Anwser to Exercise_Chap 8-Chap 20.docx

Chap 8

Exercise 8–11. To record the purchase of inventory on account and the payment of freight

charges.

Inventory......................................................................... 5,000Accounts payable........................................................ 5,000

Inventory......................................................................... 300Cash............................................................................ 300

2. To record purchase returns.

Accounts payable............................................................ 600Inventory..................................................................... 600

3. To record cash sales and cost of goods sold.

Cash................................................................................ 5,200Sales revenue.............................................................. 5,200

Cost of goods sold.......................................................... 2,800Inventory..................................................................... 2,800

Exercise 8–21. To record the purchase of inventory on account and the payment of freight

charges.

Purchases........................................................................ 5,000Accounts payable........................................................ 5,000

Freight-in........................................................................ 300Cash............................................................................ 300

2. To record purchase returns.

Accounts payable............................................................ 600Purchase returns.......................................................... 600

3. To record cash sales.

Cash................................................................................ 5,200Sales revenue.............................................................. 5,200

NO ENTRY IS MADE FOR THE COST OF GOODS SOLD.

Exercise 8–4

PERPETUAL SYSTEM PERIODIC SYSTEM($ in 000s)

PurchasesInventory 155 Purchases 155

Accounts payable 155 Accounts payable 155

FreightInventory 10 Freight-in 10

Cash 10 Cash 10

ReturnsAccounts payable 12 Accounts payable 12

Inventory 12 Purchase returns 12

SalesAccounts receivable 250 Accounts receivable 250

Sales revenue 250 Sales revenue 250

Cost of goods sold 148 No entryInventory 148

End of periodNo entry Cost of goods sold (below) 148

Inventory (ending) 30Purchase returns 12

Inventory (beginning) 25Purchases 155Freight-in 10

Cost of goods sold:Beginning inventory $25Purchases $155Less: Returns (12)Plus: Freight-in 10Net purchases 153Cost of goods available 178Less: Ending inventory (30)Cost of goods sold $148

Exercise 8–52016 2017 2018

Beginning inventory 275 (1) 249 (3) 225Cost of goods sold 627 621 584 (6)Ending inventory 249 (2) 225 216Cost of goods available for sale 876 846 (4) 800Purchases (gross) 630 610 (5) 585Purchase discounts 18 15 12 (7)Purchase returns 24 30 14Freight-in 13 32 16

Net purchases = Purchases (gross) – Purchase returns – Purchase discounts + Freight-inBeginning inventory + Net purchases = Cost of goods available for saleCost of goods available for sale – Ending inventory = Cost of goods sold

2016:(1) Cost of goods available for sale – Net purchases = Beginning inventory 876 – (630 – 18 – 24 + 13) = 275 = Beginning inventory

(2) Cost of goods available for sale – Cost of goods sold = Ending inventory 876 – 627 = 249 = Ending inventory

2017:(3) 2017 beginning inventory = 2016 ending inventory = 249

(4) Cost of goods sold + Ending inventory = Cost of goods available for sale 621 + 225 = 846 = Cost of goods available for sale

(5) Cost of goods available for sale – Beginning inventory = Net purchases 846 – 249 = 597 = Net purchases

Net purchases + Purchases discounts + Purchase returns – Freight-in = Purchases(gross) 597 + 15 + 30 – 32 = 610 = Purchases (gross)

2018:(6) Cost of goods available for sale – Ending inventory = Cost of goods sold 800 – 216 = 584 = Cost of goods sold

Exercise 8–5 (concluded)

(7) Cost of goods available for sale – Beginning inventory = Net purchases 800 – 225 = 575 = Net purchases Purchases (gross) – Purchase returns + Freight-in – Net purchases = Purchase discounts 585 – 14 + 16 – 575 = 12 = Purchase discounts

Exercise 8–6Inventory balance before additional transactions $165,000Add: 2. Goods shipped to Kwok f.o.b. shipping point on Dec. 28 17,000 3. Goods shipped to customer f.o.b. destination on December 27 22,000 Correct inventory balance $204,000

Exercise 8–81. Excluded2. Included3. Included4. Excluded5. Included6. Excluded7. Included

Exercise 8–9

Requirement 1

Purchase price = 1,000 units x $50 = $50,000

July 15, 2016Purchases........................................................................ 50,000

Accounts payable........................................................ 50,000

July 23, 2016Accounts payable............................................................ 50,000

Cash (98% x $50,000).................................................... 49,000Purchase discounts (2% x $50,000)............................... 1,000

Requirement 2

August 15, 2016Accounts payable............................................................ 50,000

Cash............................................................................ 50,000

Requirement 3The July 15 entry would include a debit to the inventory account instead of to

purchases, and the July 23 entry would include a credit to the inventory account instead of to purchase discounts.

Exercise 8–10

Requirement 1

July 15, 2016Purchases (98% x $50,000)................................................ 49,000

Accounts payable ....................................................... 49,000

July 23, 2016Accounts payable............................................................ 49,000

Cash............................................................................ 49,000

Requirement 2

August 15, 2016Accounts payable............................................................ 49,000Interest expense.............................................................. 1,000

Cash............................................................................ 50,000

Requirement 3The July 15 entry would include a debit to the inventory account instead of to

purchases.

Exercise 8–13Cost of goods available for sale:Beginning inventory (2,000 x $6.10) $12,200Purchases:

10,000 x $5.50 $55,000 6,000 x $5.00 30,000 85,000

Cost of goods available (18,000 units) $97,200

First-in, first-out (FIFO)

Cost of goods available for sale (18,000 units) $97,200Less: Ending inventory (determined below) (15,000) Cost of goods sold $82,200

Cost of ending inventory:

Date of purchase Units Unit cost Total cost

August 18 3,000 $5.00 $15,000

Last-in, first-out (LIFO)

Cost of goods available for sale (18,000 units) $97,200Less: Ending inventory (determined below) (17,700) Cost of goods sold $79,500


Date of purchase Units Unit cost Total cost

Beg. Inv. 2,000 $6.10 $12,200August 8 1,000 5.50 5,500

Total $17,700


Average cost

Cost of goods available for sale (18,000 units) $97,200Less: Ending inventory (determined below) (16,200) Cost of goods sold $81,000 *

Cost of ending inventory: $97,200

Weighted-average unit cost = = $5.40 18,000 units

3,000 units x $5.40 = $16,200

* Alternatively, could be determined by multiplying the units sold by the average cost: 15,000 units x $5.40 = $81,000

Exercise 8–14First-in, first-out (FIFO)

Cost of goods sold:

Date of Cost of Sale Units Sold Units Sold Total Cost

Aug. 14 2,000 (from Beg. Inv.) $6.10 $12,200 6,000 (from 8/8 purchase) 5.50 33,000Aug. 25 4,000 (from 8/8 purchase) 5.50 22,000 3,000 (from 8/18 purchase) 5.00 15,000 Total 15,000 $82,200

Ending inventory = 3,000 units x $5.00 = $15,000

Last-in, first-out (LIFO)Date Purchased Sold Balance

Beginning inventory

2,000 @ $6.10 = $12,200 2,000 @ $6.10 $12,200

August 8 10,000 @ $5.50 = $55,000 2,000 @ $6.1010,000 @ $5.50 $67,200

August 14 8,000 @ $ 5.50 = $44,000 2,000 @ $6.10 2,000 @ $5.50 $23,200

August 18 6,000 @ $5.00 = $30,000 2,000 @ $6.10 2,000 @ $5.50 $53,200 6,000 @ $5.00

August 25 6,000 @ $5.00 = $30,0001,000 @ $5.50 = $ 5,500

2,000 @ $6.10 1,000 @ $5.50 $17,700

Endinginventory

Total cost of goods sold = $79,500


(Note: the perpetual inventory LIFO results in this exercise are the same as periodic LIFO results, due to the timing of sales and purchases. The same LIFO layers are on hand at the end of the period under each method. This is unusual. LIFO perpetual and LIFO periodic normally produce different results for ending inventory and cost of goods sold.)

Average costDate Purchased Sold Balance

Beginning inventory

2,000 @ $6.10 = $12,200 2,000 @ $6.10 $12,200

August 8

Available

10,000 @ $5.50 = $55,000

$67,200

= $5.60/unit12,000 units

August 14 8,000 @ $5.60 = $44,800 4,000 @ $5.60 $22,400

August 18

Available

6,000 @ $5.00 = $30,000

$52,400

= $5.24/unit10,000 units

August 25 7,000 @ $5.24 = $36,680 3,000 @ $5.24 $15,720

Endinginventory

Total cost of goods sold = $81,480

Exercise 8–23Ending

Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost

1/1/16 $660,000

= $660,000 $660,000 (base) $660,000 x 1.00 = $660,000 $660,000 1.00

12/31/16 $690,000

= $663,462 $660,000 (base) $660,000 x 1.00 = $660,000

1.04 3,462 (2016) 3,462 x 1.04 = 3,600 663,600

12/31/17 $760,000

= $703,704 $660,000 (base) $660,000 x 1.00 = $660,000 1.08 3,462 (2016) 3,462 x 1.04 = 3,600

40,242 (2017) 40,242 x 1.08 = 43,461 707,061

CPA / CMA REVIEW QUESTIONS

CPA Exam Questions

1. d.

2. c. Under the net method, purchases are recorded net of the discount: $3,600 x 98% = $3,528

3. b. Average Cost = $4,950 / 140 units = $35.36 per unit

Ending Inventory = $35.36 x 5 = $176.79

4. a. 5 units x $30 = $150

5. c. 5 units x $50 = $250

6. b. If the inventory balance was lower using FIFO than LIFO, then prices during the period were moving downward. By using FIFO during such a period, the higher priced items are sold first with lower-priced goods remaining in the ending inventory.

7. b. Inventory Layer Layer at Base at Base Cost at Current Ending

Date Year Cost Year Cost Index Year Cost Inventory 1/1/16 $100,000 1.00 $100,000 12/31/16 120,000 $20,000 1.05 $21,000 121,000 12/31/17 128,000 8,000 1.10 8,800 129,800

8. a. IAS No. 2 does not permit the use of LIFO.

CMA Exam Questions

1. c. The company began March with 3,200 units in inventory at $64.30 each. The March 4 purchase added 3,400 additional units at $64.75 each. Under FIFO, the 3,600 units sold on March 14 were the oldest units. That sale eliminated all of the 3,200 units priced at $64.30 and 400 of the units priced at $64.75, leaving an inventory of 3,000 units at $64.75 prior to the March 25 purchase. On March 25, 3,500 units were acquired at $66. The 3,450 units sold on March 28 were the 3,000 remaining units priced at $64.75 and 450 units priced at $66. The ending inventory consists of 3,050 units at $66 each, or $201,300. The answer would have been the same under the periodic FIFO method.

2. a. The ending inventory consists of 3,050 units (beginning inventory plus purchases, minus sales). Under the periodic LIFO method, those units are valued at the oldest prices for the period, which is $64.30 of the beginning inventory. Multiplying $64.30 times 3,050 units produces a total inventory value of $196,115.

3. a. Under the perpetual LIFO method, the company begins with 3,200 units at $64.30. Added to this is the March 4 purchase of 3,400 units at $64.75. The March 14 sale uses all of the March 4 purchase and 200 of the original inventory units. Thus, the firm is left with 3,000 units at $64.30. The March 25 purchase of 3,500 at $66 is added to the previous 3,000 units. The March 28 sale of 3,450 units comes entirely from the March 25 purchase, leaving just 50 of those units at $66 each. Thus, at the end of the month, the inventory consists of two layers: 3,000 units at $64.30 ($192,200), and 50 units at $66 ($3,300). Adding the two together produces a total ending inventory of $196,200.

