1.
Prepare correct journal entries for Corporation I, if the errors are discovered before the books are closed, at the end of 2017.
1.
Explanation of Solution
Errors: The comparability and consistency of the financial statements decreases when a company records arithmetic mistakes, or errors. Such errors do require adjustments to make the financial information more reliable, and more relevant.
Debit and credit rules:
- Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in
stockholders’ equity accounts. - Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.
Prepare correct journal entries for Corporation I, if the errors are discovered before the books are closed, at the end of 2017.
Journal entry to correct the reduction in loss experience rate:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2017 | ||||||
December | 31 | Allowance for Doubtful Accounts | 10,000 | |||
Administrative Expenses | 10,000 | |||||
(Record reduction in loss experience rate) |
Table (1)
Description:
- Allowance for Doubtful Accounts is a contra-asset account to Accounts Receivable account. The contra-asset accounts decrease the asset value, and a decrease in contra-asset is debited.
- Administrative Expenses is an expense account. Since expenses are reduced, equity value increased, and an increase in equity is credited.
Working Notes:
Compute allowance for doubtful accounts.
Details | Amount ($) |
Net sales for the year ended December 31, 2017 | $1,000,000 |
Percentage of loss experience rate | × 1% |
Allowance for doubtful accounts | $10,000 |
Table (2)
Journal entry to record the valuation of available-for-sale securities:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2017 | ||||||
December | 31 | Available-for-Sale Securities | 16,000 | |||
Allowance for Change in Fair Value Adjustment | 16,000 | |||||
(Record reduction in market value of available-for-sale securities) |
Table (3)
Description:
- Available-for-Sale Securities (AFSS) is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since loss has occurred and lossesdecrease stockholders’ equity value, and a decrease in stockholders’ equity value is debited.
- Allowance for Change in Fair Value Adjustment is a contra-asset account. The account is credited because the market price was decreased, the decreased value is adjusted to this account.
Working Notes:
Compute unrealized gain or loss on investment in AFSS.
Journal entry to correct the 2016 overstated inventory:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2017 | ||||||
December | 31 | Retained Earnings | 4,000 | |||
Cost of Goods Sold | 4,000 | |||||
(Record reduction in overstated retained earnings) |
Table (4)
Description:
- Retained Earnings is an equity account. Since ending inventory in 2016 was overstated, cost of goods sold of 2016 were understated, and hence, revenue is overstated in 2016. The retained earnings account is debited to decrease the overstated equity.
- Cost of Goods Sold is an equity account. Since cost of goods sold of 2017 was overstated, the expense account is credited to decrease the overstated equity.
Journal entry to correct the 2017 overstated inventory:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2017 | ||||||
December | 31 | Cost of Goods Sold | 6,100 | |||
Inventory | 6,100 | |||||
(Record reduction in overstated inventory and increase in understated cost of goods sold) |
Table (5)
Description:
- Cost of Goods Sold is an equity account. Since ending inventory in 2017 was overstated, cost of goods sold of 2017 were understated. The expense account is debited to increase the understated equity.
- Inventory is an asset account. Since ending inventory in 2017 was overstated, the value of assets increased. The asset account is credited to decrease the overstated asset account.
Journal entry to correct the incorrectly charged operating expenses:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2017 | ||||||
December | 31 | Equipment | 12,000 | |||
1,100 | ||||||
Retained Earnings | 10,900 | |||||
2,200 | ||||||
(Record increase in equipment account and increase in understated retained earnings) |
Table (6)
Description:
- Equipment is an asset account. Since equipment in was understated, the value of assets decreased. The asset account is debited to increase the understated asset account.
- Depreciation Expense is an expense account. Since expenses are increased, equity value decreased, and a decrease in equity is debited.
- Retained Earnings is an equity account. Since operating expenses are overstated, revenue was understated, and hence, revenue is understated in 2017. The retained earnings account is credited to increase the understated equity.
- Accumulated Depreciation is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.
Working Notes:
Compute accumulated depreciation.
Computation of Accumulated Depreciation | |
Acquisition cost on January 1, 2016 | $12,000 |
Less: Salvage value | (1,000) |
Original depreciable base | 11,000 |
Original estimated useful life | ÷ 10 years |
Straight-line depreciation expense per year | 1,100 |
Number of years the asset was consumed, 2 years (2016 to 2017) | × 2 years |
Accumulated depreciation | $2,200 |
Table (7)
Journal entry to correct the incorrect crediting of sale proceeds:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
2017 | ||||||
December | 31 | Accumulated Depreciation | 17,500 | |||
Equipment | 15,000 | |||||
Other Income | 2,500 | |||||
(Record sale of equipment) |
Table (8)
Description:
- Accumulated Depreciation is a contra-asset account. Since the equipment is sold, the accumulated depreciation balance is reversed to reduce the balance in the account, hence, the account is debited.
- Equipment is an asset account. Since equipment is sold, asset account decreased, and a decrease in asset is credited.
- Other Income is a revenue account. Since gains and revenues increase equity, equity value is increased, and an increase in equity is credited.
