; ignore the effects of any correction on income tax]

f. During an inventory count in 2014 the company identified and wrote-off $87,000 that had been stolen in 2013. The loss was charged to the loss account in 2014.

Answer 1

a) The depreciation calculation should have been =( Asset cost- Residual values)/Life of asset

=(450000-45000)/6=67500

But it is understood that the depreciation calculation was made without taking into effect Residual value. So the depreciation was calculated as 450000/6=75000.So this resulted in Over charge of Depreciation for the years 2012,2013 and 2014 by 75000-67500=7500.Since the books has been closed for 2012 and 2013. So the effect of over charge of depreciation has to be given effect to Retained earnings. And since 2014 books have not been closed the effect of over charge of depreciation can be made in Income statement or Profit & Loss account of 2014.

So the rectification entry is

2014 Machine a/c Dr 22500

To Retained earnings a/c 15000

To Profit & Loss a/c 7500

(Being over charge of depreciation-Error pertaining to 2012, 2013 and 2014 now rectifed)

b) Generally if there is accrual of expenses then the entry created by the Accounting team will be

Expense a/c Dr -(Nominal account which will be transferred to P&L a/c)

To Expense payable a/c-(This account will be reflected in Balance sheet)

Whenever there is actual payment for the expense the Expense payable a/c is debited and Cash /Bank is credited.

So in the present situation already 2013 Books has been closed so the effect can be given to Retained earnings a/c.

2014 Salaries Payable a/c 36000

To Retained earnings a/c 36000

( Being rectification entry for overaccrual of salaries for Dec 2013 passed)

And when the actual correct amount is paid the remaining portion of Salaries payable a/c is closed.

C) Since the law suit was related to 2012 and the company did not make any provision for this and now in 2014 the case was ended against the company the Company has to make the payment good and charge it against Retained earnings since 2012 profits or loss effect would have been made to retained earnings-Prior period. So the effect given by the company is correct.

d) FASB Accounting Standards Update no 2014-02, Intangibles-Goodwill and Other (Topic no 350) Accounting for Goodwill allows the Private companies to to use straight line method of amortization for upto 10 years or less of the Company is able to demonstrate alternative useful life span. Private Companies only need to conduct impairment tests when a triggering event indicates the Company's fair value is less than its Carrying amount rather than having to do so every fiscal year because annual valuation of Goodwill is expensive and time consuming for private companies. As Per FASB statement 142 Goodwill is no longer permitted to amortized. Goodwill is carried as an asset and is subjected to impairment tests atleast once a year.

In the present case Arivat Inc. Is going for an IPO so the effect of Goodwill has to be changed inline with above as the Company is going to Public in which case the Company will no longer be allowed to amortize Goodwill rather it has to be carried as an asset and subject it to impairment tests atleast once a year.

e) Change of method of valuation in Inventory valuation-Under statement no 154 all voluntary changes in principle must be applied retrospectively to previous period Financial statements unless such application is impracticable or FASB mandates another approach. The cumulative effect of the change to decrease net income by debiting Retained earnings will be necessary. As per Statement no 154 Prior Financial statements issued for comparitive purposes to be retated for the direct effects of the Change in principle. Also this will also have effect on Opening stock of 2014.

f) It is clear that inventory was stolen in 2013 so the loss is pertaining to 2013. So the effect ahould be given to Retained earnings rather than loss account of 2014.

2014 Retained earnings a/c Dr 87000

To Loss a/c 87000

(Being rectification entry for stolen inventory in 2013 passed)

It is assumed that the inventory count was also made at the end of 2013 for closing stock valuation. So the closing stock 2013 and Opening stock 2014 are not effected. Otherwise these have to be given correct effect. Also if there is insurance to protect inventory loss a seperate entries should be made for insurance claims and money's recieved.