Problem 8–21. The transaction is not correctly accounted for. Inventory held on consignment

by another company should be included in the inventory of the consignor. Rasul should include this merchandise in its 2016 ending inventory.

2. The transaction is not correctly accounted for. Legal title to merchandise shipped f.o.b. shipping point changes hands when the goods are shipped. Rasul should record the purchase and corresponding account payable in 2016 and include the merchandise in its 2016 ending inventory.

3. The transaction is not correctly accounted for. Since the merchandise was shipped f.o.b. destination and did not arrive at the customer's location until 2017, it should be included in Rasul’s 2016 ending inventory. The sale should be recorded in 2017.

4. The transaction is correctly accounted for. Merchandise held on consignment from another company belongs to the consignor and should be excluded from the inventory of the consignee.

5. The transaction is correctly accounted for. Since the merchandise was shipped f.o.b. destination and did not arrive at Rasul’s location until 2017, it should not be included in Rasul’s 2016 ending inventory. The purchase is correctly recorded in 2017.

Problem 8–4

Requirement 1Beginning inventory (10,000 x $8.00) $ 80,000Net purchases:

Purchases (50,000* units x $10.00) $500,000Less: Returns (1,000 units x $10.50) (10,500)Less: Purchase discounts ($490,000 x 2%) (9,800)Plus: Freight-in (50,000 units x $.50) 25,000 504,700

Cost of goods available (59,000 units) 584,700Less: Ending inventory (below) ( 121,200 )Cost of goods sold $463,500

* The 5,000 units purchased on December 28 are not included. The merchandise was shipped f.o.b. destination and did not arrive at Johnson’s warehouse until 2017.


Date of purchase Units Unit cost Total costBeg. Inv. 10,000 $ 8.00 $ 80,0002016 4,000 10.30** 41,200

Total 14,000 $121,200

**$10 x 98% = $9.80 + .50 in freight charges = $10.30

Requirement 2Sales (45,000 units x $18.00) $810,000Less: Cost of goods sold (above) $463,500 Other operating expenses 150,000 (613,500)Income before income taxes $196,500

Problem 8–7

Requirement 1Beginning inventory ($60,000 + 60,000 + 63,000) $183,000Purchases:

211 $63,000212 63,000213 64,500214 66,000215 69,000216 70,500217 72,000218 72,300219 75,000 615,300

Cost of goods available 798,300

Ending inventory:213 $64,500216 70,500219 75,000 (210,000)

Cost of goods sold $588,300

Requirement 2

Cost of goods available for sale $798,300Less: Ending inventory (below) (219,300) Cost of goods sold $579,000

Cost of ending inventory (3 autos):

Car ID Cost219 $ 75,000218 72,300217 72,000 Total $219,300

Problem 8–7 (concluded)

Requirement 3

Cost of goods available for sale $798,300Less: Ending inventory (below) (183,000) Cost of goods sold $615,300

Cost of ending inventory (3 autos):

Car ID Cost203 $ 60,000207 60,000210 63,000 Total $183,000

Requirement 4

Cost of goods available for sale (12 units) $798,300Less: Ending inventory (below) (199,575) Cost of goods sold $598,725*

Cost of ending inventory: $798,300

Weighted-average unit cost = = $66,525 12 units

3 units x $66,525 = $199,575

* Alternatively, could be determined by multiplying the units sold by the average cost: 9 units x $66,525 = $598,725

Problem 8–15Ending

Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost

1/1/16 $260,000

= $260,000 $260,000 (base) $260,000 x 1.00 = $260,000 $260,000 1.00

12/31/16 $340,000

= $333,333 $260,000 (base) $260,000 x 1.00 = $260,000 1.02 73,333 (2016) 73,333 x 1.02 = 74,800 334,800

12/31/17 $350,000

= $330,189 $260,000 (base) $260,000 x 1.00 = $260,000 1.06 70,189 (2016) 70,189 x 1.02 = 71,593 331,593

12/31/18 $400,000

= $373,832 $260,000 (base) $260,000 x 1.00 = $260,000 1.07 70,189 (2016) 70,189 x 1.02 = 71,593

43,643 (2018) 43,643 x 1.07 = 46,698 378,291

12/31/19 $430,000

= $390,909 $260,000 (base) $260,000 x 1.00 = $260,000 1.10 70,189 (2016) 70,189 x 1.02 = 71,593

43,643 (2018) 43,643 x 1.07 = 46,698 17,077 (2019) 17,077 x 1.10 = 18,785 397,076

Chap 9

Brief Exercise 9–4

Beginning inventory (from records) $150,000Plus: Net purchases (from records) 450,000 Cost of goods available for sale 600,000Less: Cost of goods sold:

Net sales $700,000Less: Estimated gross profit ( ? )Estimated cost of goods sold ( ? )

Estimated cost of inventory lost $ 75,000

Estimated cost of goods sold = $600,000 – 75,000 = $525,000*Estimated gross profit = $700,000 – 525,000* = $175,000

$175,000 $700,000 = 25% gross profit ratio


Cost RetailBeginning inventory $ 300,000 $ 450,000Plus: Net purchases 861,000 1,210,000

Freight-in 22,000Net markups 48,000

Less: Net markdowns ______ (18,000 )Goods available for sale 1,183,000 1,690,000

$1,183,000Cost-to-retail percentage: = 70% $1,690,000

Less: Net sales (1,200,000 )Estimated ending inventory at retail $ 490,000 Estimated ending inventory at cost (70% x $490,000) (343,000 )Estimated cost of goods sold $ 840,000


Cost RetailBeginning inventory $ 300,000 $ 450,000 Plus: Net purchases 861,000 1,210,000


Less: Net markdowns _______ (18,000)Goods available for sale (excluding beg. Inventory) 883,000 1,240,000 Goods available for sale (including beg. Inventory) 1,183,000 1,690,000

$883,000Cost-to-retail percentage: = 71.21% $1,240,000

Less: Net sales (1,200,000 )Estimated ending inventory at retail $ 490,000 Estimated ending inventory at cost: Retail CostBeginning inventory $ 450,000 $ 300,000Current period’s layer 40,000 x 71.21 % = 28,484 Total $ 490,000 $328,484 (328,484 )Estimated cost of goods sold $ 854,516


Cost RetailBeginning inventory $ 300,000 $ 450,000Plus: Net purchases 861,000 1,210,000


Goods available for sale 1,708,000

$1,183,000Cost-to-retail percentage: = 69.26% $1,708,000Less: Net markdowns ______ (18,000 )Goods available for sale 1,183,000 1,690,000Less: Net sales (1,200,000 )Estimated ending inventory at retail $ 490,000 Estimated ending inventory at cost (69.26% x $490,000) (339,374 )Estimated cost of goods sold $ 843,626


The 2014 error caused 2014 net income to be overstated, but since 2014 ending inventory is 2015 beginning inventory, 2015 net income was understated by the same amount. So, the income statement was misstated for 2014 and 2015, but the balance sheet (retained earnings) was incorrect only for 2014. After that, no account balances are incorrect due to the 2014 error.

Analysis of 2014 ending inventory error effects:U = UnderstatedO = Overstated

2014 2015Beginning inventory Beginning inventory OPlus: net purchases Plus: net purchases Less: ending inventory O Less: ending inventoryCost of goods sold U Cost of goods sold O

Revenues RevenuesLess: cost of goods sold U Less: cost of goods sold OLess: other expenses Less: other expensesNet income O Net income U

Retained earnings O Retained earnings corrected

Brief Exercise 9–13 (concluded)

However, the 2015 error has not yet self-corrected. Both retained earnings and inventory still are overstated as a result of the second error.

Analysis of 2015 ending inventory error effects:

U = UnderstatedO = Overstated

2015Beginning inventory Plus: net purchases Less: ending inventory O Cost of goods sold U

RevenuesLess: cost of goods sold ULess: other expensesNet income O

Retained earnings O

Retained earnings on January 1, 2016, in this case, would be overstated by $500,000 (ignoring income taxes).


The financial statements that were incorrect as a result of both errors (effect of one error in 2014 and effect of two errors in 2015) would be retrospectively restated to report the correct inventory amounts, cost of goods sold, income, and retained earnings when those statements are reported again for comparative purposes in the current annual report. A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share.

Exercise 9–1

(1) (2)

Product Cost NRV (*)

Per UnitInventory Value

[Lower of (1) and (2)]

1 $ 20 $34 $20

2 90 80 80

3 50 60 50

* Selling price less costs to sell.

Exercise 9–7

Merchandise inventory, January 1, 2016 $1,900,000Purchases 5,800,000Freight-in 400,000

Cost of goods available for sale 8,100,000Less: Cost of goods sold:

Sales $8,200,000 Less: Estimated gross profit of 20% (1,640,000) (6,560,000)

Estimated loss from fire $1,540,000

Exercise 9–8

Requirement 1

Beginning inventory (from records) $ 58,500Plus: Net purchases ($110,000 – 4,000) 106,000

Freight-in (from records) 3,000 Cost of goods available for sale 167,500Less: Cost of goods sold:

Net sales ($180,000 – 5,000) $175,000Less: Estimated gross profit of 40% (70,000)Estimated cost of goods sold (105,000)

Estimated cost of inventory before theft 62,500Less: Stolen inventory (8,000)Estimated ending inventory $ 54,500

Requirement 2

Beginning inventory (from records) $ 58,500Plus: Net purchases ($110,000 – 4,000) 106,000

Freight-in (from records) 3,000 Cost of goods available for sale 167,500Less: Cost of goods sold:

Net sales ($180,000 – 5,000) $175,000Less: Estimated gross profit of 50%* (87,500)Estimated cost of goods sold (87,500)

Estimated cost of inventory before theft 80,000Less: Stolen inventory (8,000)Estimated ending inventory $ 72,000

*Gross profit as a % of cost (1 + Gross profit as a % of cost) = Gross profit as a % of sales. 100% 200% = 50%

Exercise 9–10

Cost RetailBeginning inventory $35,000 $50,000Plus: Net purchases 19,120 31,600

Net markups 1,200Less: Net markdowns ______ (800 )Goods available for sale 54,120 82,000

$54,120Cost-to-retail percentage: = 66% $82,000

Less: Net sales (32,000 )Estimated ending inventory at retail $50,000 Estimated ending inventory at cost (66% x $50,000) (33,000 )Estimated cost of goods sold $21,120

Exercise 9–11

Cost RetailBeginning inventory $190,000 $ 280,000Plus: Purchases 600,000 840,000


1,140,000 $798,000

Cost-to-retail percentage: = 70% $1,140,000

Less: Net markdowns _______ (4,000 )Goods available for sale 798,000 1,136,000Less: Net sales (800,000 )

Estimated ending inventory at retail $ 336,000 Estimated ending inventory at cost (70% x $336,000) $235,200

Exercise 9–12

Cost RetailBeginning inventory $160,000 $ 280,000 Plus: Net purchases 607,760 840,000

Net markups 20,000Less: Net markdowns _______ (4,000 )Goods available for sale (excluding beg. inventory) 607,760 856,000 Goods available for sale (including beg. inventory) 767,760 1,136,000

$607,760Cost-to-retail percentage: = 71% $856,000

Less: Net sales (800,000 )Estimated ending inventory at retail $ 336,000 Estimated ending inventory at cost: Retail CostBeginning inventory $280,000 $160,000Current period’s layer 56,000 x 71% = 39,760 Total $336,000 $199,760 (199,760 )Estimated cost of goods sold $568,000

Exercise 9–14

Requirement 1

Cost RetailBeginning inventory $ 40,000 $ 60,000Plus: Purchases 207,000 400,000

Freight-in 14,488Less: Purchase returns (4,000) (6,000)Plus: Net markups 5,800

459,800

$257,488Cost-to-retail percentage: = 56% $459,800Less: Net markdowns _______ (3,500 )Goods available for sale 257,488 456,300Less:

Normal breakage (6,000)Sales:

Net sales (280,000)Employee discounts (1,800 )

Estimated ending inventory at retail $168,500 Estimated ending inventory at cost (56% x $168,500) (94,360 )Estimated cost of goods sold $163,128

Requirement 2Net markdowns are included in the cost-to-retail percentage:

$257,488Cost-to-retail percentage: = 56.43% $456,300

Exercise 9–21

Requirement 1

Retained earnings.................................................................. 5,000Inventory ($83,000 – 78,000)............................................. 5,000

Requirement 2Effect on cost of goods sold:

Decrease in beginning inventory ($78,000 – 71,000) - $7,000

Decrease in ending inventory ($83,000 – 78,000) + 5,000Decrease in cost of goods sold $2,000

Cost of goods sold for 2015 would be $2,000 lower in the revised income statement.

