Problem 20-12

Williams-Santana, Inc., is a manufacturer of high-tech industrial parts

that was started in 2001 by two talented engineers with little business
training. In 2013, the company was acquired by one of its major
customers. As part of an internal audit, the following facts were
discovered. The audit occurred during 2014 before any adjusting
entries or closing entries were prepared.
For each situation (1) identify whether it represents an accounting change
or error. If an accounting
g change,
g , identifyy the type
yp of change;
g ; (2)
( )
Prepare any journal entry necessary as a direct result of the change or
error correction as well as any adjusting entry for 2013 related to the
situation described; (3) Briefly describe any other steps that should be
taken to appropriately report the situation.

Dr. Chula King

All Rights Reserved

Problem 20-12 (continued)

a. A five-year casualty insurance policy was purchased at the beginning of

2011 for $35,000. The full amount was debited to insurance expense at
the time.
This is an accounting error that requires retrospective restatement.
The amount that should be charged to expense every year is $7,000
($35,000 5)
2011: Expense O/S NI U/S R/E U/S by $28,000 ($35,000 - $7,000)
2012: Expense U/S NI O/S by $7,000 R/E is now U/S by $21,000
Correcting Entry: Prepaid insurance (3 x $7,000)
21,000
R/E
21,000
Adjusting Entry: Insurance expense
7,000
Prepaid insurance
7,000
A prior period adjustment to retained earnings would be reported, along
with a disclosure note describing the nature of the error and the impact
of its correction on each years net income, income before extraordinary
items, and EPS.
Dr. Chula King
All Rights Reserved

Problem 20-12 (continued)

b. Effective January 1, 2013, the company changed the salvage value used in
calculating depreciation for its office building. The building cost $600,000 on
December 29, 2002, and has been depreciated on a straight-line basis assuming
a useful life of 40 years and a salvage value of $100,000. Declining real estate
values in the area indicate that the salvage value will be no more than $25,000.
This is a change in estimate that is handled prospectively.
Annual depreciation before the change = ($600,000 - $100,000) 40 = $12,500
2013 Book value = $600,000 [(10 x $12,500)] = $475,000
New residual value = $25,000
Remaining life = 30 years (40 10)
New depreciation = ($475,000 - $25,000) 30 = $15,000
Depreciation expense
15,000
Accumulated depreciation
15,000
Disclosure is required describing the effect of the change in estimate on income
before extraordinary items, net income and EPS.
Dr. Chula King
All Rights Reserved

Problem 20-12 (continued)

c. On December 31, 2012, merchandise inventory was overstated by

$25,000 due to a mistake in the physical inventory count using the
periodic inventory system.
This is an accounting error that requires retrospective restatement.
2012: EI O/S COGS U/S NI O/S R/E O/S; also the asset
inventory is overstated.
R/E
25,000
Inventory
25,000
A prior period adjustment to retained earnings would be reported, along
with a disclosure note describing the nature of the error and the impact
of its correction on each years net income, income before extraordinary
items, and EPS.

Dr. Chula King

All Rights Reserved

Problem 20-12 (continued)

d. The company changed inventory cost methods to FIFO from LIFO at the
end of 2013 for both financial statement and income tax purposes. The
change will cause a $960,000 increase in the beginning inventory at
January 1, 2014.
This is a change in accounting principle that is reported retrospectively.
2013: EI U/S COGS O/S NI U/S R/E U/S; also, the asset
inventory is understated.
Inventory
960 000
960,000
Retained earnings
960,000
Prior years financial statements would be restated to reflect the use of the
new accounting method. A disclosure note justifying the change and
describing the effect of the change on any financial statement line items
and EPS for all periods reported is required.

Dr. Chula King

All Rights Reserved

Problem 20-12 (continued)

e. At the end of 2012, the company failed to accrue $15,500 of sales

commissions earned by employees during 2012. The expense was
recorded when the commissions were paid in early 2013.
This is an accounting error that requires retrospective restatement.
2012: Expense U/S NI O/S R/E O/S
2013: Expense O/S
R/E
15,500
Sales Commission Expense
15,500
A prior period adjustment to retained earnings would be reported, along
with a disclosure note describing the nature of the error and the impact
of its correction on each years net income, income before extraordinary
items, and EPS.

Dr. Chula King

All Rights Reserved

Problem 20-12 (continued)

f. At the beginning of 2011, the company purchased a machine at a cost of

$720,000. Its useful life was estimated to be 10 years with no salvage
value. The machine has been depreciated by the double-declining
balance method. Its carrying amount on December 31, 2012 was
$460,800. On January 1, 2013, the company changed to the straight-line
method.
This is treated as a change in estimate that is handled prospectively.
2013 Book value = $460,800
R id l value
Residual
l = $0
Remaining life = 8 years (10 2)
New depreciation = $460,800 8 = $57,600
Depreciation expense
57,600
Accumulated depreciation
57,600
Previous financial statements are not restated. Rather, the company simply
utilizes the straight-line method from this point on.
Dr. Chula King
All Rights Reserved

Problem 20-12 (continued)

g. Warranty expense is determined each year as 1% of sales. Actual

payment experience of recent years indicates that 0.75% is a better
indication of the actual cost. Management effects the change in 2013.
Credit sales for 2013 are $4,000,000; in 2012, they were $3,700,000.
This is a change in estimate that is handled prospectively.
2013 Warranty expense = 0.75% x $4,000,000 = $30,000
Warranty expense
30,000
Warranty payable
bl
30,000
If the impact of the change in estimate is material, then a disclosure note
should describe the effect of the change in estimate on income before
extraordinary items, net income and EPS for the current period.

Dr. Chula King

All Rights Reserved