Question

Splish Inc. was organized in late 2015 to manufacture and sell hosiery. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes.

2015		$139,000a		2017		$206,000
2016		162,000b		2018		279,000

^a Includes a $10,000 increase because of change in bad debt experience rate.
^b Includes a gain of $30,000.

The company has decided to expand operations and has applied for a sizable bank loan. The bank officer has indicated that the records should be audited and presented in comparative statements to facilitate analysis by the bank. Splish Inc. therefore hired the auditing firm of Check & Doublecheck Co. and has provided the following additional information.

1.		In early 2016, Splish Inc. changed its estimate from 2% of receivables to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2015, if a 1% rate had been used, would have been $10,000. The company therefore restated its net income for 2015.
2.		In 2018, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. The effect on the income statements for the previous years is as follows.

		2015		2016		2017		2018
Net income unadjusted—LIFO basis		$139,000		$162,000		$206,000		$279,000
Net income unadjusted—FIFO basis		154,000		167,000		217,000		262,000
		$15,000		$5,000		$11,000		$(17,000)

3. In 2018, the auditor discovered that:

(a)		The company incorrectly overstated the ending inventory (under both LIFO and FIFO) by $13,000 in 2017.
(b)		A dispute developed in 2016 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2015, the company was not permitted these deductions, but a tax settlement was reached in 2018 that allowed these expenses. As a result of the court’s finding, tax expenses in 2018 were reduced by $55,000.

(b) Present net income as reported in comparative income statements for the years 2015 to 2018.

Answer 1

ANSWER

a.1) Bad debt expense of 2015 should not have been reduced by $ 10,000. A change in the experience rate is considered a change in estimate which should be handled respectively.

2) A change in LIFO to FIFO is considered a change in accounting principle which must be handled respectively.

3. a) The inventory error in 2017 is a prior period adjustment & the 2017 to 2018 financial statement should be restated.

b) The Law suit settlement is correctly treated.

Comparative Income Statements
Particulars	2015	2016	2017	2018
Income before extraordinary item	145,000	137,000	204,000	275,000
Extra ordinary gain	-	30,000	-
Net Income	144,000	167,000	204,000	275,000
Net Income (un-adjusted)	139,000	162,000	206,000	279,000
1.Bad debt expenses	(10,000)
2.Inventory adjustment (FIFO)	15,000	5,000	11,000	(17,000)
3.Inventory overstatement	-	-	(13,000)	13,000
Net Income Adjusted	144,000	167,000	204,000	275,000

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