Exercise 9–22

Requirement 1

The 2014 error caused 2014 net income to be understated, but since 2014 ending inventory is 2015 beginning inventory, 2015 net income was overstated by the same amount. So, the income statement was misstated for 2014 and 2015, but the balance sheet (retained earnings) was incorrect only for 2014. After that, no account balances are incorrect due to the 2014 error.

Analysis of 2014 ending inventory effects:U = UnderstatedO = Overstated

2014 2015Beginning inventory Beginning inventory UPlus: net purchases Plus: net purchases Less: ending inventory U Less: ending inventoryCost of goods sold O Cost of goods sold U

Revenues RevenuesLess: cost of goods sold O Less: cost of goods sold ULess: other expenses Less: other expensesNet income U Net income O

Retained earnings U Retained earnings corrected



Analysis of 2015 ending inventory error effects:

U = UnderstatedO = Overstated



Retained earnings O

Requirement 2

Retained earnings (overstatement of 2015 income).............. 150,000Inventory (overstatement of 2016 beginning inventory).... 150,000

Requirement 3 The financial statements that were incorrect as a result of both errors (effect of

one error in 2014 and effect of two errors in 2015) would be retrospectively restated to report the correct inventory amount, cost of goods sold, net income, and retained earnings when those statements are reported again for comparative purposes in the current annual report. A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share.

Exercise 9–23U = understatedO = overstatedNE = no effect

Cost of Net RetainedGoods Sold Income Earnings

1. Overstatement of ending inventory U O O2. Overstatement of purchases O U U3. Understatement of beginning inventory U O O4. Freight-in charges are understated U O O5. Understatement of ending inventory O U U6. Understatement of purchases U O O7. Overstatement of beginning inventory O U U8. Understatement of purchases +

understatement of ending inventory by the same amount NE NE NE

Exercise 9–24

1. To include the $4 million in year 2016 purchases and increase retained earnings to what it would have been if 2015 cost of goods sold had not included the $4 million purchases:

Analysis:2015 2016

Beginning inventory Beginning inventoryPurchases O Purchases ULess: Ending inventoryCost of goods sold O

RevenuesLess: Cost of goods sold O U = UnderstatedLess: Other expenses O = OverstatedNet income U

Retained earnings U

($ in millions)

Purchases ........................................................... 4Retained earnings .......................................... 4

2. The 2015 financial statements that were incorrect as a result of the errors would be retrospectively restated to reflect the correct cost of goods sold, (income tax expense if taxes are considered), net income, and retained earnings when those statements are reported again for comparative purposes in the 2016 annual report.

3. A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share.


CPA Exam Questions

1. c. Net realizable value = 388,000 ($408,000 selling price – $20,000 costs to sell.)

The inventory would be valued at $388,000, the net realizable value, as it is lower than the $400,000 FIFO cost.

2. c.

Inventory, 1/1 $ 80,000

Add: Purchases 330,000Goods available for sale 410,000Less: Cost of goods sold ($360,000 120%) 300,000Estimated inventory, 5/2 $110,000

Note: Although the estimated inventory is $110,000, the estimated fire loss would be $70,000 because of the $40,000 of goods in transit included in inventory.

CPA Exam Questions (concluded)

3. d.

Cost RetailBeginning inventory and purchases $600,000 $920,000Net markups _______ 40,000Available for sale 600,000 960,000Cost-to-retail percentage: $600,000 $960,000 = 62.5%Less: Net markdowns (60,000) Sales (780,000)Estimated ending inventory at retail $120,000Estimated ending inventory at cost: ($120,000 x 62.5%) 75,000Estimated cost of goods sold $525,000

Conventional retail is the lower of average cost and net realizable value (NRV). For the lower of cost and NRV retail method, net markdowns are excluded from the cost to retail percentage.

4. c. The understatement of beginning inventory and the overstatement of ending inventory both cause the cost of goods sold to be understated. The total understatement is $78,000 ($26,000 + 52,000).

5. b. The write-down can only be reversed under IFRS.

CMA Exam Questions

1. b. The conventional retail inventory method adds beginning inventory, net purchases, and markups (but not markdowns) to calculate a cost percentage. The purpose of excluding markdowns is to approximate a lower of cost and net realizable value valuation. The cost percentage is then used to reduce the retail value of the ending inventory to cost. FCL’s cost-retail ratio is 40% ($90,000 $225,000), and ending inventory at cost is therefore $20,000 (40% x $50,000 ending inventory at retail).

2. d. The failure to record a sale means that both accounts receivable and sales will be understated. However, inventory was correctly counted, so that account and cost of goods sold were unaffected.

3. d. The overstatement (double counting) of inventory at the end of year 1 caused year 1 cost of goods sold (BI + Purchases – EI) to be understated and both inventory and income to be overstated. The year 1 ending inventory equals year 2 beginning inventory. Thus, the same overstatement caused year 2 beginning inventory and cost of goods sold to be overstated and income to be understated. This is an example of a self-correcting error. By the end of year 2, the balance sheet is correct.

Problem 9–1

Requirement 1

Product NRV per unitA $16 – (15% x $16) = $13.60B $18 – (15% x $18) = $15.30C $ 8 – (15% x $8) = $ 6.80D $ 6 – (15% x $6) = $ 5.10E $13 – (15% x $13) = $11.05

(1) (2)

Product(units) Cost

NRV

Inventory Value

[Lower of (1) and (2)]

A (1,000) $10,000 $13,600 $10,000

B (800) 12,000 12,240 12,000

C (600) 1,800 4,080 1,800

D (200) 1,400 1,020 1,020

E (600) 8,400 6,630 6,630

$33,600 $31,450

Inventory book value would be $31,450.

Requirement 2Inventory book value would be $31,450, the lower of aggregate inventory cost

($33,600) and aggregate inventory net realizable value ($31,450). The amount of the loss from inventory write-down is $2,150 ($33,600 – 31,450).

Problem 9–3

Requirement 1

Fruit Marshmallow Chocolate Toppings Toppings Topping

Estimate of cost of goods sold:Cost percentage 80% 70% 65% x Net sales $200,000 $55,000 $20,000

$160,000 $38,500 $13,000

Beginning inventory $ 20,000 $ 7,000 $ 3,000Plus: Net purchases 150,000 36,000 12,000Cost of goods available for sale 170,000 43,000 15,000

Less: Estimate of cost of goods sold 160,000 38,500 13,000

Estimate of cost of inventory lost $ 10,000 $ 4,500 $ 2,000

Requirement 2The two main factors that could cause the estimates of the inventory lost to be

over- or understated are:1. The historical cost percentages used may not be representative of the current

relationship between cost and selling price.2. Theft or spoilage losses may not be appropriately considered in the cost

percentage.

Problem 9–7 ($ in 000s) Cost Retail

Beginning inventory $ 80 $ 125Purchases 671 1,006Freight-in on purchases 30Purchase returns (1) (2)Net markups 4Net markdowns ___ (8)Goods available for sale $780 1,125

Cost-to-retail percentages:Average cost ratio: $780 ÷ $1,125 = .6933Conventional cost ratio: $780 ÷ ($1,125 + 8) = .6884

Deduct: Net sales (916)Ending inventory:

At retail (sales price) $ 209Average cost ($209 x .6933) $144 .90 Conventional ($209 x .6884) $143 .88

Note that the lower of average cost and net realizable value cost-to-retail percentage is approximated by excluding net markdowns.

Problem 9–8

($ in 000s)

Cost Retail

Beginning inventory $ 80 $ 125

Plus: Net purchases 671 1,006

Freight-in 30

Net markups 4

Less: Purchase returns (1) (2)

Net markdowns ___ (8 )

Goods available for sale (excluding beginning inventory) 700 1,000

Goods available for sale (including beginning inventory) 780 1,125

$80Base layer cost-to-retail percentage: = 64%

$125

$7002016 layer cost-to-retail percentage: = 70%

$1,000

Less: Net sales (916 )

Estimated ending inventory at current year retail prices $ 209

Estimated ending inventory at cost (calculated below) (130 )

Estimated cost of goods sold $650

___________________________________________________________________________

Step 1 Step 2 Step 3 Ending Ending Inventory Inventory Inventory Inventory Layers Layersat Year-End at Base Year at Base Year Converted toRetail Prices Retail Prices Retail Prices Cost

$209$209 = $190 $125 (base) x 1.00 x 64% = $ 80

(above) 1.10 65 (2016) x 1.10 x 70% = 50

Total ending inventory at dollar-value LIFO retail cost ...................... $130


Capitalized cost of the machine:

Purchase price $35,000Freight 1,500Installation 3,000Testing 2,000

Total cost $41,500

Note: Personal property taxes on the machine for the period after acquisition are not part of acquisition cost. They are expensed in the period incurred.


Capitalized cost of land:

Purchase price $600,000Broker’s commission 30,000Title insurance 3,000Miscellaneous closing costs 6,000Demolition of old building 18,000

Total cost $657,000

All of the expenditures, including the costs to demolish the old building, are included in the initial cost of the land.


Cost of land and building:

Purchase price $600,000Broker’s commission 30,000Title insurance 3,000Miscellaneous closing costs 6,000

Total cost $639,000

The total must be allocated to the land and building based on their relative fair values:

Asset Fair Value

Percent of Total Fair Value

InitialValuation(Percent x$639,000)

Land $420,000 60% $383,400Building 280,000 40 255,600

$700,000 100% $639,000


Calculation of goodwill:

Consideration exchanged $14,000,000Less fair value of net assets:

Book value of assets $8,300,000Plus: Excess of fair value over book value of intangible assets 2,500,000 (10,800,000)

Goodwill $ 3,200,000


Proceeds $16,000Less book value: Cost $80,000

Accum. depreciation (71,000) 9,000Gain on sale of equipment $ 7,000

Journal entry (not required):

Cash................................................................................ 16,000Accumulated depreciation (account balance) .................... 71,000

Gain (difference)........................................................... 7,000Equipment (account balance).......................................... 80,000


Pickup trucks = Fair value of equipment plus cash paid$17,000 + 8,000 = $25,000

Loss on exchange = $20,000 (book value) – 17,000 (fair value) = $3,000


Pickup trucks (determined above) ...................................... 25,000Accumulated depreciation (account balance) .................... 45,000Loss (difference)................................................................ 3,000

Cash ........................................................................... 8,000Equipment (account balance).......................................... 65,000


Pickup trucks = Fair value of equipment plus cash paid$24,000 + 8,000 = $32,000

Gain on exchange = $24,000 (fair value) – 20,000 (book value) = $4,000


Pickup trucks (determined above) ...................................... 32,000Accumulated depreciation (account balance) .................... 45,000

Cash ........................................................................... 8,000Gain (difference)........................................................... 4,000Equipment (account balance).......................................... 65,000


Pickup trucks = Book value of equipment plus cash paid$20,000 + 8,000 = $28,000

No gain is recognized in this situation.


