21.9 Exercise
Chapter 21
Exercise 21.1
Identify if the following changes are an accounting policy change (P), an accounting estimate change (AE), or an error (E).
| Item | Type of Change |
|---|---|
| The useful life of a piece of equipment was revised from five years to six years. | |
| An accrued litigation liability was adjusted upwards once the lawsuit was concluded. | |
| An item was missed in the year-end inventory count. | |
| The method used to depreciate a factory machine was changed from straight-line to declining balance when it was determined that this better reflected the pattern of use. | |
| A company adopted the new IFRS for revenue recognition. | |
| The accrued pension liability was adjusted downwards as the company’s actuary had not included one employee group when estimating the remaining service life. | |
| The allowance for doubtful accounts was adjusted upwards due to current economic conditions. | |
| The allowance for doubtful accounts was adjusted downwards because the previous estimate was based on an aged trial balance that classified some outstanding invoices into the wrong aging categories. | |
| A company changed its inventory cost flow assumption from LIFO to FIFO, as the newly appointed auditors indicated that LIFO was not allowable under IFRS. | |
| A company began to apply the revaluation model to certain property, plant, and equipment assets, as it was felt that this presentation would be more useful to investors. |
Exercise 21.2
The financial controller of McEwan Limited, a publishing company, noted the following two items in a report to the finance director on the preliminary accounts for the year ended December 31, 2021:
- A copyright for a novel originally purchased for $100,000 in 2018 was being amortized over ten years with an expected residual value of $10,000. However, due to poor sales and a scandal earlier this year involving the author, it is now expected that the book will only be commercially viable for another year and the copyright will have no residual value.
- An insurance premium of $1,500 was paid on November 1, 2020, for a one-year policy. The payment was recorded as a debit to insurance expense in 2020.
Required:
- Discuss the appropriate accounting treatment for two changes above.
- Assuming the books are closed for 2020 and open for 2021, provide the journal entries required to address the two changes. Ignore income tax effects.
Exercise 21.3
The accountant of Swift Inc. was preparing for the audit of its financial statements for the year ended December 31, 2022, and discovered that an automobile was being incorrectly depreciated. The automobile was purchased on January 1, 2021, for $50,000 and the estimated residual value after five years was expected to be $5,000. The company uses the straight-line basis for depreciating vehicles, but the residual value was not considered when determining the depreciation amount. The financial controller informed the accountant that the company was switching to the double-declining balance method of depreciation for the current and future years, as it was believed this method would more accurately portray the consumption of benefits received from the asset’s use.
Required:
Prepare the journal entries required on December 31, 2022. Ignore income tax effects.
Exercise 21.4
Aldiss Ltd. currently uses the cost model for reporting its property, plant, and equipment assets. Management has decided to begin applying the revaluation model in the 2022 fiscal year to the company’s office building, as it is believed that this will provide more relevant information to the shareholders. Although the company has been using the cost model, the following reliable valuations of the building were obtained:
| 31 December 2018 | $800,000 | |
| 31 December 2020 | $825,000 | |
| 31 December 2022 | $740,000 |
The building was purchased on January 1, 2018, for $750,000. Straight-line depreciation is used and the estimated useful life is 30 years with no residual value.
Required:
Prepare the journal entries required on December 31, 2022, to reflect the accounting policy change. Ignore income tax effects.
Exercise 21.5
Simic Distributors has been using the weighted average (WA) costing method to report its inventory and cost of sales amounts for several years. Early in 2021, management decided that the FIFO costing method would provide more relevant information to the financial statement readers. The following information regarding year-end inventory amounts has been determined:
| Date | Inventory – WA | Inventory – FIFO |
|---|---|---|
| 31 December 2018 | $500,000 | $530,000 |
| 31 December 2019 | $590,000 | $650,000 |
| 31 December 2020 | $660,000 | $730,000 |
Information for inventory amounts prior to the 2018 fiscal year cannot be obtained. The company’s retained earnings balances prior to the change were $1,100,000 on December 31, 2019, and $1,375,000 on December 31, 2020. The company’s tax rate is 30%.
Required:
- Prepare the journal entry required in 2021 to reflect the accounting policy change. Assume the books have been closed for 2020 and for all previous years.
- Prepare the comparative column of the retained earnings portion of the statement of shareholders’ equity that will be presented in the 2021 financial statements. The net income previously reported in 2020 was $275,000.
Exercise 21.6
The auditors of Boyle Inc. have just completed the fieldwork of the company’s first audit for the year ended December 31, 2021. The following potential errors have been identified:
- The balance of the salaries payable account, $52,000 has remained unchanged from the previous year. The controller indicated that the balance should be $45,000.
- On December 28, 2020, a fire destroyed one of the company’s delivery vehicles. Insurance proceeds of $8,000 were received on January 16, 2021, and were credited to miscellaneous revenue. The delivery vehicle’s original cost was $40,000, and at the time of the fire the accumulated depreciation was $26,000. Further depreciation of $5,000 was recorded in 2021, as the vehicle had not been removed from the equipment subledger.
- Based on deteriorating economic circumstances, the company decided that the allowance for doubtful accounts for 2021 should be 2% of the accounts receivable balance instead of the 1% that had been used in the previous year. The accounts receivable balances were $1,500,000 in 2021 and $1,750,000 in 2020. No entry has yet been made for the 2021 bad debts, and the balance in the allowance for doubtful accounts has remained unchanged from December 31, 2020.
