P22.1B (L0 2,3) (Change in Estimate and Error Correction) Bishop Way Company is in the process of preparing its financial statements for 2020. Assume that no entries for depreciation have been recorded in 2020. The following information related
to depreciation of fixed assets is provided to you
1. Bishop Way purchased equipment on January 2, 201 , for $142,000. At that time, the equipment had an estimated useful
life of 8 years with a $6,000 salvage value. The equipment is depreciated on a straight-line basis. On January 2, 2020, as a
result of additional information, the company determined that the equipment has a remaining useful life of 6 years with a
$2,000 salvage value.
2. During 2020, Bishop Way changed from the double-declining-balance method for its warehouse to the straight-line
method. The building was purchased on January 1, 2018 and originally cost $620,000.
Straight-line $30,000 $30,000
Declining-balance 55,800 62,000
3. Bishop Way purchased a machine on July 1, 201
useful life of 6 years. Bishop Way’s bookkeeper recorded straight-line depreciation in 2018 and 2019 but failed to consider
the salvage value.
(a) Prepare the journal entries to record depreciation expense for 2020 and correct any errors made to date related to the
(b) Show comparative net income for 2019 and 2020. Income before depreciation expense was $420,000 in 2020, and was
$386,000 in 2019. (Ignore taxes.)
P22.2B (L0 2,3) (Comprehensive Accounting Change and Error Analysis Problem) Royal Palm Inc. was organized in
late 2017 to manufacture and sell personal water craft. At the end of its third year of operation, the company has been fairly successful, as indicated by the following reported net incomes.
2018 $230,000 2020 $240,000b
Includes unusual loss of $45,000.
Includes a $26,000 increase because of change in bad debt experience rate.
In March 2021, the company has decided to expand operations and has applied for a sizable bank loan. The bank officer has
indicated that the records should be audited and presented in comparative statements to facilitate analysis by the bank. Royal
Palm Inc. therefore hired an auditing firm and has provided the following additional information:
1. In early 2021, Royal Palm Inc. changed its estimate from 2.5% to 1.8% on the amount of bad debt expense to be charged to
operations. Bad debt expense for 2020, if a 1.8% rate had been used, would have been $26,000 less. The company therefore
restated its net income for 2020.
2. The auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO in 2021. The
effect on the income statements for the previous years is as follows:
2018 2019 2020
Net income unadjusted-LIFO basis $230,000 $205,000 $240,000
Net income unadjusted-FIFO basis 240,000 225,000 255,000
$ 10,000 $ 20,000 $ 15,000
3. In 2021, the auditor discovered that:
(a) The company incorrectly understated the ending inventory by $12,000 in 2017.
(b) A dispute developed in 2018 with the Internal Revenue Service over the deductibility of certain expenses. In 2018, the
company was not permitted these deductions, but a tax settlement was reached in 20 that allowed these expenses.
As a result of the court’s finding, tax expenses in 2021 were reduced by $31,000.
8, at a cost of $72,000. The machine has a salvage value of $9,000 and a
It had a useful life of 20 years
and a salvage value of $20,000. The following computations present depreciation on both bases for 2018 and 2019:
2 Chapter 22 Accounting Changes and Error Analysis
(a) Indicate how each of these changes or corrections should be handled in the accounting records. (Ignore income tax
(b) Present comparative income statements for the years 2018 to 2020, starting with income before unusual loss.
(Ignore income tax considerations.)
P22.3B (L0 1,2,3) (Error Corrections and Accounting Changes) Hammer Company is in the process of adjusting and correcting its books at the end of 20 . In reviewing its records, the following information is compiled:
1. Hammer has failed to accrue salaries and wages payable at the end of each of the last 2 years, as follows:
December 31, 2019 $6,100
December 31, 2020 $4,500
2. In reviewing the December 31, 2020, inventory, Hammer discovered errors in its inventory-taking procedures that have
caused inventories for the last 3 years to be incorrect, as follows:
December 31, 2018 Overstated $ 8,900
December 31, 2019 Understated $15,000
December 31, 2020 Overstated $ 4,600
Hammer has already made an entry that established the incorrect December 31, 2020, inventory amount.