Pickup trucks (determined above) ...................................... 28,000Accumulated depreciation (account balance) .................... 45,000

Cash ........................................................................... 8,000Equipment (account balance).......................................... 65,000

Exercise 10–2To record the purchase of equipment.

Equipment ($45,000 + 2,200 + 700 + 1,000)......................... 48,900Accounts payable........................................................ 47,200Cash............................................................................ 1,700

To record prepaid insurance for the equipment.

Prepaid insurance............................................................ 900Cash............................................................................ 900

Exercise 10–8

Asset Fair Value



Land $ 300,000 30% $270,000Building A 450,000 45 405,000Building B 250,000 25 225,000

$1,000,000 100% $900,000

Exercise 10–16

Equipment—new ($200,000 + 60,000)............................... 260,000Accumulated depreciation (account balance)..................... 220,000

Cash............................................................................ 60,000Equipment—old (account balance)................................ 400,000Gain ($200,000 – 180,000).............................................. 20,000

Exercise 10–17

Equipment—new ($170,000 + 60,000)............................... 230,000Loss ($180,000 – 170,000).................................................. 10,000Accumulated depreciation (account balance)..................... 220,000

Cash............................................................................ 60,000Equipment—old (account balance)................................ 400,000

Exercise 10–18

Requirement 1Fair value of land + Cash given = Fair value of equipment$150,000 + 10,000 = $160,000

Requirement 2

Equipment ($150,000 + 10,000).......................................... 160,000Cash............................................................................ 10,000Land (book value).......................................................... 120,000Gain ($150,000 – 120,000).............................................. 30,000

Exercise 10–19

Requirement 1Fair value of land – Cash received = Fair value of equipment$150,000 – 10,000 = $140,000

Requirement 2

Equipment ($150,000 – 10,000).......................................... 140,000Cash................................................................................ 10,000

Land (book value).......................................................... 120,000Gain ($150,000 – 120,000).............................................. 30,000

CPA Exam Questions

1. d. Simons Company should value the land at $170,500. All expenditures incurred to purchase land should be part of the capitalized asset. $150,000 + ($150,000 x .07) + 5,000 + 5,000

2. c. Costs attributable to land: $60,000 + 2,000 + 5,000 – 3,000 = $64,000Costs attributable to building: $8,000 + 350,000 = $358,000

3. d. There are eight payments due, the first one due immediately, and the remaining seven due each year on December 31. Therefore, the correct factor to use is the present value of an annuity in advance (annuity due) for eight periods, or 5.712 x $20,000 = $114,240, the present value at the inception of the note and therefore the initial value of the machine. Another way to calculate the answer is to view the annuity as a seven-period ordinary annuity, with a down payment today of $20,000. This would yield a calculation of $20,000 + ($20,000 x 4.712) or $114,240.

4. b. The recorded cost of the new asset is equal to the fair value of the asset given up, $20,000. In this case, there are two new assets acquired: new truck, $15,000, and cash, $5,000. The gain on the trade is $8,000 (FV old truck $20,000 – 12,000 book value).

5. c. Dahl Corporation should capitalize the materials, engineering fees, and labor and electricity for construction and testing: ($20,000 + 5,000 + 3,000 + 1,000 + 1,000 + 1,000). The labor and electricity to run the machine should not be capitalized. These should be expensed because they are not part of the construction costs and were not incurred prior to activating the asset.


6. b. The interest cost capitalized is the lesser of the formula amount based on average accumulated expenditures or the actual interest cost incurred. In this case the formula amount ($40,000) is the smaller amount and should be the amount capitalized as part of the cost of the building.

7. a. Amortization of capitalized software is the greater of the amount calculated using the percentage-of-revenue method and the straight-line method. In this case, the straight-line percentage is 20% (1/5) and the percentage-of-revenue method is 30%. Therefore, we amortize 30% of the cost yielding book value of 70%.

8. d. All of the expenditures are considered research and development.

9. c. Only development costs that meet certain criteria can be capitalized.

10. d. Both methods are acceptable.

CMA Exam Questions

1. a. The costs of fixed assets (plant and equipment) are all costs necessary to acquire these assets and to bring them to the condition and location required for their intended use. These costs include shipping, installation, pre-use testing, sales taxes, and interest capitalization. The original cost of the machinery to be recorded in the books is the sum of the purchase price, installation, and delivery charges.

2. d. GAAP states that the basic principle to be followed in these exchanges is to value the asset received at fair value and to recognize gain or loss (the difference between the fair value and the book value of the asset given up). Harper’s used machine has a book value of $64,000 ($162,500 cost – $98,500 accumulated depreciation). The fair value of the used machine is $80,000, resulting in a gain of $16,000 ($80,000 – 64,000). The only exceptions to using fair value are (1) when fair value is not determinable and (2) when the exchange lacks commercial substance.

3. c. The answer is the same as question 2.

Problem 10–11. To record the acquisition of land and building.

Land (determined below)......................................................................... 62,500Building (determined below).............................................. 37,500

Cash............................................................................ 100,000

Asset Fair Value



Land $ 75,000 62.5% $ 62,500Building 45,000 37.5 37,500

$120,000 100.0% $100,000

2. To record the acquisition of equipment for cash and a note.

Equipment (determined below)........................................... 37,037Discount on note payable (difference).............................. 2,963

Note payable (face amount)........................................... 40,000

Present value of note payments:

PV = $40,000 (.92593) = $37,037Present value of $1: n = 1, i=8% (from Table 2)

3. To record the acquisition of a truck by donation.

Truck............................................................................... 2,500Revenue—donation of asset....................................... 2,500


4. To capitalize organization costs.

Organization cost expense.............................................. 3,000Cash............................................................................ 3,000

5. To record the purchase of equipment.

Equipment ($15,000 + 500)................................................ 15,500Cash............................................................................ 15,500

6. To record the acquisition of office equipment by the issuance of common stock.

Office equipment............................................................ 5,500Common stock............................................................ 5,500

7. To record the acquisition of land in exchange for cash and a note.

Land................................................................................ 20,000Cash............................................................................ 2,000Note payable............................................................... 18,000

Problem 10–3

Requirement 1PELL CORPORATION

Analysis of Changes in Plant AssetsFor the Year Ended December 31, 2016

Balance Balance 12/31/15 Increase Decrease 12/31/16

Land $ 350,000 $438,000 [1] $ 788,000 Land improvements 180,000 180,000 Building 1,500,000 1,500,000 Machinery and equipment 1,158,000 287,000 [2] $58,000 1,387,000 Automobiles 150,000 19,000 [3] 18,000 151,000 Totals $3,338,000 $744,000 $76,000 $4,006,000

Explanation of Amounts: [1] Cost of land acquired 11/1/16:

Pell stock exchanged (10,000 shares x $38) $380,000 Legal fees and title insurance 23,000 Razing existing building 35,000

$438,000 [2] Cost of machinery and equipment purchased 1/2/16:

Invoice cost $260,000 Installation cost 27,000

$287,000 [3] Cost recorded for new automobile 12/31/16:

Fair value of trade-in $ 3,750 Cash paid 15,250

$ 19,000


Requirement 2Pell Corporation

Gain or Loss from Plant Asset DisposalsFor the Year Ended December 31, 2016

Sale of machine on 3/31/16: Selling price $36,500 Less: Book value of machine ($58,000 – 24,650) (33,350) Gain on sale of machine $ 3,150

Trade-in of automobile on 12/31/16: Book value of trade-in ($18,000 – 13,500) $ 4,500 Less: Fair value of trade-in (3,750) Loss on trade-in $ 750

Problem 10–7

Robers:

Cash................................................................................ 5,000New equipment ($75,000 – 5,000)...................................... 70,000Accumulated depreciation—old asset (account balance).. . 55,000

Old equipment (account balance)................................... 120,000Gain on exchange of assets ($75,000 – 65,000).............. 10,000

Phifer:

New equipment ($70,000 + 5,000)..................................... 75,000Accumulated depreciation—old asset (account balance).. . 63,000Loss ($77,000 – 70,000) .............................................................. 7,000

Cash............................................................................ 5,000Old equipment (account balance)................................... 140,000

Chap12 Exercise 11–21. Straight-line:

$115,000 – 5,000 = $11,000 per year 10 years

2. Sum-of-the-years’ digits:

Sum-of-the-digits is ([10 (10 + 1)] ÷ 2) = 55

2016 $110,000 x 10/55 = $20,0002017 $110,000 x 9/55 = $18,000

3. Double-declining balance:

Straight-line rate is 10% (1 ÷ 10 years) x 2 = 20% DDB rate

2016 $115,000 x 20% = $23,0002017 ($115,000 – 23,000) x 20% = $18,400

4. One hundred fifty percent declining balance:

Straight-line rate is 10% (1 ÷ 10 years) x 1.5 = 15% rate

2016 $115,000 x 15% = $17,2502017 ($115,000 – 17,250) x 15% = $14,663

5. Units-of-production:

$115,000 – 5,000 = $.50 per unit depreciation rate 220,000 units

2016 30,000 units x $.50 = $15,000 2017 25,000 units x $.50 = $12,500

Exercise 11–6

Requirement 1

1. Straight-line:

$260,000 – 20,000 = $40,000 per year 6 years

2016 $40,000 x 8/12 = $26,6672017 $40,000 x 12/12 = $40,000

2. Sum-of-the-years’ digits:

Sum-of-the-years’ digits is ([6 (6 + 1)] ÷ 2) = 21

2016 $240,000 x 6/21 x 8/12 = $45,714

2017 $240,000 x 6/21 x 4/12 = $22,857 + $240,000 x 5/21 x 8/12 = 38,095

$60,952

3. Double-declining balance:

1/6 (the straight-line rate) x 2 = 1/3 DDB rate

2016 $260,000 x 1/3 x 8/12 = $57,778

2017 $260,000 x 1/3 x 4/12 = $28,889 + ($260,000 – 86,667) x 1/3 x 8/12 = 38,518

$67,407 or,2017 ($260,000 – 57,778) x 1/3 = $67,407

Exercise 11–11

Requirement 1Cost of the equipment:

Purchase price $154,000Freight charges 2,000Installation charges 4,000

$160,000

Straight-line rate of 12.5% (1 ÷ 8 years) x 2 = 25% DDB rate.

Year

Book Value Beginning

of Year XDepreciation

Rate per Year = DepreciationBook ValueEnd of Year

2016 $160,000 25% $ 40,000 $120,0002017 120,000 25% 30,000 90,0002018 90,000 25% 22,500 67,5002019 67,500 25% 16,875 50,6252020 50,625 * 5,000 45,6252021 45,625 * 5,000 40,6252022 40,625 * 5,000 35,6252023 35,625 * 5,000 30,625Total $129,375

* Switch to straight-line in 2020:

Straight-line depreciation:

$50,625 – 30,625 = $5,000 per year 4 years

Requirement 2For plant and equipment used in the manufacture of a product, depreciation is

a product cost and is included in the cost of inventory. Eventually, when the product is sold, depreciation will be included in cost of goods sold.

Exercise 11–12

Requirement 1 $4,500,000

Depletion per ton = = $5.00 per ton 900,000 tons

2016 depletion = $5.00 x 240,000 tons = $1,200,000

Requirement 2Depletion is part of product cost and is included in the cost of the inventory of

coal, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion is then included in cost of goods sold in the income statement when the coal is sold.

Exercise 11–15

Requirement 1a. To record the purchase of a patent.

January 1, 2014Patent.............................................................................. 700,000

Cash............................................................................ 700,000

To record amortization on the patent.

