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Chapter 22: Q5E. (page 1309)

Presented below are income statements prepared on a LIFO and FIFO basis for Kenseth Company, which started operations on January 1, 2016. The company presently uses the LIFO method of pricing its inventory and has decided to switch to the FIFO method in 2017. The FIFO income statement is computed in accordance with the requirements of GAAP. Kenseth鈥檚 profit-sharing agreement with its employees indicates that the company will pay employees 10% of income before profit-sharing. Income taxes are ignored. LIFO Basis FIFO Basis 2017 2016 2017 2016 Sales \(3,000 \)3,000 \(3,000 \)3,000 Cost of goods sold 1,130 1,000 1,100 940 Operating expenses 1,000 1,000 1,000 1,000 Income before profi t-sharing 870 1,000 900 1,060 Profi t-sharing expense 87 100 96 100 Net income \( 783 \) 900 \( 804 \) 960 Instructions Answer the following questions. (a) If comparative income statements are prepared, what net income should Kenseth report in 2016 and 2017? (b) Explain why, under the FIFO basis, Kenseth reports \(100 in 2016 and \)96 in 2017 for its profit-sharing expense. (c) Assume that Kenseth has a beginning balance of retained earnings at January 1, 2017, of \(900 using the LIFO method. The company declared and paid dividends of \)500 in 2017. Prepare the -retained earnings statement for 2017, assuming that Kenseth has switched to the FIFO method.

Short Answer

Expert verified

The net income of 2017 is $804, 2016 is $960, and closing retained earnings is $1,264. The amounts are recorded as $96 and $100 because of the indirect effect.

Step by step solution

01

Comparative Income Statement

2017 ($)

2016 ($)

Sales

3,000

3,000

Cost of goods sold

1,100

940

Operating expenses

1,000

1,000

Income before profit sharing

900

1,060

Profit-sharing Expenses

96

100

Net Income

804

960

02

Explanation of the amounts

This is the indirect effect, as this happened in the period before the change. The profit-sharing expenses were recorded as $96 and $100 in 2017.

03

Retained Earnings Statement

2017 ($)

Retained earnings, Jan 1 as reported

900

Cumulative Effect change to FIFO

60

Retained Earnings, Jan 1 as adjusted

960

Add: Net Income

804

Less: Dividends

-500

Retained Earnings, Dec 31

1,264

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Most popular questions from this chapter

Pam Erickson Construction Company changed from the completed-contract to the percentage-of-completion method of accounting for long-term construction contracts during 2018. For tax purposes, the company employs the completed-contract method and will continue this approach in the future. (Hint: Adjust all tax consequences through the Deferred Tax Liability account.) The appropriate information related to this change is as follows. Pretax Income from: Percentage-of-Completion Completed-Contract Difference 2017 \(780,000 \)590,000 $190,000 2018 700,000 480,000 220,000 Instructions (a) Assuming that the tax rate is 35%, what is the amount of net income that would be reported in 2018? (b) What entry(ies) are necessary to adjust the accounting records for the change in accounting principle?

Taveras Co. decides at the beginning of 2017 to adopt the FIFO method of inventory valuation. Taveras had used the LIFO method for financial reporting since its inception on January 1, 2015, and had maintained records adequate to apply the FIFO method retrospectively. Taveras concluded that FIFO is the preferable inventory method because it reflects the current cost of inventory on the balance sheet. The following table presents the effects of the change in accounting principles on inventory and cost of goods sold. Inventory Determined by Cost of Goods Sold Determined by Date LIFO Method FIFO Method LIFO Method FIFO Method January 1, 2015 \( 0 \) 0 \( 0 \) 0 December 31, 2015 100 80 800 820 December 31, 2016 200 240 1,000 940 December 31, 2017 320 390 1,130 1,100 Other information: 1. For each year presented, sales are \(3,000 and operating expenses are \)1,000. 2. Taveras provides two years of financial statements. Earnings per share information is not required. Instructions (a) Prepare income statements under LIFO and FIFO for 2015, 2016, and 2017. (b) Prepare income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method for 2017 and 2016. (c) Prepare the note to the financial statements describing the change in method of inventory valuation. In the note, indicate the income statement line items for 2017 and 2016 that were affected by the change in accounting principle. (d) Prepare comparative retained earnings statements for 2016 and 2017 under FIFO. Retained earnings reported under LIFO are as follows: Retained Earnings Balance December 31, 2015 $1,200 December 31, 2016 2,200 December 31, 2017 3,070

Gordon Company started operations on January 1, 2012, and has used the FIFO method of inventory valuation since its inception. In 2018, it decides to switch to the average-cost method. You are provided with the following information.

Net Income Retained Earnings (Ending Balance) Under FIFO Under Average-Cost Under FIFO 2012 \(100,000 \) 90,000 $100,000 2013 70,000 65,000 160,000 2014 90,000 80,000 235,000 2015 120,000 130,000 340,000 2016 300,000 290,000 590,000 2017 305,000 310,000 780,000

Instructions (a) What is the beginning retained earnings balance at January 1, 2014, if Gordon prepares comparative financial statements starting in 2014?