3. At December 31, 2020, Hammer decided to change the depreciation method on its equipment from double-decliningbalance to straight-line. The equipment had an original cost of $200,000 when purchased on January 1, 2019. It has a
5-year useful life and no salvage value. Depreciation expense recorded prior to 2020 under the double-decliningbalance method was $80,000. Hammer has already recorded 2020 depreciation expense of $48,000 using the doubledeclining-balance method.
4. Before 2020, Hammer accounted for its income from long-term construction contracts on the completed-contract basis.
Early in 2020, Hammer changed to the percentage-of-completion basis for accounting purposes. It continues to use the
completed-contract method for tax purposes. Income for 2020 has been recorded using the percentage-of-completion
method. The following information is available
Prior to 2020 $210,000 $256,000
2020 55,000 84,000
Prepare the journal entries necessary at December 31, 2020, to record the above corrections and changes. The books are still open
for 2020. The income tax rate is 0%. Hammer has not yet recorded its 2020 income tax expense and payable amounts so currentyear tax effects may be ignored. Prior-year tax effects must be considered in item 4.
P22.4B (L0 4) (Accounting Changes) Power Corporation performs year-end planning in October of each year before its
calendar year ends in December. The preliminary estimated net income is $2.76 million. The CFO meets with the company president to review the projected numbers. She presents the following projected information
PROJECTED INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2020
Cost of goods sold $26,000,000
Operating expenses 11,600,000 40,400,000
Income before income tax 4,600,000
Income tax 1,840,000
Net income $ 2,760,000
CAO FIXTURES COMPANY
STATEMENT OF INCOME AND RETAINED EARNINGS
FOR THE YEARS ENDED AUGUST 31
201 201 201 201 2020
Sales-net $ 8,642 $ 10,689 $14,381 $15,400 $16,098
Cost of goods sold
Beginning inventory 1,500 1,100 1,000 1,600 2,000
Purchases 6,000 8,100 12,600 13,100 13,900
Ending inventory (1,100) (1,000) (1,600) (2,000) (1,800)
Total 6,400 8,200 12,000 12,700 14,100
Gross profi t 2,242 2,489 2,381 2,700 1,998
Administrative expenses 800 810 926 930 948
Income before taxes 1,442 1,679 1,455 1,770 1,050
Income taxes (40%) 577 672 582 708 420
Net income 865 1,007 873 1,062 630
Retained earnings-beginning 1,568 2,433 3,440 4,313 5,375
Retained earnings-ending $ 2,433 $ 3,440 $ 4,313 $ 5,375 $ 6,005
Earnings per share $8.65 $10.07 $8.73 $10.62 $6.30
B Problems 3
Security Cost Estimated Market
A $2,000,000 $2,800,000
C 3,000,000 4,000,000
J 1,000,000 800,000
Total $6,000,000 $7,600,000
SELECTED BALANCE SHEET INFORMATION
AT DECEMBER 31, 2020
Estimated cash balance $2,000,000
Available-for-sale securities (at cost) 6,000,000
Fair value adjustment (1/1/20) 1,400,000
The corporation has never used robotic equipment before, and the CFO assumed an accelerated method because of the rapidly
changing technology in robotic equipment. The company normally uses straight-line depreciation for production equipment.
The president explains to the CFO that it is important for the corporation to show a $5,000,000 income before taxes because
the president receives a $1,000,000 bonus if the income before taxes and bonus reaches $5,000,000. The president also does not
want the company to pay more than $1,800,000 in income taxes to the government.
(a) What can the CFO do within GAAP to accommodate the president’s wishes to achieve $5,000,000 in income before taxes
and bonus? Present the revised income statement based on your decision.
(b) Are the actions ethical? Who are the stakeholders in this decision, and what effect do the CFO’s actions have on their
P22.5B (L0 1) (Change in Principle—Inventory—Periodic) The management of Cao Fixtures Company had concluded,
with the concurrence of its independent auditors, that results of operations would be more fairly presented if Cao changed its
method of pricing inventory from last-in, first-out (LIFO) to FIFO in 2020. Given below is the 5-year summary of income under
LIFO and a schedule of what the inventories would be if stated on the FIFO method.
