(a) Lara Croft has been hired as a new auditor for Jolie Inc. Ms. Croft has suggested the following accounting changes in regards to the company’s financial statements. 1. At December 31, 2019, Jolie Inc. had a receivable of $500,000 from Relic Inc. on its statement of financial position. Relic had gone bankrupt, and no recovery is expected. Jolie proposes to write off the receivable as a prior period item. 2. The client proposes the following changes in depreciation policies. (a) For office furniture and fixtures, it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2019, would have been $250,000 less. The effect of the change on 2020 income alone is a reduction of $60,000. (b) For its equipment in the leasing division, the client proposes to adopt the sum-of-theyears’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2020. If straight-line depreciation were used, 2020 income would be $110,000 greater. 3. In preparing its 2019 statements, one of the client’s bookkeepers overstated ending inventory by $178,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment. 4. In the past, the client has spread pre-production costs in its furniture division over 5years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize pre-production costs on a per- unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction. If the new accounting method had been used prior to 2020, retained earnings at December 31, 2019, would have been $215,000 less. 5. For the nursery division, the client proposes to switch from FIFO to average-cost inventories because it believes that average-cost will provide a better matching of current costs with revenues. The effect of making this change on 2020 earnings will be an increase of $320,000. The client says that the effect of the change on December 31, 2019, retained earnings cannot be determined. 6. To achieve a better matching of revenues and expenses in its building construction division, the client proposes to switch from the cost-recovery method of accounting to the percentage-of-completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2019, would have been $950,000 greater.
QUESTION TWO
(a) Lara Croft has been hired as a new auditor for Jolie Inc. Ms. Croft has suggested the
following accounting changes in regards to the company’s financial statements.
1. At December 31, 2019, Jolie Inc. had a receivable of $500,000 from Relic Inc. on its
2. The client proposes the following changes in
(b) For its equipment in the leasing division, the client proposes to adopt the sum-of-theyears’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2020. If straight-line depreciation were used, 2020 income would be $110,000 greater.
3. In preparing its 2019 statements, one of the client’s bookkeepers overstated ending inventory by $178,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment.
4. In the past, the client has spread pre-production costs in its furniture division over 5years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize pre-production costs on a per- unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction. If
the new accounting method had been used prior to 2020, retained earnings at December 31, 2019, would have been $215,000 less.
5. For the nursery division, the client proposes to switch from FIFO to average-cost inventories because it believes that average-cost will provide a better matching of current costs with revenues. The effect of making this change on 2020 earnings will be an increase of $320,000. The client says that the effect of the change on December 31, 2019, retained earnings cannot be determined.
6. To achieve a better matching of revenues and expenses in its building construction division, the client proposes to switch from the cost-recovery method of accounting to the percentage-of-completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2019, would have been $950,000 greater.
b.While reviewing the company’s records for 2019 and 2020, Ms. Croft discovered that no adjustments were made for the following items.
1. Interest income of $14,100 was not accrued at the end of 2019. It was recorded when received in February 2020.
2. A computer costing $4000 was expensed when purchased on July 1, 2019. It is expected to have a 4 year life with no residual value. The company typically uses straight line depreciation for all fixed assets.
3. Research costs of $33,000 were incurred early in 2019. They were capitalized and were to be amortized over a 3-year period. Amortization of $11,000 was recorded for 2019 and $11,000 for 2020.
4. On January 2, 2019, Jolie Inc. 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’s rent 8,000
Last month’s rent 8,000
$36,000
5. The company received $36,000 from a customer at the beginning of 2019 for services that it is to perform evenly over a 3-year period beginning in 2019. None of the amount received was reported as unearned revenue at the end of 2019.
6. Merchandise inventory costing $18,200 was in the warehouse at December 31, 2019, but was incorrectly omitted from the physical count at that date. The company uses the periodic inventory method.
Instructions
(i) Indicate and explain the effect of any errors on the net income figure reported on the income statement for the year ending December 31, 2019, and the retained earnings figure reported on the statement of financial position at December 31, 2020. 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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Net Income for 2019 |
Retained Earnings for 12/31/2020 |
Explanation |
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Item |
Understated |
Overstated |
Understated |
Overstated |
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