December 31, 2014 and 2015Amortization expense ($700,000 ÷ 10 years)...................... 70,000

Patent.......................................................................... 70,000

b. To record the purchase of a franchise.

2016Franchise......................................................................... 500,000

Cash............................................................................ 500,000

c. To record research and development expenses.

2016Research and development expense............................... 380,000

Cash............................................................................ 380,000


2016 Year-end adjusting entries

Patent: To record amortization on the patent after change in useful life.

December 31, 2016Amortization expense (determined below)......................... 112,000

Patent.......................................................................... 112,000

Calculation of annual amortization after the estimate change: ($ in thousands)

$700 Cost $70 Previous annual amortization ($700 ÷ 10 years)

x 2 years 140 Amortization to date (2014–2015)560 Unamortized cost (balance in the patent account)

÷ 5 Estimated remaining life $112 New annual amortization

Franchise: To record amortization of franchise.

December 31, 2016Amortization expense ($500,000 ÷ 10 years)...................... 50,000

Franchise..................................................................... 50,000

Requirement 2

Intangible assets:

Patent $448,000 [1] Franchise 450,000 [2] Total intangibles $898,000

[1] $560,000 – 112,000[2] $500,000 – 50,000

Exercise 11–19

Requirement 1

Depreciation expense (determined below).......................... 3,088Accumulated depreciation—computer....................... 3,088

Calculation of annual depreciation after the estimate change:

$40,000 Cost$7,200 Previous annual depreciation ($36,000 ÷ 5 years)

x 2 years 14,400 Depreciation to date (2014–2015)25,600 Undepreciated cost 900 Revised residual value24,700 Revised depreciable base÷ 8 Estimated remaining life (10 years – 2 years)

$ 3,088 New annual depreciation

Requirement 2

Depreciation expense (determined below).......................... 3,889Accumulated depreciation—computer....................... 3,889


$40,000 Cost Previous depreciation:

$12,000 2014 – ($36,000 x 5/15) 9,600 2015 – ($36,000 x 4/15)

21,600 Depreciation to date (2014–2015)18,400 Undepreciated cost 900 Revised residual value17,500 Revised depreciable basex 8 /36 Estimated remaining life – 8 years

$ 3,889 2016 depreciation

Exercise 11–20SYD depreciation

[10 + 9 + 8 x ($1.5 – .3) million] = $589,091

55

$1,500,000 Cost 589,091 Depreciation to date, SYD (2013–2015)

910,909 Undepreciated cost as of 1/1/16 300,000 Less residual value

610,909 Depreciable base ÷ 7 yrs. Remaining life (10 years – 3 years)$ 87,273 New annual depreciation

Adjusting entry (2016 depreciation):

Depreciation expense (calculated above)............................ 87,273Accumulated depreciation.......................................... 87,273

Exercise 11–22

Requirement 1Analysis:

Correct Incorrect (Should Have Been Recorded) (As Recorded)

2013 Equipment 350,000 Expense 350,000 Cash 350,000 Cash 350,000

2013 Expense 70,000 Depreciation entry omitted Accum. deprec. 70,000



During the three-year period, depreciation expense was understated by $210,000, but other expenses were overstated by $350,000, so net income during the period was understated by $140,000, which means retained earnings is currently understated by that amount.

During the three-year period, accumulated depreciation was understated, and continues to be understated by $210,000.

To correct incorrect accountsEquipment .......................................................... 350,000

Accumulated depreciation ($70,000 x 3 years)... 210,000 Retained earnings ($350,000 – 210,000)............. 140,000

Requirement 2Correcting entry:

Assuming that the equipment had been disposed of, no correcting entry would be required because, after five years, the accounts would show appropriate balances.

Exercise 11–23

Requirement 1Book value $6.5 millionFair value 3 .5 millionImpairment loss $3.0 million

Requirement 2Because the undiscounted sum of future cash flows of $6.8 million exceeds

book value of $6.5 million, there is no impairment loss.

Exercise 11–26

Requirement 1An impairment loss is indicated because the estimated undiscounted sum of

future cash flows of $15 million is less than the book value of $18.3 million.

The amount of the loss to be reported is calculated using the estimated fair value rather than the undiscounted future cash flows:

Book value $18,300,000Estimated fair value 11,000,000Impairment loss $ 7,300,000

Requirement 2The loss would appear in the income statement along with other operating

expenses.

Requirement 3

Loss on impairment ............................................ 7,300,000Accumulated depreciation .................................. 14,200,000

Plant assets...................................................... 21,500,000

Requirement 4An impairment loss is indicated because the estimated undiscounted sum of

future cash flows of $12 million is less than the book value of $18.3 million.

The amount of the loss to be reported is calculated using the estimated fair value rather than the undiscounted future cash flows:

Book value $18,300,000Estimated fair value 11,000,000Impairment loss $ 7,300,000

Requirement 5Because the estimated undiscounted sum of future cash flows of $19 million

exceeds the book value of $18.3 million, no impairment loss is indicated.

Exercise 11–29

Requirement 1

Calculation of goodwill:

Consideration exchanged $420 millionLess fair value of net assets:

Assets $512 millionLess: Liabilities assumed (150) million (362) million

Goodwill $ 58 million

Requirement 2

Because the book value of the net assets ($410 million) exceeds fair value ($400 million), an impairment loss is indicated.

Determination of implied fair value of goodwill:Fair value of Harman, Inc. $400 millionFair value of Harman’s net assets (excluding goodwill) 370 million Implied fair value of goodwill $ 30 million

Measurement of impairment loss:Book value of goodwill (determined in requirement 1) $ 58 millionImplied fair value of goodwill 30 million

Impairment loss $ 28 million

Requirement 3

Entry to record the impairment loss:($ in millions)

Loss on impairment of goodwill ........................ 28Goodwill ......................................................... 28

CPA Exam Questions

1. a. Double-declining-balance depreciation rate = 2 x 1/8 = ¼ or 25%

First year depreciation will be $7,500 x 0.25 = $1,875

Second year depreciation will be ($7,500 – 1,875) x 0.25 = $1,406

2. b. The depreciation method used must be straight line because year 1 depreciation is $7,400 (($40,000 – 3,000) / 5 = $7,400). Year 2 depreciation would also be $7,400.

3. b. $20,000/5,000,000 gallons = $0.004/gallon

($0.004/gallon) x (250,000 gallons) = $1,000

4. d. Goodwill is an indefinite life intangible asset and is therefore not amortized.

5. c. $50,000 10 years = $5,000 per year in amortization. $50,000 – 5,000 = $45,000. The 3% franchise fee is a period expense and is not capitalized.

6. c. First two years = ($60,000 – 0) 10 = $6,000 per year

Year 2016 = [$60,000 – (2 x $6,000) – 3,000] 3 = $15,000

7. d. The book value of the stamping machine is its cost less accumulated depreciation. Depreciation taken through 2016 was [($22,000,000 – 4,000,000) / 12] x 7 = $10,500,000 so book value is ($22,000,000 – 10,500,000) = $11,500,000. Because the $11,500,000 book value is more than expected future cash flows of [(5 x $1,500,000) + 1,000,000] = $8,500,000, the stamping machine is impaired.

8. d. $147,000. All of the expenditures are capitalized.


9. c. $12,000.

$80,000 10 years = $ 8,000 20,000 5 years = 4,000

Total depreciation = $12,000

10. a. When as asset is revalued, the entire class of property, plant, and equipment to which the asset belongs must be revalued.

11. b. A decrease in income. If book value is higher than fair value, the difference is reported as an expense in the income statement.

12. b. An active market must exist for an intangible asset to be revalued.

13. c. $70 million. Book value of $400 million – 330 million recoverable amount (higher of fair value less costs to sell and present value of future cash flows).

14. d. $45 million. Book value of $500 million – 455 million recoverable amount (higher of fair value less costs to sell and present value of future cash flows).

CMA Exam Questions

1. d. Because 50% of the original estimate of quality ore was recovered during the years 2008 through 2015, recorded depletion of $250,000 [50% x ($600,000 – 100,000 salvage value)]. In 2016, the earlier depletion of $250,000 is deducted from the $600,000 cost along with the $100,000 salvage value. The remaining depletable cost of $250,000 will be allocated over the 250,000 tons believed to remain in the mine. The $1 per ton depletion is then multiplied times the tons mined each year.

2. a. Given that the company paid $6,000,000 for net assets acquired with a fair value of $5,496,000, goodwill was $504,000. According to GAAP, acquired goodwill is not amortized but is qualitatively assessed and/or tested annually for impairment.

3. a. The cost should be amortized over the remaining legal life or useful life, whichever is shorter. In addition to the initial costs of obtaining a patent, legal fees incurred in the successful defense of a patent should be capitalized as part of the cost, whether it was internally developed or purchased from an inventor. The legal fees capitalized then should be amortized over the remaining useful life of the patent.

Problem 11–5(1) $65,000

Allocation in proportion to appraised values at date of exchange:% of

Amount TotalLand $72,000 8Building 828,000 92

$900,000 100

Land $812,500 x 8% = $ 65,000Building $812,500 x 92% = 747,500

$812,500(2) $747,500 [From (1)]

(3) 50 years $747,500 – 47,500 $14,000 annual depreciation

(4) $ 14,000 Same as prior year, since method used is straight line.

(5) $ 85,400 3,000 shares x $25 per share = $75,000Plus demolition of old building 10,400

$85,400(6) None No depreciation before use.

(7) $ 16,000 Fair value.

(8) $ 2,400 $16,000 x 15% (1.5 x Straight-line rate of 10%).

(9) $ 2,040 ($16,000 – 2,400) x 15%.

(10) $ 99,000 Total cost of $110,000 – 11,000 in normal repairs.

(11) $ 17,000 ($99,000 – 5,500) x 10/55.

(12) $ 5,100 ($99,000 – 5,500) x 9/55 x 4/12.

(13) $ 30,840 PVAD = $4,000 (7.71008 ) Present value of an annuity due of $1: n = 11, i = 8% (from Table 6)

(14) $ 2,056 $30,840

15 years

Problem 11–10a. This is a change in estimate.

No entry is needed to record the change.

2016 adjusting entry:Depreciation expense (determined below) ......................... 370,000

Accumulated depreciation ......................................... 370,000


$10,000,000 Cost$250,000 Previous depreciation ($10,000,000 ÷ 40 years)

x 3 yrs (750,000 ) Depreciation to date (2013–2015) 9,250,000 Undepreciated cost

÷ 25 yrs. Estimated remaining life (25 years: 2016–2040)$ 370,000 New annual depreciation

A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period.


b. This is a change in accounting principle that is accounted for as a change in estimate.

Depreciation expense (below) .......................21,000 Accumulated depreciation ............. 21,000

SYD2012 depreciation $ 60,000 ($330,000 x 10/55)

2013 depreciation 54,000 ($330,000 x 9/55)

2014 depreciation 48,000 ($330,000 x 8/55)

2015 depreciation 42,000 ($330,000 x 7/55)

Accumulated depreciation $204,000

$330,000 Cost 204,000 Depreciation to date, SYD (above) 126,000 Undepreciated cost as of 1/1/16 0 Less residual value126,000 Depreciable base

÷ 6 yrs. Remaining life (10 years – 4 years)$ 21,000 New annual depreciation

A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.

c. This is a change in accounting principle accounted for as a change in estimate.

Because the change will be effective only for assets placed in service after the date of change, depreciation schedules do not require revision because the change does not affect assets depreciated in prior periods. A disclosure note still is required to provide justification for the change and to report the effect of the change on current year’s income.

