CONCEPTS FOR ANALYSIS
CA22-1 GROUPWORK (Analysis of Various Accounting Changes and Errors) Mathys Inc. has recently hired a new independent auditor, Karen Ogleby, who says she wants “to get everything straightened out.” Consequently, she has proposed the following accounting changes in connection with Mathys Inc.’s 2017 financial statements.
1. At December 31, 2016, the client had a receivable of $820,000 from Hendricks Inc. on its balance sheet. Hendricks Inc. has gone bankrupt, and no recovery is expected. The client 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, 2016, would have been $250,000 less. The effect of the change on 2017 income alone is a reduction of $60,000.
(b) For its new equipment in the leasing division, the client proposes to adopt the sum-of-the-years’-digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2017. If straight-line depreciation were used, 2017 income would be $110,000 greater.
3. In preparing its 2016 statements, one of the client’s bookkeepers overstated ending inventory by $235,000 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 preproduction costs in its furniture division over 5 years. 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 preproduction 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 2017, retained earnings at December 31, 2016, would have been $375,000 less.
5. For the nursery division, the client proposes to switch from FIFO to LIFO inventories because it believes that LIFO will provide a better matching of current costs with revenues. The effect of making this change on 2017 earnings will be an increase of $320,000. The client says that the effect of the change on December 31, 2016, retained earnings cannot be determined.
6. To achieve an appropriate recognition of revenues and expenses in its building construction division, the client proposes to switch from the completed-contract 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, 2016, would have been $1,075,000 greater.
Instructions
(a) For each of the changes described above, decide whether:
(1) The change involves an accounting principle, accounting estimate, or correction of an error.
(2) Restatement of opening retained earnings is required.
(b) What would be the proper adjustment to the December 31, 2016, retained earnings?
CA22-2 (Analysis of Various Accounting Changes and Errors) Various types of accounting changes can affect the financial statements of a business enterprise differently. Assume that the following list describes changes that have a material effect on the financial statements for the current year of your business enterprise.
1. A change from the completed-contract method to the percentage-of-completion method of accounting for long-term construction- type contracts.
2. A change in the estimated useful life of previously recorded fixed assets as a result of newly acquired information.
3. A change from deferring and amortizing preproduction costs to recording such costs as an expense when incurred because future benefits of the costs have become doubtful. The new accounting method was adopted in recognition of the change in estimated future benefits.
4. A change from including the employer share of FICA taxes with payroll tax expenses to including it with “Retirement benefits” on the income statement.
5. Correction of a mathematical error in inventory pricing made in a prior period.
6. A change from presentation of statements of individual companies to presentation of consolidated statements.
7. A change in the method of accounting for leases for tax purposes to conform with the financial accounting method. As a result, both deferred and current taxes payable changed substantially.
8. A change from the FIFO method of inventory pricing to the LIFO method of inventory pricing.
Instructions
Identify the type of change that is described in each item above and indicate whether the prior year’s financial statements should be recast when presented in comparative form with the current year’s financial statements.
CA22-3 (Analysis of Three Accounting Changes and Errors) The following are three independent, unrelated sets of facts relating to accounting changes.
Situation 1: Sanford Company is in the process of having its first audit. The company has used the cash basis of accounting for revenue recognition. Sanford president, B. J. Jimenez, is willing to change to the accrual method of revenue recognition.
Situation 2: Hopkins Co. decides in January 2018 to change from FIFO to weighted-average pricing for its inventories.
Situation 3: Marshall Co. determined that the depreciable lives of its fixed assets are too long at present to fairly match the cost of the fixed assets with the revenue produced. The company decided at the beginning of the current year to reduce the depreciable lives of all of its existing fixed assets by 5 years.
Instructions
For each of the situations described, provide the information indicated below.
(a) Type of accounting change.
(b) Manner of reporting the change under current generally accepted accounting principles, including a discussion where applicable of how amounts are computed.
