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Chapter 22: Q9P. (page 1319)

Lowell Corporation has used the accrual basis of accounting for several years. A review of the records, however, indicates that some expenses and revenues have been handled on a cash basis because of errors made by an inexperienced bookkeeper. Income statements prepared by the bookkeeper reported \(29,000 net income for 2016 and \)37,000 net income for 2017. Further examination of the records reveals that the following items were handled improperly.

1. Rent was received from a tenant in December 2016. The amount, \(1,000, was recorded as revenue at that time even though the rental pertained to 2017.

2. Salaries and wages payable on December 31 have been consistently omitted from the records of that date and have been entered as expenses when paid in the following year. The amounts of the accruals recorded in this manner were:

December 31, 2015 \)1,100

December 31, 2016 1,200

December 31, 2017 940

3. Invoices for supplies purchased have been charged to expense accounts when received. Inventories of supplies on hand at the end of each year have been ignored, and no entry has been made for them.

December 31, 2015 $1,300

December 31, 2016 940

December 31, 2017 1,420

Instructions

Prepare a schedule that will show the corrected net income for the years 2016 and 2017. All items listed should be labeled clearly. (Ignore income tax considerations.)

Short Answer

Expert verified

The net income is revenues minus expenses, and the correct net income for 2016 is $27,540 and for 2017 is $38,740.

Step by step solution

01

Definition of Net Income

The net income is the income computed by deducting all direct and indirect expenses incurred during the year from revenues generated during the year.

02

Schedule showing corrected net incomes

2016 ($)

2017 ($)

Net Income as reported

29,000

37,000

Rent received in 2016, earned in 2017

-1,000

1,000

Salaries and wages not accrued, 12/31/15

1,100

Salaries and wages not accrued, 12/31/16

-1,200

1,200

Salaries and wages not accrued, 12/31/17

-940

Inventory of supplies, 12/31/15

-1,300

Inventory of supplies, 12/31/16

940

-940

Inventory of supplies, 12/31/17

1,420

Corrected Net Income

27,540

38,740

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Most popular questions from this chapter

(Error Correction Entries) The first audit of the books of Bruce Gingrich Company was made for the year ended December 31, 2018. In examining the books, the auditor found that certain items had been overlooked or incorrectly handled in the last 3 years.

These items are:

1. At the beginning of 2016, the company purchased a machine for \(510,000 (salvage value of \)51,000) that had a useful life of 6 years. The bookkeeper used straight-line depreciation but failed to deduct the salvage value in computing the depreciation base for the 3 years.

2. At the end of 2017, the company failed to accrue sales salaries of \(45,000.

3. A tax lawsuit that involved the year 2016 was settled late in 2018. It was determined that the company owed an additional \)85,000 in taxes related to 2016. The company did not record a liability in 2016 or 2017 because the possibility of loss was considered remote, and charged the \(85,000 to a loss account in 2018.

4. Gingrich Company purchased a copyright from another company early in 2016 for \)45,000. Gingrich had not amortized the copyright because its value had not diminished. The copyright has a useful life at purchase of 20 years.

5. In 2018, the company wrote off $87,000 of inventory considered to be obsolete; this loss was charged directly to Retained Earnings. Instructions Prepare the journal entries necessary in 2018 to correct the books, assuming that the books have not been closed. Disregard effects of corrections on income tax.

On December 31, 2017, before the books were closed, the management and accountants of Madrasa Inc. made the following determinations about three pieces of equipment.

1. Equipment A was purchased January 2, 2014. It originally cost \(540,000 and, for depreciation purposes, the straight-line method was originally chosen. The asset was originally expected to be useful for 10 years and have a zero salvage value. In 2017, the decision was made to change the depreciation method from straight-line to sum-of-the-years鈥�-digits, and the estimates relating to useful life and salvage value remained unchanged.

2. Equipment B was purchased January 3, 2013. It originally cost \)180,000 and, for depreciation purposes, the straight-line method was chosen. The asset was originally expected to be useful for 15 years and have a zero residual value. In 2017, the decision was made to shorten the total life of this asset to 9 years and to estimate the residual value at \(3,000.

3. Equipment C was purchased January 5, 2013. The asset鈥檚 original cost was \)160,000, and this amount was entirely expensed in 2013. This particular asset has a 10-year useful life and no residual value. The straight-line method was chosen for depreciation purposes.

Additional data:

1. Income in 2017 before depreciation expense amounted to \(400,000.

2. Depreciation expense on assets other than A, B, and C totaled \)55,000 in 2017.

3. Income in 2016 was reported at \(370,000.

4. Ignore all income tax effects.

5. 100,000 shares of common stock were outstanding in 2016 and 2017.

Instructions

(a) Prepare all necessary entries in 2017 to record these determinations.

(b) Prepare comparative retained earnings statements for Madrasa Inc. for 2016 and 2017. The company had retained earnings of \)200,000 at December 31, 2015.

Discuss and illustrate how a correction of an error in previously issued financial statements should be handled.

Presented below are the comparative income and retained earnings statements for Denise Habbe Inc. for the years 2017 and 2018.

2018 2017 Sales \(340,000 \)270,000 Cost of sales 200,000 142,000 Gross profit 140,000 128,000 Expenses 88,000 50,000 Net income \( 52,000 \) 78,000 Retained earnings (Jan. 1) \(125,000 \) 72,000 Net income 52,000 78,000 Dividends (30,000) (25,000) Retained earnings (Dec. 31) \(147,000 \)125,000

The following additional information is provided: 1. In 2018, Denise Habbe Inc. decided to switch its depreciation method from sum-of-the-years鈥� digits to the straight-line method. The assets were purchased at the beginning of 2017 for \(100,000 with an estimated useful life of 4 years and no salvage value. (The 2018 income statement contains depreciation expense of \)30,000 on the assets purchased at the beginning of 2017.) 2. In 2018, the company discovered that the ending inventory for 2017 was overstated by $24,000; ending inventory for 2018 is correctly stated.

Instructions Prepare the revised retained earnings statement for 2017 and 2018, assuming comparative statements. (Ignore income taxes.)

Simmons Corporation owns stock of Armstrong, Inc. Prior to 2017, the investment was accounted for using the equity method. In early 2017, Simmons sold part of its investment in Armstrong, and began using the fair value method. In 2017, Armstrong earned net income of \(80,000 and paid dividends of \)95,000. Prepare Simmons鈥檚 entries related to Armstrong鈥檚 net income and dividends, assuming Simmons now owns 10% of Armstrong鈥檚 stock.
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