Chap13


Cash ................................................................ 60,000,000Notes payable.............................................. 60,000,000

Interest expense ($60,000,000 x 12% x 3/12)........ 1,800,000Interest payable.......................................... 1,800,000


a.December 31

$100,000 x 12% x 6/12 = $6,000

b.September 30

$100,000 x 12% x 3/12 = $3,000


December 12Cash....................................................................... 24,000

Deferred sales revenue ...................................... 24,000

January 16Cash....................................................................... 216,000Deferred sales revenue........................................... 24,000

Sales revenue..................................................... 240,000


In 2016 Lizzie would recognize $11,500 of revenue ($4,000 + 3,000 + 2,500 + 2,000). In 2017 Lizzie would recognize the remainder of $6,500 ($18,000 – 11,500), either because gift cards were redeemed (the $1,000 in January and the $500 in February) or because they are viewed as expired.


Accounts receivable............................................... 645,000Sales revenue .................................................... 600,000Sales taxes payable ([6% + 1.5%] x $600,000)....... 45,000


This is a loss contingency and the estimated warranty liability is credited and warranty expense is debited in the period in which the products under warranty are sold. Right will report a liability of $130,000:

Warranty Liability __________________________________________

150,000Warranty expense (1% x $15,000,000)Actual expenditures 20,000

130,000Balance


Only the third situation’s costs should be accrued. A liability should be accrued for a loss contingency if it is both probable that the confirming event will occur and the amount can be at least reasonably estimated. If one or both of these criteria is not met, but there is at least a reasonable possibility that the loss will occur, a disclosure note should describe the contingency. Both criteria are met only for the warranty costs.

Exercise 13–5

Requirement 1

Wages expense (700 x $900).............................................. 630,000Liability—compensated future absences ............. 630,000

Requirement 2

Liability—compensated future absences .................. 630,000Wages expense ($31 million + [5% x $630,000]).............. 31,031,500

Cash (or wages payable) (total)............................. 31,661,500

Exercise 13–8

Requirement 1

Cash....................................................................... 7,500Deferred sales revenue ...................................... 7,500

Requirement 2

Cash....................................................................... 25,500Liability—refundable deposits ......................... 25,500

Requirement 3

Accounts receivable............................................... 856,000Sales revenue .................................................... 800,000Sales taxes payable ([5% + 2%] x $800,000).......... 56,000

Exercise 13–20

Requirement 1

Warranty expense ([4% x $2,000,000] – $30,800)............. 49,200Estimated warranty liability .................................. 49,200

Requirement 2

Bad debt expense (2% x $2,000,000)................................. 40,000Allowance for uncollectible accounts ................... 40,000

Requirement 3

This is a loss contingency. Classical can use the information occurring after the end of the year and before the financial statements are issued to determine appropriate disclosure.

Loss—litigation......................................................... 1,500,000Liability—litigation............................................... 1,500,000

A disclosure note also is appropriate.

Requirement 4

This is a gain contingency. Gain contingencies are not accrued even if the gain is probable and reasonably estimable. The gain should be recognized only when realized. A disclosure note is appropriate.

Requirement 5

Loss—product recall.................................................... 500,000Liability—product recall.......................................... 500,000

A disclosure note also is appropriate.

Requirement 6

Promotional expense ([60% x $25 x 10,000] – $105,000)... 45,000Estimated premium liability .................................... 45,000

Exercise 13–24

Requirement 1

Accrued liability and expenseWarranty expense (3% x $3,600,000)............................................... 108,000

Estimated warranty liability ............................................... 108,000

Actual expenditures (summary entry)Estimated warranty liability ................................................... 88,000

Cash, wages payable, parts and supplies, etc. ................... 88,000

Requirement 2

Actual expenditures (summary entry)Estimated warranty liability ($50,000 – 23,000)....................... 27,000Loss on product warranty (3% – 2%] x $2,500,000)................... 25,000

Cash, wages payable, parts and supplies, etc. ................... 52,000* *(3% x $2,500,000) – $23,000 = $52,000


CPA Exam Questions

1. d. The accrued interest at end of the first year, February 28, 2016, is $1,200 ($10,000 x 12% = $1,200). The interest for the remaining ten months is compounded based on the carrying amount of the total liability at February 28, 2014, $11,200 ($10,000 principal plus the $1,200 accrued interest). Therefore, the interest is $11,200 x 12% x 10/12 = $1,120 for the last ten months. The accrued interest liability at December 31, 2016, would be the total interest for the two time periods, $1,200 + 1,120 = $2,320.

2. a. The liability for compensated absences at December 31, 2016, is $15,000 for the 150 vacation days times $100 per day. The key word in dealing with sick pay is the word “required.” The problem asks what is the liability required at December 31, 2016. Since the accrual of sick pay is optional, North Corp. would not be required to accrue a liability for sick pay.

3. a. The amount excluded from current liabilities through refinancing cannot exceed the amount actually refinanced. Therefore, Largo should consider the $500,000 paid by the refinancing to be a long-term liability and the $250,000 a current liability on the December 31, 2016, balance sheet. The refinancing was completed before the issuance of the financial statements and meets both criteria (intent and financial ability) for the classification of the $500,000 as a long-term liability.

4. a. Gain contingencies should not be recognized in the financial statements until realized. Adequate disclosure should be made in the notes but care should be taken to avoid misleading implications as to the likelihood of realization of the contingent gain.


5. c. For an extended warranty, revenue is deferred upon initial sale and then recognized over the warranty period. No contingent liability is recorded.

6. d.

2016 and 2017 sales = $ 400,000Warranty % 6 %2016 and 2017 allowance $ 24,000Actual expenditure (9,750 ) 12/31/17 remaining liability $ 14,250

7. a. Under IFRS, contingent liabilities (called “provisions”) are accrued if the probability of payment is more likely than not, defined as a probability of greater than 50%.

8. a. Under IFRS, contingent assets are accrued if they are virtually certain to occur.

9. c. Under IFRS, contingent liabilities (called “provisions”) are accrued equal to the expected value of a range of equally likely amounts. In this case, $15 million is the expected value of the range of $10 million to $20 million.

CMA Exam Questions

1. b. If an enterprise intends to refinance short-term obligations on a long-term basis and demonstrates an ability to consummate the refinancing, the obligations should be excluded from current liabilities and classified as noncurrent. Under U.S. GAAP the ability to consummate the refinancing may be demonstrated by a post-balance-sheet-date issuance of a long-term obligation or equity securities, or by entering into a financing agreement.

2. d. There are four requirements that must be met before a liability is accrued for future compensated absences. These requirements are that the obligation must arise for past services, the employee rights must vest or accumulate, payment is probable, and the amount can be reasonably estimated. If the amount cannot be reasonably estimated, no liability should be recorded. However, the obligation should be disclosed.

3. c. GAAP requires a contingent liability to be recorded, along with the related loss, when it is probable that an asset has been impaired or a liability has been incurred, and the amount of the loss can be reasonably estimated. The key words are “probable” and “reasonably estimated.”

4. c. The likelihood of contingencies is divided into three categories: probable (likely to occur), reasonably possible, and remote. When contingent losses are probable and the amount can be reasonably estimated, the amount of the loss should be charged against income. If the amount cannot be reasonably estimated but the loss is at least reasonably possible, full disclosure should be made, including a statement that an estimate cannot be made.

Problem 13–4Requirement 1

a. Interest expense ($600,000 x 10% x 5/12)...................... 25,000Interest payable................................................. 25,000

b. No adjusting entry since interest has been paid up to December 31. $950,000 can be reported as a noncurrent liability, because (a) intent and (b) ability to refinance has been demonstrated for that amount.

c. Accounts receivable (to eliminate the credit balance)... 18,000Deferred revenue.............................................. 18,000

d. Rent revenue (10/12 x $30,000).................................. 25,000Deferred rent revenue ...................................... 25,000

Requirement 2

CURRENT LIABILITIES:Accounts payable $ 35,000Current portion of long-term debt250,000Accrued interest payable 25,000Advances from customers 18,000Deferred rent revenue 25,000Bank notes payable 600,000

Total current liabilities $953,000

LONG-TERM LIABILITIES:Mortgage note payable $950,000

Problem 13–6

a. This is a loss contingency. Eastern can use the information occurring after the end of the year in determining appropriate disclosure. It is unlikely that Eastern would choose to accrue the $122 million loss because the judgment will be appealed and that outcome is uncertain. A disclosure note is appropriate:

_______________________________Note X: Contingency

In a lawsuit resulting from a dispute with a supplier, a judgment was rendered against Eastern Manufacturing Corporation in the amount of $107 million plus interest, a total of $122 million at February 3, 2017. Eastern plans to appeal the judgment. While management and legal counsel are presently unable to predict the outcome or to estimate the amount of any liability the company may have with respect to this lawsuit, it is not expected that this matter will have a material adverse effect on the company.

b. This is a loss contingency. Eastern can use the information occurring after the end of the year in determining appropriate disclosure. Eastern should accrue the $140 million loss because the ultimate outcome appears settled and the loss is probable.

Loss—litigation........................................... 140,000,000Liability—litigation................................. 140,000,000

A disclosure note also is appropriate:

_________________________________Notes: Litigation

In November 2015, the State of Nevada filed suit against the Company, seeking civil penalties and injunctive relief for violations of environmental laws regulating hazardous waste. On January 12, 2017, the Company announced that it had reached a settlement with state authorities on this matter. Based upon discussions with legal counsel, the Company has accrued and charged to operations in 2016, $140 million to cover the anticipated cost of all violations. The Company believes that the ultimate settlement of this claim will not have a material adverse effect on the Company's financial position.


c. This is a gain contingency. Gain contingencies are not accrued even if the gain is probable and reasonably estimable. The gain should be recognized only when realized.

Though gain contingencies are not recorded in the accounts, they should be disclosed in notes to the financial statements.

_______________________________Note X: Contingency

Eastern is the plaintiff in a pending lawsuit filed against United Steel for damages due to lost profits from rejected contracts and for unpaid receivables. The case is in final appeal. No amount has been accrued in the financial statements for possible collection of any claims in this litigation.

d. No disclosure is required because the claim is as yet unasserted (no lawsuit has been filed), and it is not probable that a claim will be asserted in the future. Even if an unfavorable outcome is thought to be probable in the event a lawsuit is filed, and even if the amount of losses that could result from the lawsuit is estimable, disclosure is not required unless an unasserted claim is probable.

Chap 20

Brief Exercise 20-2

To record the change: ($ in millions)

Inventory ($47.6 million – 64 million)......................................... 16.4Retained earnings ...................................................................................... 16.4

Brief Exercise 20-3

When a company changes to the LIFO inventory method from another inventory method, accounting records of prior years often are inadequate to determine the cumulative income effect of the change for prior years. For instance, it would be necessary to make assumptions as to when specific LIFO inventory layers were created in years prior to the change. So, a company changing to LIFO generally does not revise the balance in retained earnings. This is the case for J J Dishes. No entry is made. Instead, the beginning inventory in the year the LIFO method is adopted ($96 million for J J) becomes the base year inventory for all future LIFO calculations. A disclosure note would be included in the financial statements describing the nature of and justification for the change as well as an explanation as to why retrospective application was impracticable.

Brief Exercise 20-4

A change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method is similar to changing the economic useful life of a depreciable asset, and therefore the two events should be reported the same way. Accordingly, Irwin reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from then on. The undepreciated cost remaining at the time of the change would be depreciated straight line over the remaining useful life.

