Question

Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was started in 2009 by two talented engineers with little business training. In 2021, 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 2021 before any adjusting entries or closing entries were prepared. The income tax rate is 25% for all years.

1. A five-year casualty insurance policy was purchased at the beginning of 2019 for $31,000. The full amount was debited to insurance expense at the time.
2. Effective January 1, 2021, the company changed the salvage value used in calculating depreciation for its office building. The building cost $568,000 on December 29, 2010, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $100,000. Declining real estate values in the area indicate that the salvage value will be no more than $25,000.
3. On December 31, 2020, merchandise inventory was overstated by $21,000 due to a mistake in the physical inventory count using the periodic inventory system.
4. The company changed inventory cost methods to FIFO from LIFO at the end of 2021 for both financial statement and income tax purposes. The change will cause a $920,000 increase in the beginning inventory at January 1, 2022.
5. At the end of 2020, the company failed to accrue $15,600 of sales commissions earned by employees during 2020. The expense was recorded when the commissions were paid in early 2021.
6. At the beginning of 2019, the company purchased a machine at a cost of $640,000. 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, 2020, was $409,600. On January 1, 2021, the company changed to the straight-line method.
7. Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.75% is a better indication of the actual cost. Management effects the change in 2021. Credit sales for 2021 are $3,200,000; in 2020 they were $2,900,000.

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 2021 related to the situation described. Any tax effects should be adjusted for through Income tax payable or Refund—income tax.

Answer 1

Both requirements are done under same heading

a. This is an accounting error that requires retrospective restatement. The amount that should be charged to expense every year is $6200 ($31,000 ÷ 5)

Date	Particulars	Debit ($)	Credit ($)
Correcting entry	Prepaid insurance (3*6200)	18,600
	Retained earnings		18,600
Adjusting entry	Insurance expense	6200
	Prepaid insurance		6200

b. This is a change in estimate that is handled prospectively.

Annual depreciation before the change = ($568,000 - $100,000) ÷ 40 = $11,700

2021 Book value = $568,000 – [(10 x $11,700)] = $451,000

New residual value = $25,000

Remaining life = 30 years (40 – 10)

New depreciation = ($451,000 - $25,000) ÷ 30 = $14,200

Date	Particulars	Debit ($)	Credit ($)
	Depreciation expense	14200
	Accumulated depreciation		14,200

c. This is an accounting error that requires retrospective restatement.

Date	Particulars	Debit ($)	Credit ($)
	Retained Earnings	21,000
	Inventory		21,000

d. This is a change in accounting principle that is reported retrospectively.

Date	Particulars	Debit ($)	Credit ($)
	Inventory	920,000
	Retained Earnings		920,000

e. This is an accounting error that requires retrospective restatement.

Date	Particulars	Debit ($)	Credit ($)
	Retained Earnings	15,600
	Sales commission expense		15,600

f. This is treated as a change in estimate that is handled prospectively.

2021 Book value = $409,600

Residual value = $0

Remaining life = 8 years (10 – 2)

New depreciation = $409,600 ÷ 8 = $51,200

Date	Particulars	Debit ($)	Credit ($)
	Depreciation expense	51,200
	Accumulated depreciation		51,200

g. This is a change in estimate that is handled prospectively.

2021 Warranty expense = 0.75% x $3,200,000 = $24,000

Date	Particulars	Debit ($)	Credit ($)
	Warranty expense	24,000
	Warranty payable		24,000