Estimated market value at December 31, 2020:
Other information at December 31, 2020:
Accumulated depreciation (5-year SL) 3,400,000
New robotic equipment (purchased 1/1/20) 3,000,000
Accumulated depreciation (5-year DDB) 1,200,000
6 7 8 9
4 Chapter 22 Accounting Changes and Error Analysis
Prepare comparative statements for the 5 years, assuming that Cao Fixtures changed its method of inventory pricing to FIFO.
Indicate the effects on net income and earnings per share for the years involved. Cao Fixtures started business in 2013. (All
amounts except EPS are rounded up to the nearest dollar.)
P22.6B (L0 1,3,4) (Accounting Change and Error Analysis) On December 31, 2020, before the books were closed, the management and accountants of Tannery Inc. made the following determinations about three depreciable assets:
1. Depreciable asset X was purchased January 4, 2018. The asset’s original cost was $114,000, and this amount was entirely
expensed in 2018. This particular asset has a 8-year useful life and no salvage value. The straight-line method was chosen for depreciation purposes.
2. Depreciable asset Y was purchased January 2, 2019. It originally cost $540,000 and, for depreciation purposes, the sum-ofthe-years’ digit method was originally chosen. The asset was originally expected to be useful for 10 years and have a zero
salvage value. In 2020, the decision was made to change the depreciation method from sum-of-the-years’ digits to straightline, and the estimates relating to useful life and salvage value remained unchanged.
3. Depreciable asset Z was purchased January 3, 20 . It originally cost $160,000 and, for depreciation purposes, the straightline method was chosen. The asset was originally expected to be useful for 8 years and have a zero salvage value. In 20 ,
the decision was made to extend the total life of this asset to 10 years and to estimate the salvage value at $5,000.
1. Income in 2020 before depreciation expense amounted to $316,000.
2. Depreciation expense on assets other than X, Y, and Z totaled $41,000 in 2020.
3. Income in 2019 was reported at $298,000.
4. Ignore all income tax effects.
5. 100,000 shares of common stock were outstanding in 2019 and 2020.
(a) Prepare all necessary entries in 2020 to record these determinations.
(b) Prepare comparative retained earnings statements for Tannery Inc. for 2019 and 2020. The company had retained earnings of $325,000 at December 31, 201 .
P22.7B (L0 3,4) (Error Corrections) You have been assigned to examine the financial statements of Maple Company for the
year ended December 31, 2020. You discover the following situations
1. Depreciation of $2,500 for 2020 on executive vehicles was not recorded.
2. The physical inventory count on December 31, 2019, improperly excluded merchandise costing $10,600 that had been on
consignment with a customer. Maple uses a periodic inventory system.
3. A collection of $3,600 on account from a customer received on December 31, 2020, was not recorded until January 4, 2021.
4. In 2020, the company sold for $2,500 fully depreciated equipment that originally cost $12,000. The company credited the
proceeds from the sale to the Equipment account.
5. During November 2020, a competitor company filed a patent-infringement suit against Maple claiming damages of
$600,000. The company’s legal counsel has indicated that an unfavorable verdict is possible and a reasonable estimate of
the court’s award to the competitor is $200,000. The company has not reflected or disclosed this situation in the financial
6. Maple has a portfolio of trading securities. No entry has been made in 2020 to adjust to market. Information on cost and
market value is as follows:
December 31, 2019 $120,000 $127,000
December 31, 2020 $146,000 $150,000
7. At December 31, 2020, an analysis of payroll information shows accrued salaries of $4,600. The accrued salaries account
had a balance of $1,400 at December 31, 20 , which was unchanged from its balance at December 31, 20 .
SCHEDULE OF INVENTORY BALANCES USING FIFO METHOD
FOR THE YEARS ENDED AUGUST 31
201 201 201 201 201 20
$1,550 $1,120 $1,050 $1,690 $2,150 $2,160
5 6 7 8 9 20
B Problems 5
8. A large piece of equipment was purchased on January 3, 2020, for $75,000 and was charged to Maintenance and Repairs
Expense. The equipment is estimated to have a service life of 5 years and no residual value. Maple normally uses the straightline depreciation method for this type of equipment.
9. A $6,000 insurance premium paid on October 1, 20 , for a policy that expires on September 30, 2021, was charged to insurance expense.
10. A patent was acquired at the beginning of 201 for $210,000. No amortization has been recorded since its acquisition. The
estimated remaining life of the patent is 12 years.