(b) What is the beginning retained earnings balance at January 1, 2017, if Gordon prepares comparative financial statements starting in 2017?

(c) What is the beginning retained earnings balance at January 1, 2018, if Gordon prepares single-period financial statements for 2018?

(d) What is the net income reported by Gordon in the 2017 income statement if it prepares comparative financial statements starting with 2015?

You have been asked by a client to review the records of Roberts Company, a small manufacturer of precision tools and machines. Your client is interested in buying the business, and arrangements have been made for you to review the accounting records. Your examination reveals the following information.

1. Roberts Company commenced business on April 1, 2015, and has been reporting on a fiscal year ending March 31. The company has never been audited, but the annual statements prepared by the bookkeeper reflect the following income before closing and before deducting income taxes.

Year Ended March 31 Income Before Taxes

2016 \( 71,600

2017 111,400

2018 103,580

2. A relatively small number of machines have been shipped on consignment. These transactions have been recorded as ordinary sales and billed as such. On March 31 of each year, machines billed and in the hands of consignees amounted to:

2016 \)6,500

2017 none

2018 5,590

Sales price was determined by adding 25% to cost. Assume that the consigned machines are sold the following year.

3. On March 30, 2017, two machines were shipped to a customer on a C.O.D. basis. The sale was not entered until April 5, 2017, when cash was received for \(6,100. The machines were not included in the inventory at March 31, 2017. (Title passed on March 30, 2017.)

4. All machines are sold subject to a 5-year warranty. It is estimated that the expense ultimately to be incurred in connection with the warranty will amount to 陆 of 1% of sales. The company has charged an expense account for warranty costs incurred. Sales per books and warranty costs were as follows.

Year Ended March 31 Sales Warranty Expense for Sales Made in

2016 2017 2018 Total

2016 \) 940,000 \(760 \) 760

2017 1,010,000 360 \(1,310 1,670

2018 1,795,000 320 1,620 \)1,910 3,850

Bad Debts Incurred on Sales Made in Bad Debt Expense 2016 2017 2018 Total Based on 1% of Receivables 2016 \(750 \) 750 \(2,334 2017 800 \) 520 1,320 2,557 2018 350 1,800 \(1,700 3,850 4,458

5. Bad debts have been recorded on a direct write-off basis. Experience of similar enterprises indicates that losses will approximate 1% of receivables. Bad debts written off were:

6. The bank deducts 6% on all contracts financed. Of this amount, 陆% is placed in a reserve to the credit of Roberts Company that is refunded to Roberts as finance contracts are paid in full. (Thus, Roberts should have a receivable for these payments and should record revenue when the net balance is remitted each year.) The reserve established by the bank has not been reflected in the books of Roberts. The excess of credits over debits (net increase) to the reserve account with Roberts on the books of the bank for each fiscal year were as follows. 2016 \) 3,000 2017 3,900 2018 5,100 \(12,000

7. Commissions on sales have been entered when paid. Commissions payable on March 31 of each year were as follows. 2016 \)1,400 2017 900 2018 1,120

8. A review of the corporate minutes reveals the manager is entitled to a bonus of 1% of the income before deducting income taxes and the bonus. The bonuses have never been recorded or paid.

Instructions

(a) Present a schedule showing the revised income before income taxes for each of the years ended March 31, 2016, 2017, and 2018. (Make computations to the nearest whole dollar.)

(b) Prepare the journal entry or entries you would give the bookkeeper to correct the books. Assume the books have not yet been closed for the fiscal year ended March 31, 2018. Disregard correction of income taxes.

On March 5, 2018, you were hired by Hemingway Inc., a closely held company, as a staff member of its newly created internal auditing department. While reviewing the company鈥檚 records for 2016 and 2017, you discover that no adjustments have yet been made for the following items. Items

1. Interest income of \(14,100 was not accrued at the end of 2016. It was recorded when received in February 2017.

2. A computer costing \)4,000 was expensed when purchased on July 1, 2016. It is expected to have a 4-year life with no salvage value. The company typically uses straight-line depreciation for all fixed assets.

3. Research and development costs of \(33,000 were incurred early in 2016. They were capitalized and were to be amortized over a 3-year period. Amortization of \)11,000 was recorded for 2016 and \(11,000 for 2017.

4. On January 2, 2016, Hemingway leased a building for 5 years at a monthly rental of \)8,000. On that date, the company paid the following amounts, which were expensed when paid. Security deposit \(20,000 First month鈥檚 rent 8,000 Last month鈥檚 rent 8,000 \)36,000

5. The company received \(36,000 from a customer at the beginning of 2016 for services that it is to perform evenly over a 3-year period beginning in 2016. None of the amount received was reported as unearned revenue at the end of 2016.

6. Merchandise inventory costing \)18,200 was in the warehouse at December 31, 2016, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method.

Instructions

Indicate the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2016, and the retained earnings figure reported on the balance sheet at December 31, 2017. Assume all amounts are material, and ignore income tax effects. Using the following format, enter the appropriate dollar amounts in the appropriate columns. Consider each item independent of the other items. It is not necessary to total the columns on the grid.
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