1.
Prepare correct journal entries for Corporation I, if the errors are discovered before the books are closed, at the end of 2020.
1.
Explanation of Solution
Errors: The comparability and consistency of the financial statements decreases when a company records arithmetic mistakes, or errors. Such errors do require adjustments to make the financial information more reliable, and more relevant.
Debit and credit rules:
- Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
- Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.
Prepare correct journal entries for Corporation I, if the errors are discovered before the books are closed, at the end of 2020.
Journal entry to correct the reduction in loss experience rate:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2020 | ||||||
December | 31 | Allowance for Doubtful Accounts | 10,000 | |||
Administrative Expenses | 10,000 | |||||
(Record reduction in loss experience rate) |
Table (1)
Description:
- Allowance for Doubtful Accounts is a contra-asset account to Accounts Receivable account. The contra-asset accounts decrease the asset value, and a decrease in contra-asset is debited.
- Administrative Expenses is an expense account. Since expenses are reduced, equity value increased, and an increase in equity is credited.
Working Notes:
Compute allowance for doubtful accounts.
Details | Amount ($) |
Net sales for the year ended December 31, 2020 | $1,000,000 |
Percentage of loss experience rate | × 1% |
Allowance for doubtful accounts | $10,000 |
Table (2)
Journal entry to record the valuation of available-for-sale securities:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2020 | ||||||
December | 31 | Available-for-Sale Securities | 16,000 | |||
Allowance for Change in Fair Value Adjustment | 16,000 | |||||
(Record reduction in market value of available-for-sale securities) |
Table (3)
Description:
- Available-for-Sale Securities (AFSS) is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since loss has occurred and losses decrease stockholders’ equity value, and a decrease in stockholders’ equity value is debited.
- Allowance for Change in Fair Value Adjustment is a contra-asset account. The account is credited because the market price was decreased, the decreased value is adjusted to this account.
Working Notes:
Compute unrealized gain or loss on investment in AFSS.
Journal entry to correct the 2019 overstated inventory:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2020 | ||||||
December | 31 | 4,000 | ||||
Cost of Goods Sold | 4,000 | |||||
(Record reduction in overstated retained earnings) |
Table (4)
Description:
- Retained Earnings is an equity account. Since ending inventory in 2019 was overstated, cost of goods sold of 2019 were understated, and hence, revenue is overstated in 2019. The retained earnings account is debited to decrease the overstated equity.
- Cost of Goods Sold is an equity account. Since cost of goods sold of 2020 was overstated, the expense account is credited to decrease the overstated equity.
Journal entry to correct the 2020 overstated inventory:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2020 | ||||||
December | 31 | Cost of Goods Sold | 6,100 | |||
Inventory | 6,100 | |||||
(Record reduction in overstated inventory and increase in understated cost of goods sold) |
Table (5)
Description:
- Cost of Goods Sold is an equity account. Since ending inventory in 2020 was overstated, cost of goods sold of 2020 were understated. The expense account is debited to increase the understated equity.
- Inventory is an asset account. Since ending inventory in 2020 was overstated, the value of assets increased. The asset account is credited to decrease the overstated asset account.
Journal entry to correct the incorrectly charged operating expenses:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2020 | ||||||
December | 31 | Equipment | 12,000 | |||
1,100 | ||||||
Retained Earnings | 10,900 | |||||
2,200 | ||||||
(Record increase in equipment account and increase in understated retained earnings) |
Table (6)
Description:
- Equipment is an asset account. Since equipment in was understated, the value of assets decreased. The asset account is debited to increase the understated asset account.
- Depreciation Expense is an expense account. Since expenses are increased, equity value decreased, and a decrease in equity is debited.
- Retained Earnings is an equity account. Since operating expenses are overstated, revenue was understated, and hence, revenue is understated in 2020. The retained earnings account is credited to increase the understated equity.
- Accumulated Depreciation is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.
Working Notes:
Compute accumulated depreciation.
Computation of Accumulated Depreciation | |
Acquisition cost on January 1, 2019 | $12,000 |
Less: Salvage value | (1,000) |
Original depreciable base | 11,000 |
Original estimated useful life | ÷ 10 years |
Straight-line depreciation expense per year | 1,100 |
Number of years the asset was consumed, 2 years (2019 to 2020) | × 2 years |
Accumulated depreciation | $2,200 |
Table (7)
Journal entry to correct the incorrect crediting of sale proceeds:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2020 | ||||||
December | 31 | Accumulated Depreciation | 17,500 | |||
Equipment | 15,000 | |||||
Other Income | 2,500 | |||||
(Record sale of equipment) |
Table (8)
Description:
- Accumulated Depreciation is a contra-asset account. Since the equipment is sold, the accumulated depreciation balance is reversed to reduce the balance in the account, hence, the account is debited.
- Equipment is an asset account. Since equipment is sold, asset account decreased, and a decrease in asset is credited.
- Other Income is a revenue account. Since gains and revenues increase equity, equity value is increased, and an increase in equity is credited.
Journal entry for prepaid expenses paid in 2019:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
Prepaid Insurance | 900 | |||||
Insurance Expenses | 900 | |||||
Retained Earnings | 1,800 | |||||
(Record unrecognized prepaid expenses and incurred in 2020) |
Table (9)
Description:
- Prepaid Insurance is an asset account. Since balance of prepaid expenses were recorded in 2020, asset value increased, and an increase in asset is debited.
- Insurance Expense is an equity account. Expenses decrease equity value, and a decrease in equity is debited.
- Retained Earnings is an equity account. Since prepaid expenses of 2019 were recorded as expenses in 2020, and was included in the computation of net income, the net income in 2020 was understated. The equity account is credited to increase the understated value.
Working Notes:
Calculate the value of insurance expense for one year.
Journal entry for reducing additional paid-in capital in excess of par from common stock value:
Date | Account Titles and Explanation | Post Ref | Debit ($) | Credit ($) | ||
Common Stock | 60,000 | |||||
Paid-In Capital in Excess of Par | 60,000 | |||||
(Record reduction of additional paid-in capital from common stock) |
Table (10)
Description:
- Common Stock is a stockholders’ equity account. Since additional paid-in capital is adjusted from common stock, equity value is decreased, and a decrease in equity is debited.
- Paid-In Capital in Excess of Par is a stockholders’ equity account. Since common stock issued at a value in excess of par value is adjusted, paid-in capital value is increased, and an increase in equity is credited.
2.
Calculate the correct net income for 2019 and 2020, after including the omissions.
2.
Explanation of Solution
Calculate the correct net income for the years 2019 and 2020.
Details | 2020 | 2019 |
Reported net income | $220,000 | $195,000 |
Change in loss experience rate | 10,000 | |
Overstated ending merchandise inventory in 2019 | 4,000 | (4,000) |
Overstated ending merchandise inventory in 2020 | (6,100) | |
Decrease in operating expenses in 2019 | 10,900 | |
Increase in operating expenses in 2020 | (1,100) | |
Proceeds from sale of equipment | 2,500 | |
Recognition of prepaid insurance | (900) | 1,800 |
Correct pretax income | $228,400 | $203,7000 |
Table (11)
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Chapter 22 Solutions
Intermediate Accounting: Reporting And Analysis
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