Error Correction
Response to the following problems:
Q 1. The bookkeeper of the Cask Company, who has maintained its accounting records since the company's formation in January 2008, has prepared the unaudited financial statements. In your examination of these statements at the end of 2010, you discover the following items:
1. Sales taxes collected from customers have been included in the sales account. The Sales Tax Expense account is debited when the sales taxes are remitted to the state in the month following the sale. All sales are subject to a 6% sales tax. Total sales (excluding sales tax) for the three years 2008 through 2010 were $200,000, $300,000, and $500,000, respectively. The Sales Tax Expense account balance for the three years was $10,000, $15,000, and $26,000, respectively.
2. An account payable of $15,000 for merchandise purchased in December 2008 was recorded in January 2009. The merchandise was not included in inventory at December 31, 2008.
3. Merchandise with a cost of $4,000 was included twice in the December 31, 2009 inventory.
4. The company has used the direct write-off method of accounting for bad debts. Accounts written off in the three years 2008 through 2010 were $2,000, $4,500, and $6,500, respectively. The appropriate balances of Allowance for Doubtful Accounts at the end of 2008 through 2010 are $5,000, $6,000, and $8,200, respectively.
5. On January 1, 2009, 12%, 10-year bonds with a face value of $600,000 were issued at 102. The premium was credited to Additional Paid-in Capital. The bonds pay interest on June 30 and December 31, and use of the straight-line amortization method is appropriate.
6. Travel advances to the sales personnel of $18,000 were included as selling expenses for 2009. The travel occurred in 2010.
7. Salaries payable at the end of each year have not been accrued. Appropriate amounts at the end of 2008 through 2010 are $10,000, $11,000, and $7,000, respectively.
8. Installation, freight, and testing costs of $25,000 on a machine purchased in January 2008 were expensed at that time. The machine has a life of five years and a residual value of $10,000.
Required
Analyze the effects of the errors on income for 2008, 2009, and 2010, and the 2010 ending balance sheet (ignore income taxes).
Q 2. The financial statements of the Gray Company showed income before income taxes of $4,030,000 for the year ended December 31, 2011, and $3,330,000 for the year ended December 31, 2010. Additional information is as follows:
1. Capital expenditures were $2,800,000 in 2011 and $4,000,000 in 2010. Included in the 2011 capital expenditures is equipment purchased for $1,000,000 on January 1, 2011, with no salvage value. Gray used straight-line depreciation based on a 10-year estimated life in its financial statements. As a result of additional information now available, it is estimated that this equipment should have only an eight-year life.
2. Gray made an error in its financial statements that should be regarded as material. A payment of $180,000 was made in January 2011 and charged to expense in 2011 for insurance premiums applicable to policies commencing and expiring in 2010. No liability had been recorded for this item at December 31, 2010.
3. The allowance for doubtful accounts reflected in Gray's financial statements was $7,000 at December 31, 2011, and $97,000 at December 31, 2010. During 2011, $90,000 of uncollectible receivables were written off against the allowance for doubtful accounts. In 2010, the provision for doubtful accounts was based on a percentage of net sales. The 2011 provision has not yet been recorded. Net sales were $58,500,000 for the year ended December 31, 2011, and $49,230,000 for the year ended December 31, 2010. Based on the latest available facts, the 2011 provision for doubtful accounts is estimated to be 0.2% of net sales.
4. A review of the estimated warranty liability at December 31, 2011, which is included in "other liabilities" in Gray's financial statements, has disclosed that this estimated liability should be increased $170,000.
5. Gray has two large blast furnaces that it uses in its manufacturing process. These furnaces must be periodically relined. Furnace A was relined in January 2005 at a cost of $230,000 and in January 2010 at a cost of $280,000. Furnace B was relined for the first time in January 2011 at a cost of $300,000. In Gray's financial statements, these costs were expensed as incurred.:
Since a relining will last for five years, a more appropriate matching of revenues and costs would result if the cost of the relining were capitalized and depreciated over the productive life of the relining. Gray has decided to make a change in accounting principle from expensing relining costs as incurred to capitalizing them and depreciating them over their productive life on a straight-line basis with a full year's depreciation in the year of relining. This change meets the requirements for a change in accounting principle under GAAP.
Required
1. For the years ended December 31, 2011 and 2010, prepare a worksheet reconciling income before income taxes as given previously with income before income taxes, as adjusted for the preceding additional information. Show supporting computations in good form. Ignore income taxes and deferred tax considerations in your answer.
2. As of January 1, 2011, compute the retrospective adjustment of retained earnings for the cumulative effect of the change in accounting principle from expensing to capitalizing relining costs. Ignore income taxes and deferred tax considerations in your answer.