- Due to a number of cut-off errors, the ending inventory balance on December 31, 2020, was overstated by $8,000 and was understated by $12,000 on December 31, 2021.
Required:
Prepare the journal entries required to correct the above errors. The books for 2021 are still open, but the books for 2020 have been closed. Ignore income tax effects.
Exercise 21.7
Spark Ltd. has just completed preparing its financial statements for the year ended December 31, 2022. The assistant controller has brought the following items to the attention of the controller:
- In 2021, $9,000 of repairs expense was mistakenly charged to the equipment account. Depreciation has already been recorded in 2021 and 2022. The company uses straight-line depreciation and records half of the normal depreciation charge in the year of acquisition. The equipment’s estimated useful life is six years with no residual value.
- No adjustment has yet been made for accrued interest on a loan receivable. Regular interest payments are made on February 28, May 31, August 31, and November 30, with interest revenue being recorded at the time of the payment. The balance of the loan receivable is $150,000 and the annual interest rate is 8%. The balance of the interest receivable account is $1,000, which is unchanged from the previous year.
- On July 1, 2020 a factory building was purchased for $1,000,000. The full amount of the purchase price was recorded in the building account, but 25% of the cost should have been allocated to land. The building is being depreciated on a straight-line basis with an estimated useful life of 50 years and a residual value of $50,000.
- On September 30, 2022, a fully depreciated factory machine was sold to a scrap metal dealer for $1,500. The original cost of the machine was $52,000. When the machine was sold, the proceeds were credited to the factory machine account.
Required:
Prepare the journal entries required in 2022 to correct the above items. The books for 2022 are open, but the books for previous years are closed. Ignore income tax effects.
Exercise 21.8
You are the senior in charge of the audit of Rankin Ltd. for the year ended December 31, 2021. In the process of reviewing the audit working papers, you discovered the following:
- In 2020, an automobile purchase was incorrectly charged to the repair expense account. The cost of the automobile was $35,000, and its expected useful life was six years with a residual value of $5,000. The company uses double-declining balance depreciation with a full year of depreciation being charged in the year of acquisition.
- In 2019, a lawsuit was launched against the company for a product liability issue. The company’s lawyers initially indicated that the company was likely to lose, and a provision of $750,000 was established. Late in 2021, the case was approaching a verdict, and the company’s lawyers now indicated that the company would not lose the case and would, therefore, not be required to pay a settlement.
- Goods that were sold on credit for $18,000 on December 28, 2021, FOB destination were recorded as a sale on that date. The customer received the goods on January 4, 2022. The cost of the goods was $11,500.
- In December 2020, an advance deposit of $60,000 was received from a customer for work that was to be completed in 2021. When the deposit was received, it was a recorded as revenue.
Required:
Prepare the journal entries required in 2021 to correct the above items. The books for 2021 are open but the books for previous years are closed. The company’s income tax rate is 20%.
Exercise 21.9
You have been asked to provide an analysis of the reported net income of Hodgins Manufacturing Ltd. for the years ended December 31, 2021, and 2020. The reported net incomes were $1,200,000 in 2021 and $1,050,000 in 2020. You have also received the following information:
- A surplus building was rented to a tenant, starting on July 1, 2020. The lease term was 24 months and the annual rent was $60,000. The tenant paid the full amount required under the lease (i.e., $120,000) on July 1, 2020, and this amount was recorded as rental income.
- The company has never reported unused office supplies as an asset on its balance sheet. Office supplies have always been immediately expensed when purchased. The balances of office supplies on-hand were as follows:
31 December 2019 $18,000 31 December 2020 $13,500 31 December 2021 $19,200 - The company started offering a three-year warranty on its products in 2020. The warranty expense recorded was based only on actual expenditures made in each year. It was estimated, however, that warranty claims should eventually total 1% of revenue in each year. Sales and expenditures were as follows:
Actual Warranty Costs for sales in: Year Sales 2020 2021 Total 2020 $5,000,000 $12,000 – $12,000 2021 $5,200,000 $30,000 $16,000 $46,000
Required:
Complete the table below, analyzing the company’s net income. Ignore income tax effects.
| 2021 | 2020 | |
|---|---|---|
| Reported net income | $1,200,000 | $1,050,000 |
| Adjustment for rent | ||
| Adjustment for office supplies | ||
| Adjustment for warranty | ||
| Corrected net income |
Exercise 21.10
On January 1, Y4, Hoover Company discovered that depreciation expense in the years prior to Y4 was incorrectly calculated and recorded. Total depreciation expense of $234,650 was recorded.
The correct amount of depreciation should have been $156,800.
Hoover has a tax rate of 20%. The books (accounting records) from prior years are all closed.
Required:
Prepare Hoover’s Y4 journal entry with respect to depreciation expense prior to Y4.
Exercise 21.11
In Y7, Zurich Limited discovered that equipment purchased on January 1, Y5 for $97,920 was expensed in error at that time. The equipment should have been depreciated over six years.
There is no expected residual value on the equipment.
Zurich has a tax rate of 30%.
Required:
Prepare Zurich’s Y7 entry to correct the error and record Y7 depreciation expense.