(c) Effect of the change on the balance sheet and income statement.
CA22-4 WRITING (Analysis of Various Accounting Changes and Errors) Katherine Irving, controller of Lotan Corp., is aware of a pronouncement on accounting changes. After reading the pronouncement, she is confused about what action should be taken on the following items related to Lotan Corp. for the year 2017.
1. In 2017, Lotan decided to change its policy on accounting for certain marketing costs. Previously, the company had chosen to defer and amortize all marketing costs over at least 5 years because Lotan believed that a return on these expenditures did not occur immediately. Recently, however, the time differential has considerably shortened, and Lotan is now expensing the marketing costs as incurred.
2. In 2017, the company examined its entire policy relating to the depreciation of plant equipment. Plant equipment had normally been depreciated over a 15-year period, but recent experience has indicated that the company was incorrect in its estimates and that the assets should be depreciated over a 20-year period.
3. One division of Lotan Corp., Hawthorne Co., has consistently shown an increasing net income from period to period. On closer examination of its operating statement, it is noted that bad debt expense and inventory obsolescence charges are much lower than in other divisions. In discussing this with the controller of this division, it has been learned that the controller has increased his net income each period by knowingly making low estimates related to the write-off of receivables and inventory.
4. In 2017, the company purchased new machinery that should increase production dramatically. The company has decided to depreciate this machinery on an accelerated basis, even though other machinery is depreciated on a straight-line basis.
5. All equipment sold by Lotan is subject to a 3-year warranty. It has been estimated that the expense ultimately to be incurred on these machines is 1% of sales. In 2017, because of a production breakthrough, it is now estimated that ½ of 1% of sales is sufficient. In 2015 and 2016, warranty expense was computed as $64,000 and $70,000, respectively. The company now believes that these warranty costs should be reduced by 50%.
6. In 2017, the company decided to change its method of inventory pricing from average-cost to the FIFO method. The effect of this change on prior years is to increase 2015 income by $65,000 and increase 2016 income by $20,000.
Instructions
Katherine Irving has come to you, as her CPA, for advice about the situations above. Prepare a report, indicating the appropriate accounting treatment that should be given for each of these situations.
CA22-5 WRITING (Change in Principle, Estimate) As a certified public accountant, you have been contacted by Joe Davison, CEO of Sports-Pro Athletics, Inc., a manufacturer of a variety of athletic equipment. He has asked you how to account for the following changes.
1. Sports-Pro appropriately changed its depreciation method for its machinery from the double-declining-balance method to the units-of-production method effective January 1, 2017.
2. Effective January 1, 2017, Sports-Pro appropriately changed the salvage values used in computing depreciation for its office equipment.
3. On December 31, 2017, Sports-Pro appropriately changed the specific subsidiaries constituting the group of companies for which consolidated financial statements are presented.
Instructions
Write a 1–1.5 page letter to Joe Davison explaining how each of the above changes should be presented in the December 31, 2017, financial statements.
CA22-6 ETHICS (Change in Estimate) Mike Crane is an audit senior of a large public accounting firm who has just been assigned to the Frost Corporation’s annual audit engagement. Frost has been a client of Crane’s firm for many years. Frost is a fastgrowing business in the commercial construction industry. In reviewing the fixed asset ledger, Crane discovered a series of unusual accounting changes, in which the useful lives of assets, depreciated using the straight-line method, were substantially lowered near the midpoint of the original estimate. For example, the useful life of one dump truck was changed from 10 to 6 years during its fifth year of service. Upon further investigation, Mike was told by Kevin James, Frost’s accounting manager, “I don’t really see your problem. After all, it’s perfectly legal to change an accounting estimate. Besides, our CEO likes to see big earnings!”
Instructions
Answer the following questions.
(a) What are the ethical issues concerning Frost’s practice of changing the useful lives of fixed assets?
(b) Who could be harmed by Frost’s unusual accounting changes?
(c) What should Crane do in this situation?
