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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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At the end of 2020, while auditing Sandlin Company’s books, before the books have been closed, you find the following items:

  1. a. A building with a 30-year life (no residual value, depreciated using the straight-line method) was purchased on January 1, 2020, by issuing a $90,000 non-interest-bearing, 4-year note. The entry made to record the purchase was a debit to Building and a credit to Notes Payable for $90,000; 12% is a fair rate of interest on the note.
  2. b. The inventory at the end of 2020 was found to be overstated by $15,000. At the same time, it was discovered that the inventory at the end of 2019 had been overstated by $35,000. The company uses the perpetual inventory system.
  3. c. For the last 3 years, the company has failed to accrue salaries and w-ages. The correct amounts at the end of each year were: 2018, $12,000; 2019, $18,000; and 2020, $10,000.

Required:

  1. 1. Prepare journal entries to correct the errors. Ignore income taxes.
  2. 2. Assume, instead, that the company discovered the errors after it had closed the books. Prepare journal entries to correct the errors. Ignore income taxes.

1.

To determine

Prepare correct journal entries for Company S, if the errors are discovered before the books are closed, at the end of 2020.

Explanation

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.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

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 Company S, if the errors are discovered before the books are closed, at the end of 2020.

a.

Journal entry to correct the failure to record discount on note payable:

DateAccount Titles and ExplanationPost Ref.Debit ($)Credit ($)
  Discount on Note Payable 32,803 
     Building  32,803
  (Record discount on notes payable)   

Table (1)

Description:

  • Discount on Note Payable is a contra-liability account to Notes Payable account. The contra-liability account increased, and an increase in contra-liability is debited.
  • Building is an asset account. The asset value decreased due to discount, and a decrease in asset is credited.

Working Note 1:

Compute discount on note payable value.

Discount on note payable = {Note payable value–(Note payable value×Present value of $1 at 12% for 1 time period)}=$90,000–($90,000×0.635518)=$90,000–$57,197=$32,803

Journal entry to correct the erroneous depreciation expense:

DateAccount Titles and ExplanationPost Ref.Debit ($)Credit ($)
  Accumulated Depreciation–Building 1,093 
     Depreciation Expense–Building  1,093
  (Record reduction in depreciation expense)   

Table (2)

Description:

  • Accumulated Depreciation–Building is a contra-asset account. Since the depreciation expense was overstated by $1,093, the accumulated depreciation is also overstated.  Hence, the contra-asset account is debited to decrease the expense value.
  • Depreciation Expense is an expense account. Since the depreciation expense was overstated by $1,093, the expense account is credited to decrease the expense value.

Working Note 2:

Compute overstated (understated) depreciation expense value (Refer to Working Note 1 for value and computation of discount on note payable).

Overstated (understated)depreciation expense} = {Incorrectly recorded depreciation expense–Correct depreciation expense}=$90,00030 years – ($90,000–$32,903)30 years=$3,000$1,907=$1,093

Journal entry to correct the failure to record interest expense:

DateAccount Titles and ExplanationPost Ref.Debit ($)Credit ($)
  Interest Expense 6,864 
     Discount on Note Payable  6,864
  (Record interest expense on notes payable)   

Table (3)

Description:

  • Interest Expense is an expense account

2.

To determine

Prepare correct journal entries for Company S, if the errors are discovered after the books are closed, at the end of 2020.

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