Question

A) Company A has the following income statement information for the years 2015-2017:

                                                2015 Income           2016 Income           2017 Income

                                                Statement as           Statement as              Statement

                                                   Reported                  Reported                  Totals      

Construction Rev               10,000,000                12,500,000                17,000,000

Construction Costs            6,200,000                7,250,000                10,260,000

Gross Profit                         3,800,000                5,250,000                6,740,000

Operating Expenses         2,100,000                2,835,000                3,219,000

Income from

   Operations                       1,700,000                2,415,000                3,521,000

Non-Operating Items        (220,000)                   (171,000)                  (249,000)

Income from

   Continuing Operations          1,480,000                2,244,000                3,272,000

Income Tax Expense               370,000                     561,000                     818,000

Net Income                            1,110,000               1,683,000                2,454,000

During 2017, Company A changed its method of accounting for long-term contracts from completed contract to percentage of completion. This change brought Hogan’s accounting into line with other companies in the industry and was made due to improvements in Hogan’s abilities to project future costs. Company A will continue to use completed contract for tax purposes. Construction revenues and costs for 2015 and 2016 under percentage of completion would have been:

                                                                               2015                         2016                       

Construction Revenues                                        13,000,000                14,300,000               

Construction Costs                                               7,650,000                8,715,000               

For years prior to 2015, the change would have increased income from continuing operations by a total of $3,200,000. Company A is a calendar year company. Assume a tax rate of 25% for all years.

Required: Prepare in good form the 2017 Income Statement showing 2015 and 2016 Income Statements for comparative purposes. Additionally, prepare the retained earnings portion of the Statement of Stockholder’s equity for these comparative statements. (The retained earnings balance on January 1, 2015 was $3,654,000) Assume Company A declared and paid $100,000 of cash dividends each year 2015-2017.

B) Francis, Inc. is in the process of preparing their 2017 financial statements. During 2017, the following items occurred:

The company changed its method of depreciating its plant assets from double-declining balance to straight-line. This change brings Francis into line with most companies in the industry.

The company discovered an error in the 2014 ending inventory balance. The error resulted in 2014 ending inventory being understated.

The company sold a significant portion of their investment in Stout Corp. during 2017. Prior to this sale and for the previous 5 years, Francis owned 80% of the voting stock of Stout. After the sale, Francis owns 35% of the voting stock of Stout.

During 2017, the company changed its inventory method from weighted-average to FIFO. FIFO is consistent with the actual flow of goods and also with other companies in the industry.

Required: Prepare a report for the company controller explaining how each of these items should be accounted for on the 2017 books and how they will affect the 2017 financial statements and any prior statements shown for comparative purposes. The company generally reports the current year and two prior years in their annual financial statements. Give codification references that justify your answer.

Answer 1

Company A
	2015	2015 (Revised)	Effect of changes in methods	2016	2016 (Revised)	Effect of changes in methods	2017
Construction revenue	10000000	13000000	3000000	12500000	14300000	1800000	17000000
Construction cost	6200000	7650000	1450000	7250000	8715000	1465000	10260000
Gross Profit	3800000	5350000	1550000	5250000	5585000	335000	6740000
Operating expense	2100000	2100000	0	2835000	2835000	0	3219000
Income from operations	1700000	3250000	1550000	2415000	2750000	335000	3521000
Non-opearting items	220000	220000	0	171000	171000	0	249000
Income from continuing operations	1480000	3030000	1550000	2244000	2579000	335000	3272000
Income tax expense	370000	757500	387500	561000	644750	83750	818000
Net income	1110000	2272500	1162500	1683000	1934250	251250	2454000

If the company made a change in charging depreciation from double declining to straight line method, this is a change in accounting principle. It requires retrospective effects. This approach requires the reporting of the cumulative effect of the impact on the carrying amounts of assets and liabilities as if the new method had been used all along with an offsetting adjustment to the opening balance of retained earnings as of the beginning balance of the first period presented.

The company discovers an error in inventory balance which resulted an understatement. Understatement in the closing inventory means opening inventory in the next year is also understated. Current year profit is also understated. And next year’s profit is overstated. At the end of two years, the adjustment in retained earnings or the profit gets adjusted automatically with similar effect in the inventory balance.

Changes in reporting entities also require retrospective application. Prior period financial statements are reflected to show the financial information for the new reporting entity as if the entity had existed in that form all along. Cumulative earnings differences are reported through beginning retained earnings as of the beginnings of the first period presented.