Assume the trial balance has been prepared but the books have not been closed for 2020. Assuming all amounts are material,
prepare journal entries showing the adjustments that are required. (Ignore income tax considerations.)
P22.8B (L0 4) (Comprehensive Error Analysis) On March 5, 20 , you were hired by Miami Hangers Inc., a closely held
company, as a staff member of its newly created internal auditing department. While reviewing the company’s records for 201
and 2020, you discover that no adjustments have yet been made for the items listed below.
1. Interest income of $6,800 was not accrued at the end of 201 . It was recorded when received in January 2020.
2. Furniture costing $16,000 was expensed when purchased on July 1, 2019. It is expected to have a 10-year life with no
salvage value. The company typically uses straight-line depreciation for all fixed assets.
3. Research and development costs of $76,000 were incurred early in 20 . They were capitalized and were to be amortized
over a 4-year period. Amortization of $19,000 was recorded for 2019 and $19,000 for 20 .
4. On January 2, 2019, Miami Hangers leased a building for 5 years at a monthly rental of $12,000. On that date, the company
paid the following amounts, which were expensed when paid
Security deposit $10,000
First month’s rent 12,000
Last month’s rent 12,000
5. The company received $28,000 from a customer at the beginning of 2019 for services that it is to be performed evenly over
a 2-year period beginning in 2019. None of the amount received was reported as unearned revenue at the end of 2019.
6. Merchandise inventory costing $34,600 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.
Indicate 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 balance sheet 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.
P22.9B (L0 4) (Error Analysis) SLC Corporation has used the accrual basis of accounting for several years. A review of the
records, however, indicates that some expenses and revenues have been handled on a cash basis because of errors made by an
inexperienced bookkeeper. Income statements prepared by the bookkeeper reported $46,000 net income for 2019 and $52,000 net
income for 2020. Further examination of the records reveals that the following items were handled improperl
1. Rent was received from a tenant in Janaury 2020. The amount, $2,000, was recorded as revenue at that time even though
the rental pertained to December 2019.
2. Salaries and wages payable on December 31 have been consistently omitted from the records of that date and have been
entered as expenses when paid in the following year. The amounts of the accruals recorded in this manner were:
December 31, 2018 $2,400
December 31, 201 1,150
December 31, 2020 2,180
Net Income for 201 Retained Earnings at 12/31/20
Item Understated Overstated Understated Overstated
6 Chapter 22 Accounting Changes and Error Analysis
3. Invoices for office supplies purchased have been charged to expense accounts when received. Inventories of supplies on
hand at the end of each year have been ignored, and no entry has been made for them.
December 31, 2018 $800
December 31, 2019 1,160
December 31, 2020 650
Prepare a schedule that will show the corrected net income for the years 2019 and 2020. All items listed should be labeled clearly.
(Ignore income tax considerations.)
P22.10B (L0 3,4) (Error Analysis and Correcting Entries) You have been asked by a client to review the records of Beaches
Company, a small distributor of high quality hot tubs and pools. Your client is interested in buying the business, and arrangements have been made for you to review the accounting records. Your examination reveals the following information:
1. Beaches Company commenced business on July 1, 2018, and has been reporting on a fiscal year ending June 30. The company has never been audited, but the annual statements prepared by the bookkeeper reflect the following income before
closing and before deducting income taxes:
Year Ended Income
June 30 Before Taxes
2. A relatively small number of hot tubs have been shipped on consignment. These transactions have been recorded as ordinary sales and billed as such. On June 30 of each year, the selling price of hot tubs billed and in the hands of consignees
Sales price was determined by adding 20% to cost. Assume that the consigned machines are sold the following year.
3. On June 28, 201 , two hot tubs were shipped to a customer on a C.O.D. basis. The sale was not entered until July 10, 2019, when
cash was received for $6,800. The hot tubs were not included in the inventory at June 30, 2019. (Title passed on June 28, 2019.)