($ in millions)

Asset’s cost $35.0Accumulated depreciation to date (calculated below) (16 .2) Undepreciated cost, Jan. 1, 2016 $18.8Estimated residual value (2 .0) To be depreciated over remaining 7 years $16.8

7 yearsAnnual straight-line depreciation 2016–2022 $ 2.4

Calculation of SYD depreciation

(10 + 9 + 8) x [$35 – 2] million) = $16.2 million

55*

* n (n = 1) 2 = [10 (11)] 2 = 55

Adjusting entry (2016 depreciation):($ in millions)

Depreciation expense (calculated above).............................................. 2.4Accumulated depreciation............................................................ 2.4

Brief Exercise 20-5

A change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method is similar to changing the economic useful life of a depreciable asset, and therefore the two events should be reported the same way. Accordingly, Irwin reports the change prospectively; previous financial statements are not revised. Instead, the undepreciated cost remaining at the time of the change would be depreciated by the sum-of-the-years’-digits method over the remaining useful life.

($ in millions)

Asset’s cost $35.0Accumulated depreciation to date (calculated below) (9 .9) Undepreciated cost, Jan. 1, 2016 $25.1Estimated residual value (2 .0) To be depreciated over remaining 7 years $23.1

Calculation of straight-line depreciation to date

($35 – 2) 10 years = $3.3 x 3 years = $9.9

Adjusting entry (2016 depreciation):($ in millions)

Depreciation expense (calculated below)............................................. 5.78Accumulated depreciation............................................................ 5.78

Calculation of SYD depreciation

7 x 23.1 million = $5.775 million

28*

* n (n + 1) 2 = [7 (8)] 2 = 28

Brief Exercise 20-7The fact that claims were less than expected represents a change in estimate. As a result, no adjustments are made to any 2015 financial statements, and the 2016 warranty expense is unaffected by any previous estimates. 2016 warranty expense is $350,000 times 4%, or $14,000. Quapau would record the following entry to record the expense (not required):

Accrued liability and expenseWarranty expense (4% x $350,000).................................................. 14,000


Brief Exercise 20-9

To correct the error:

Machinery............................................................................... 65,000 Buildings............................................................................. 65,000

Other step(s) that would be taken in connection with the error:When comparative balance sheets are reported that include 2015, the 2015

balance sheet would be restated to reflect the correction. A disclosure note should describe the error and the impact of its correction on each year’s net income, income from continuing operations, and earnings per share. In this case, because the machine was purchased at the end of 2015, depreciation in 2015 is correct and net income for 2015 is not impacted by the error.

Exercise 20-10

Requirement 1 In general, we report voluntary changes in accounting principles

retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company’s knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Clinton reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change would be depreciated straight line over the remaining useful life. A disclosure note should justify that the change is preferable and describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported.

Requirement 2 Asset’s cost $2,560,000Accumulated depreciation to date (given) (1,801,000 ) Undepreciated cost, Jan. 1, 2016 $ 759,000Estimated residual value (160,000 ) To be depreciated over remaining 3 years $ 599,000

3 yearsAnnual straight-line depreciation 2014-2016 $ 200,000

Adjusting entry (2016):

Depreciation expense (calculated above).......................... 200,000Accumulated depreciation ....................................... 200,000

Exercise 20-11

Requirement 1In general, we report voluntary changes in accounting principles

retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company’s knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Canliss reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the SYD method from now on. The undepreciated cost remaining at the time of the change would be depreciated by the SYD method over the remaining useful life (three years). A disclosure note should justify that the change is preferable and describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported.

Requirement 2 Asset’s cost $800,000Accumulated depreciation to date ($160,000 x 2) (320,000 ) To be depreciated over remaining 3 years $ 480,000

2016 SYD depreciation: 3 x $480,000 = $240,000(3 + 2 + 1)

Adjusting entry:

Depreciation expense (calculated above).......................... 240,000Accumulated depreciation ....................................... 240,000

Not required:

2017 SYD depreciation: 2 x $480,000 = $160,000(3 + 2 + 1)

2018 SYD depreciation: 1 x $480,000 = $80,000

(3 + 2 + 1)

Exercise 20-14

Requirement 1

Accrued liability and expenseWarranty expense (3% x $3,600,000)............................................... 108,000


Actual expenditures (summary entry)Estimated warranty liability ................................................... 88,000

Cash, wages payable, parts and supplies, etc. ................... 88,000

Requirement 2

Actual expenditures (summary entry)Estimated warranty liability ($50,000 – 23,000)........................ 27,000Loss on product warranty (3% – 2%] x $2,500,000)................... 25,000

Cash, wages payable, parts and supplies, etc. ................... 52,000* *(3% x $2,500,000) – $23,000 = $52,000

Exercise 20-16

Requirement 1This is a change in accounting estimate.

Requirement 2When an estimate is revised as new information comes to light, accounting for

the change in estimate is quite straightforward. We do not recast prior years' financial statements to reflect the new estimate. Instead, we merely incorporate the new estimate in any related accounting determinations from there on. If the after-tax income effect of the change in estimate is material, the effect on net income and earnings per share must be disclosed in a note, along with the justification for the change.

Requirement 3

$800,000 Cost$160,000 Old annual depreciation ($800,000 ÷ 5 years) x 2 years 320,000 Depreciation to date (2014–2015)

480,000 Book value

__ ÷ 6 New estimated remaining life (8 years – 2 years used)$ 80,000 New annual depreciation

Exercise 20-17

Requirement 1

Depreciation expense (determined below)... 3,088Accumulated depreciation .................. 3,088

Calculation of annual depreciation after the estimate change:$40,000 Cost

$7,200 Old annual depreciation ($36,000 ÷ 5 years) x 2 years 14,400 Depreciation to date (2014–2015)

$25,600 Book value (900 ) Revised residual value$24,700 Revised depreciable base ÷ 8 Estimated remaining life (10 years – 2 years used)$ 3,088 New annual depreciation

Requirement 2

Depreciation expense (determined below)... 3,889Accumulated depreciation................... 3,889


$40,000 Cost Previous depreciation:

$12,000 2014: ($36,000 x 5/15) 9,600 2015: ($36,000 x 4/15)

21,600 Depreciation to date (2014–2015)$18,400 Book value (900 ) Revised residual value

$17,500 Revised depreciable basex 8 /36* Estimated remaining life: 8years$ 3,889 2016 depreciation

* n (n + 1) ÷ 2 = 8 (9) ÷ 2 = 36

Exercise 20-18

EP 1. Change from declining balance depreciation to straight-line.

E 2. Change in the estimated useful life of office equipment.

E 3. Technological advance that renders worthless a patent with an unamortized cost of $45,000.

PR 4. Change from determining lower of cost or market for inventories by the individual item approach to the aggregate approach.

PR 5. Change from LIFO inventory costing to weighted-average inventory costing.

E 6. Settling a lawsuit for less than the amount accrued previously as a loss contingency.

R 7. Including in the consolidated financial statements a subsidiary acquired several years earlier that was appropriately not included in previous years.

N * 8. Change by a retail store from reporting warranty expense on a pay-as-you-go basis to estimating the expense in the period of sale.

PR 9. A shift of certain manufacturing overhead costs to inventory that previously were expensed as incurred to more accurately measure cost of goods sold. (Either method is generally acceptable.)

E 10. Pension plan assets for a defined benefit pension plan achieving a rate of return in excess of the amount anticipated.

*Error correction: change from an unacceptable method to GAAP.

Exercise 20-19

Requirement 1

The 2014 error caused 2014 net income to be understated, but since 2014 ending inventory is 2015 beginning inventory, 2015 net income was overstated by the same amount. So, the income statement was misstated for 2014 and 2015, but the balance sheet (retained earnings) was incorrect only for 2014 with regard to this error. After that, no account balances are incorrect due to the 2014 error.

Analysis: U = UnderstatedO = Overstated

2014 2015Beginning inventory Beginning inventory UPlus: net purchases Plus: net purchases Less: ending inventory U Less: ending inventoryCost of goods sold O Cost of goods sold U

Revenues RevenuesLess: cost of goods sold O Less: cost of goods sold ULess: other expenses Less: other expensesNet income U Net income O

Retained earnings U Retained earnings corrected

Exercise 20-19 (concluded)





Retained earnings O

Requirement 2

Retained earnings (overstatement of 2015 income)......................... 150,000Inventory (overstatement of 2016 beginning inventory).............. 150,000

Requirement 3

The financial statements that were incorrect as a result of both errors (effect of one error in 2014 and effect of two errors in 2015) would be retrospectively restated to report the correct inventory amounts, cost of goods sold, income, and retained earnings when those statements are reported again for comparative purposes in the current annual report. A “prior period adjustment” to retained earnings would be reported, net of tax, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s income from continuing operations, net income, and earnings per share.

Exercise 20-24

U = understatedO = overstatedNE = no effect

Cost of Net RetainedGoods Sold Income Earnings

1. Overstatement of ending inventory U O O2. Overstatement of purchases O U U3. Understatement of beginning inventory U O O4. Freight-in charges are understated U O O5. Understatement of ending inventory O U U6. Understatement of purchases U O O7. Overstatement of beginning inventory O U U8. Understatement of purchases and

understatement of ending inventory, by the same amount NE NE NE

CPA Exam Questions

1. b. The depreciation prior to the change is as follows: SYD Depreciation:

2014 depreciation $11,400 ($34,200 x 5/15)

2015 depreciation 9,120 ($34,200 x 4/15)

Accumulated depreciation $20,520

Since a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle, Kap reports the change prospectively, just like a change in estimate. Kap depreciates the remaining undepreciated cost on a straight-line basis over the remaining useful life:

Asset’s cost $36,000Accumulated depreciation to date (calculated above) (20,520 )

Undepreciated cost, Jan. 1, 2016 $15,480Estimated residual value (1,800 ) To be depreciated over remaining 3 years $13,680

3 years

Annual straight-line depreciation 2016–2018 $ 4,560

2. b. Most changes in accounting principle are accounted for retrospectively. That is, financial statements of prior periods are restated to report the financial information for the new reporting entity in all periods. Changes in estimate are accounted for prospectively.

3. a. The change in the estimate for warranty costs is based on new information obtained from experience and qualifies as a change in accounting estimate. A change in accounting estimate affects current and future periods and is not accounted for by restating prior periods. The accounting change is a part of continuing operations but is not reported net of taxes.

CPA Exam Questions (continued)

4. b. This is a change in reporting entity to be accounted for retrospectively. That is, financial statements of prior periods are restated to report the financial information for the new reporting entity in all periods.

5. b. The insurance premiums of $60,000 were charged in error to insurance expense on the 2015 income statements. The premiums should have been allocated equally at $20,000 per year for 2015, 2016, and 2017. Therefore, the beginning retained earnings at 2016 are understated by $28,000—the effect of the error ($40,000) less the $12,000 tax effect ($40,000 × 30%). The corrected retained earnings would be the beginning balance plus the correction of the error ($400,000 + 28,000 = $428,000).

6. c. The $60,000 understated ending inventory would cause the 2015 cost of goods sold to be overstated, understating net income and retained earnings. That same error would cause 2016 beginning inventory to be understated, overstating net income and retained earnings by the same amount, effectively correcting the retained earnings balance. The $75,000 overstated ending inventory would cause the 2016 cost of goods sold to be understated, overstating net income and retained earnings.

IFRS CPA Exam Questions

7. b According to IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors, a change in accounting policy normally should be recognized retrospectively for all periods presented in the financial statements. This is true also for U.S. GAAP.

CPA Exam Questions (continued)8. d Errors discovered in reporting periods subsequent to the error that has

occurred should be recognized in the financial statements as if the error had not occurred by restating those financial statements both in all periods affected and cumulatively in opening retained earnings for the earliest period presented if the error occurred before that date. As an adjustment to beginning retained earnings for the reporting period in which the error was discovered is incorrect because when an error is corrected all affected financial statement captions for the current and prior periods should be restated. A note disclosure is necessary when an error is corrected but a note disclosure is never sufficient for error correction. The only amounts recognized in the current statement of comprehensive income for an error that occurred in a prior period are the amounts specific to the current period. This is true also for U.S. GAAP. When correcting errors in previously issued financial statements, IFRS (IAS No. 81) permits the effect of the error to be reported in the current period if it’s not considered practicable to report it retrospectively as is required by U.S. GAAP.