4. All hot tubs and pools are sold subject to a 3-year warranty. It is estimated that the expense ultimately to be incurred in
connection with the warranty will amount to 0.6% of sales. The company has charged an expense account for warranty
Sales per books and warranty costs were as follows:
5. Bad debts have been recorded on a direct write-off basis. Experience of similar enterprises indicates that losses will
approximate ½ of 1% of sales. Bad debts written off were:
Year Ended for Sales Made in
June 30 Sales 20 2020 2021 Total
20 $1,200,000 $1,540 $1,540
2020 1,560,000 1,180 $1,680 2,860
20 2,089,000 820 1,190 $1,900 3,910
Bad Debts Incurred on Sales Made in
June 30 2019 2020 2021 Total
2019 $810 $ 810
2020 950 $1,100 2,050
2021 310 820 $1,640 2,770
6. The bank deducts 10% on all contracts financed. Of this amount, 1% is placed in a reserve to the credit of Beaches Company that is refunded to Beaches as finance contracts are paid in full. The reserve established by the bank has not been
B Problems 7
reflected in the books of Beaches. The excess of credits over debits (net increase) to the reserve account with Beaches on the
books of the bank for each fiscal year were as follows:
2019 $ 4,600
7. Commissions on sales have been entered when paid. Commissions payable on June 30 of each year were as follows:
8. A review of the corporate minutes reveals the manager is entitled to a bonus of 1% of the income before deducting income
taxes and the bonus. The bonuses have never been recorded or paid.
(a) Present a schedule showing the revised income before income taxes for each of the years ended June 30, 2019, 20 , and
2021. Make computations to the nearest whole dollar.
(b) Prepare the journal entry or entries you would give the bookkeeper to correct the books. Assume the books have not
yet been closed for the fiscal year ended June 30, 2021. Disregard correction of income taxes.
*P22.11B (L0 5) (Fair Value to Equity Method with Goodwill) On January 1, 20 , Phipps Inc. paid $500,000 for 20,000 shares
of Payson Company’s voting common stock, which was a 10% interest in Payson. At that date, the net assets of Payson totaled
$4,000,000. The fair values of all of Payson’s identifiable assets and liabilities were equal to their book values. Phipps does not
have the ability to exercise significant influence over the operating and financial policies of Payson. Phipps received dividends of
$1.25 per share from Payson on June 1, 20 . Payson reported net income of $340,000 for the year ended December 31, 20 .
On July 1, 20 , Phipps paid $1,900,000 for 60,000 additional shares of Payson Company’s voting common stock which
represents a 30% investment in Payson. The fair values of all of Payson’s identifiable assets net of liabilities were equal to their
book values of $5,400,000. As a result of this transaction, Phipps has the ability to exercise significant influence over the operating and financial policies of Payson. Phipps received dividends of $1.50 per share from Payson on June 1, 2021, and $2.00 per
share on December 1, 2021. Payson reported net income of $520,000 for the year ended December 31, 2021, and $325,000 for the
6 months ended December 31, 20 .
(a) Prepare a schedule showing the income or loss before income taxes for the year ended December 31, 2020, that Phipps
should report from its investment in Payson in its income statement issued in March 2021.
(b) During March 2022, Phipps issues comparative financial statements for 2020 and 2021. Prepare schedules showing the
income or loss before income taxes for the years ended December 31, 20 and 20 , that Phipps should report from its
investment in Payson.
*P22 12B (L0 5) (Change from Fair Value to Equity Method) On January 2, 2019, Hudson Company purchased for $600,000
cash a 10% interest in Lawrence Corp. On that date, the net assets of Lawrence had a book value of $4,500,000. The excess of cost
over the underlying equity in net assets is attributable to undervalued depreciable assets having a remaining life of 10 years from
the date of Hudson’s purchase.
The fair value of Hudson’s investment in Lawrence securities is as follows: December 31, 2019, $620,000, and December 31,
On January 3, 2021, Hudson purchased an additional 30% of Lawrence’s stock for $2,240,000 cash when the book value of
Lawrence’s net assets was $5,650,000. The excess was attributable to depreciable assets having a remaining life of 8 years.
During 2019, 2020, and 20 , the following occurred:
Lawrence Dividends Paid by
Net Income Lawrence to Hudson
20 $425,000 $12,000
2020 470,000 14,000
2021 610,000 32,000
On the books of Hudson Company, prepare all journal entries in 201 , 20 , and 20 that relate to its investment in Lawrence
Corp., reflecting the data above and a change from the fair value method to the equity method.
9 20 21