9. d IAS 8 states that a change in accounting policy because of the entity’s initial application of an IFRS should be applied in accordance with the transitional guidance in that IFRS. If the IFRS does not include specific transitional guidance or if the change is being made voluntarily, the change should be applied retrospectively, unless it is impracticable to do so. Prospectively is incorrect because the default application required by IAS 8 is not prospective application. Practicably is incorrect because practicability is a separate issue that is not considered in isolation from other IFRS guidance. In accordance with management’s judgment is incorrect because while management is responsible for all financial reporting matters, it must apply IFRS to its financial statements in accordance with the applicable IFRS.

1 “Accounting Policies, Changes in Accounting Estimates and Errors, “International Accounting Standard No. 8 (IASCF), as amended effective January 1, 2014.


10. c Errors discovered in reporting periods subsequent to the error that has occurred should be recognized in the financial statements as if the error had not occurred by restating those financial statements both in all periods affected and cumulatively in opening retained earnings for the earliest period presented if the error occurred before that date. As an adjustment to beginning retained earnings for the reporting period in which the error was discovered is incorrect because when an error is corrected all affected financial statement captions for the current and prior periods should be restated. A note disclosure is necessary when an error is corrected but a note disclosure is never sufficient for error correction. The only amounts recognized in the current statement of comprehensive income for an error that occurred in a prior period are the amounts specific to the current period. When correcting errors in previously issued financial statements, IFRS (IAS No. 82) permits the effect of the error to be reported in the current period if it’s not considered practicable to report it retrospectively as is required by U.S. GAAP.

11. a According to IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors, a change in accounting policy is permitted if the change will result in a more reliable and more relevant presentation of the financial statements.

12. c Upon first-time adoption of IFRS, an entity may elect to use fair value as deemed cost for any individual item of property, plant, and equipment. Intangible assets can be revalued to fair value only when there is an active market. Neither of the other two asset responses is allowed to be revalued.

13. a A company’s first IFRS financial statements must include at least three balance sheets and two of each of the other financial statements. If the company’s first IFRS reporting period is as of and for the year ended December 31, year 2, the first balance sheet will be the opening balance sheet of year 1. The date of transition to IFRS is the date of the opening balance sheet. Thus, the company’s date of transition to IFRS is January 1, year 1.

14. a

2 “Accounting Policies, Changes in Accounting Estimates and Errors, “International Accounting Standard No. 8 (IASCF), as amended effective January 1, 2014.

15. b LIFO is not a permissible method for accounting for inventory under IFRS.

CMA Exam Questions

1. d. A change in the liability is merely a change in an estimate; it is not a change in principle. A change in estimate should be accounted for prospectively, that is, in the current and future periods.

2. a. Prior-period adjustments (error corrections) are to be accounted for through retained earnings, not the income statement. Thus, the beginning balance of retained earnings should be credited for revenue that was erroneously not accrued in a prior period. The amount of the credit at May 31, 2016, is $91,800 (2015 accrued interest revenue).

3. c. The correction of an error in the financial statements of a prior period is accounted for and reported as a prior-period adjustment and excluded from the determination of net income for the current period.

Problem 20-31. This is a change in accounting principle to be recorded retrospectively.

($ in 000s)Retained earnings ($3,550 – 3,140) .......................................... 410

Inventory (reduction to Average method)................................. 410

Weihrich will recast its financial statements to appear as if the average method always had been used. It also will reduce retained earnings to the balance it would have had if the average method had been used previously; that is, by the cumulative income difference between the average and FIFO methods. Simultaneously, inventory is reduced to the balance it would have been if the average method had always been used. A disclosure note should justify that the change is preferable and describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported.

2. This is a change in accounting principle that usually is reported prospectively.


When a company changes to the LIFO inventory method from another inventory method, it usually does not report the change retrospectively. Instead, the base year inventory for all future LIFO calculations is the beginning inventory in the year the LIFO method is adopted. A disclosure note should describe the nature of and justification for the change as well as an explanation of why retrospective application was impracticable.

3. This is a change in accounting principle to be partially recorded retrospectively.

($ in 000s)Retained earnings ($750 – 540) ................................................ 210

Inventory (decrease to LIFO for 2015 difference only)............... 210

In its comparative 2016–2015 financial statements, Weihrich should report numbers for 2015 as if it had carried forward the 2014 ending balance in inventory

(measured on the previous FIFO inventory costing basis) and then had begun applying LIFO as of January 1, 2015. There would be no adjustment to accounts for the cumulative income effect of not using LIFO prior to that.

Problem 20-8a. This is a change in estimate.

No entry is needed to record the change

2016 adjusting entry:Warranty expense (2% x $4,000,000)................................... 80,000

Estimated warranty liability .................................... 80,000

If the effect is material, a disclosure note should describe the effect of a change in estimate on income from continuing operations, net income, and related per share amounts for the current period.

b. This is a change in estimate.


2016 adjusting entry:Depreciation expense (determined below) ..................... 45,000

Accumulated depreciation ....................................... 45,000

Calculation of annual depreciation after the estimate change:$1,000,000 Cost

$25,000 Old depreciation ($1,000,000 ÷ 40 years) x 3 yrs (75,000 ) Depreciation to date (2013-2015)

$ 925,000 Undepreciated cost (700,000 ) New estimated salvage value $ 225,000 To be depreciated ÷ 5 Estimated remaining life (5 years: 2016–2020)$ 45,000 New annual depreciation

A disclosure note should describe the effect of a change in estimate on income from continuing operations, net income, and related per share amounts for the current period.

Problem 20-8 (continued)

c. This is a change in accounting principle that usually is reported prospectively.


When a company changes to the LIFO inventory method from another inventory method, accounting records usually are insufficient to determine the cumulative income effect of the change necessary to retrospectively revise accounts. So, a company changing to LIFO usually reports the beginning inventory in the year the LIFO method is adopted ($690,000 in this case) as the base year inventory for all future LIFO calculations. The disclosure required is a note to the financial statements describing the nature of and justification for the change as well as an explanation as to why the retrospective application was impracticable.

d. This is a change in accounting estimate resulting from a change in accounting principle.


2016 adjusting entry:Depreciation expense (determined below) ..................... 24,000

Accumulated depreciation ....................................... 24,000

Problem 20-8 (concluded)

A change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. Accordingly, the Hoffman Group reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change is depreciated straight line over the remaining useful life.

($ in 000s)

Asset’s cost $330Accumulated depreciation to date (calculated below) (162 ) Undepreciated cost, Jan. 1, 2016 $168Estimated residual value (0 ) To be depreciated over remaining 7 years $168

÷ 7 yearsAnnual straight-line depreciation 2016–2022 $ 24

Calculation of SYD depreciation:

(10 + 9 + 8) x $330,000) = $162,00055

e. This is a change in estimate.

To revise the liability on the basis of the new estimate:Loss—litigation.................................................................. 150,000

Liability—litigation ($350,000 – 200,000)......................... 150,000

A disclosure note should describe the effect of a change in estimate on income from continuing operations, net income, and related per share amounts for the current period.

f. This is a change in accounting principle accounted for prospectively.

Because the change will be effective only for assets placed in service after the date of change, the change doesn’t affect assets depreciated in prior periods. The nature of and justification for the change should be described in the disclosure

notes. Also, the effect of the change on the current period’s financial statements should be disclosed.

Problem 20-9 P R 1. By acquiring additional stock, Wagner increased its investment

in Wise, Inc., from a 12% interest to 25% and changed its method of accounting for the investment to the equity method.

N P 2. Wagner instituted a postretirement benefit plan for its employees in 2016. Wagner did not previously have such a plan.

EP P 3. Wagner changed its method of depreciating computer equipment from the SYD method to the straight-line method.

X R 4. Wagner determined that a liability insurance premium it both paid and expensed in 2015 covered the 2015–2017 period.

P R 5. By selling shares in Launch Corp, Wagner decreased its investment in the company from a 23% interest to 15% and changed its method of accounting for the investment from the equity method the to the cost method.

E P 6. Due to an unexpected relocation, Wagner determined that its office building previously depreciated using a 45-year life should be depreciated using an 18-year life.

E P 7. Wagner offers a three-year warranty on the farming equipment it sells. Manufacturing efficiencies caused Wagner to reduce its expectation of warranty costs from 2% of sales to 1% of sales.

P R 8. Wagner changed from LIFO to FIFO to account for its materials and work in process inventories.

P R 9. Wagner changed from FIFO to average cost to account for its equipment inventory.

X R 10. Wagner sells extended service contracts on some of its equipment sold. Wagner performs services related to these contracts over several years, so in 2016 Wagner changed from recognizing revenue from these service contracts on a cash basis to the accrual basis.

Problem 20-10

Requirement 1


2014 2015Beginning inventory Beginning inventory U-6,000Plus: Net purchases Plus: Net purchases U-3,000Less: E nding inventory U-6,000 Less: E nding inventory O-9,000Cost of goods sold O-6,000 Cost of goods sold U-18,000

Revenues RevenuesLess: Cost of goods sold O-6,000 Less: Cost of goods sold U-18,000Less: O ther expenses Less: O ther expenses Net income U-6,000 Net income O-18,000

Retained earnings U-6,000 Retained earnings O-12,000

Requirement 2

Retained earnings.................................... 12,000Inventory.............................................. 9,000Purchases............................................. 3,000

Requirement 3The financial statements that were incorrect as a result of both errors (effect of

one error in 2014 and effect of three errors in 2015) would be retrospectively restated to report the correct inventory amounts, cost of goods sold, income, and retained earnings when those statements are reported again for comparative purposes in the 2016 annual report. A prior period adjustment to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income from continuing operations, and earnings per share.

Problem 20-15

1a. To correct the error:Equipment (cost).................................................................... 45,000

Accumulated depreciation ([$45,000 ÷ 5] x 2 years)............. 18,000Retained earnings ($45,000 – [$9,000 x 2 years])..................... 27,000

2016 adjusting entry:Depreciation expense ($45,000 ÷ 5) ...................................... 9,000

Accumulated depreciation................................................. 9,000

b. To reverse erroneous entry:Cash ...................................................................................... 17,000

Office supplies ................................................................. 17,000

To record correct entry:Tools ..................................................................................... 17,000

Cash .................................................................................. 17,000 Note: These entries can, of course, be combined.

c. To correct the error:Inventory .......................................................................................... 78,000

Retained earnings ...................................................................... 78,000

d. To correct the error:Retained earnings ([$12 x 2,000 shares] – $2,000)...................... 22,000

Paid-in capital—excess of par........................................... 22,000

Note: A “small” stock dividend (< 25%) requires that the market value of the additional shares be “capitalized.”

Problem 20-15 (concluded)

e. To correct the error:Retained earnings (overstatement of 2015 income)....................... 104,000

Interest expense (overstatement of 2016 interest) ................... 104,000

2016 adjusting entry:

Interest expense (4/6 x $156,000)............................................. 104,000

Interest payable (4/6 x $156,000)......................................... 104,000

f. To correct the error:Prepaid insurance ($72,000 ÷ 3 yrs x 2 years: 2016–2017) .......... 48,000

Retained earnings ($72,000 – [$72,000 ÷ 3 years]) ............... 48,000

2016 adjusting entry:Insurance expense ($72,000 ÷ 3 years) ......................................... 24,000

Prepaid insurance ............................................................. 24,000

Documents

Anwser to Exercise_Chap 8-Chap 20.docx