Journal entry for prepaid expenses paid in 2016:
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | ||
Prepaid Insurance | 900 | |||||
Insurance Expenses | 900 | |||||
Retained Earnings | 1,800 | |||||
(Record unrecognized prepaid expenses and incurred in 2020) |
Table (9)
Description:
- Prepaid Insurance is an asset account. Since balance of prepaid expenses were recorded in 2017, asset value increased, and an increase in asset is debited.
- Insurance Expense is an equity account. Expenses decrease equity value, and a decrease in equity is debited.
- Retained Earnings is an equity account. Since prepaid expenses of 2016were recorded as expenses in 2017, and was included in the computation of net income, the net income in 2017 was understated. The equity account is credited to increase the understated value.
Working Notes:
Calculate the value of insurance expense for one year.
Journal entry for reducing additional paid-in capital in excess of par from common stock value:
Date | Account Titles and Explanation | Post Ref | Debit ($) | Credit ($) | ||
Common Stock | 60,000 | |||||
Paid-In Capital in Excess of Par | 60,000 | |||||
(Record reduction of additional paid-in capital from common stock) |
Table (10)
Description:
- Common Stock is a stockholders’ equity account. Since additional paid-in capital is adjusted from common stock, equity value is decreased, and a decrease in equity is debited.
- Paid-In Capital in Excess of Par is a stockholders’ equity account. Since common stock issued at a value in excess of par value is adjusted, paid-in capital value is increased, and an increase in equity is credited.
2.
Calculate the correct net income for 2016 and 2017, after including the omissions.
2.
Explanation of Solution
Calculate the correct net income for the years 2016 and 2017.
Details | 2017 | 2016 |
Reported net income | $220,000 | $195,000 |
Change in loss experience rate | 10,000 | |
Overstated ending merchandise inventory in 2016 | 4,000 | (4,000) |
Overstated ending merchandise inventory in 2017 | (6,100) | |
Decrease in operating expenses in 2016 | 10,900 | |
Increase in operating expenses in 2017 | (1,100) | |
Proceeds from sale of equipment | 2,500 | |
Recognition of prepaid insurance | (900) | 1,800 |
Correct pretax income | $228,400 | $203,7000 |
Table (11)
Want to see more full solutions like this?
Chapter 22 Solutions
Intermediate Accounting: Reporting and Analysis
- Pat Colt is auditing the financial statements of Manning Company. The following is a summary of the uncorrected misstatements that Colt has identified during the past three years. These misstatements are Immaterial and have related to Isolated matters. In this summary, parentheses Imply that the misstatements would have reduced balances if they had been corrected (e.g., In 2020, the misstatements would have reduced net income by $82,500, assets by $100,000, liabilities by $17,500, and equity by $82,500 if corrected). Year 2020 2021 2022 Effect on Net Income $ (82,500) (22,000) 30,000 Effect on Assets $ (100,000) (25,500) 30,000 Effect on Liabilities $ (17,500) (3,500) 0 Effect on Equity $ (82,500) (22,000) 30,000 During the most recent audit, Colt concluded that expenses totaling $130,000 were recognized in January 2024 (when Manning paid them) but should have been recognized in 2023. Required: a. What is the dollar Impact of the misstatement identified in 2023 on each of the following…arrow_forwardPat Colt is auditing the financial statements of Manning Company. The following is a summary of the uncorrected misstatements that Colt has identified during the past three years. These misstatements are immaterial and have related to isolated matters. In this summary, parentheses imply that the misstatements would have reduced balances if they had been corrected (e.g., in 2020, the misstatements would have reduced net income by $82,500, assets by $100,000, liabilities by $17,500, and equity by $82,500 if corrected). Year 2020 2021 2022 Effect on Net Income $ (82,500) (22,000) 30,000 Effect on Assets $ (100,000) (25,500) 30,000 Effect on Liabilities $ (17,500) (3,500) 0 During the most recent audit, Colt concluded that expenses totaling $130,000 were recognized in January 2024 (when Manning paid them) but should have been recognized in 2023. Required: a. What is the dollar impact of the misstatement identified in 2023 on each of the following (assume a 21% tax rate for Manning)? Note:…arrow_forwardYou were engaged by Lanao Company to audit its financial statements for the first time. In examining the books, you found out that certain adjustments had been overlooked at the end of 2014 and 2015. You also discovered that other items had been improperly recorded. These omissions and other failures for each year are summarized below: 12/31/15 12/31/14 P780,000 P873,600 213,000 307,800 Salaries payable Interest receivable 259,200 384,000 Prepaid insurance Advances from customers (Collections from customers had been recorded as sales but should have been recognized as advances from customers because goods were not shipped until the following year) Machinery (Capital expenditures had been recorded as repairs but should have been charged to Machinery; the depreciation rate is 10% per year, but depreciation in the year of expenditure is to be recognized at 5%) 561,000 470,400 522,000 564,000 Based on the above and the result of your audit, answer the following: 1. What is the total effect…arrow_forward
- Ingalls Corporation is in the process of negotiating a loan for expansion purposes. The books and records have never been audited, and the bank has requested that an audit be performed. Ingalls has prepared the following comparative financial statements for the years ended December 31, 2020 and 2019: 1. Prepare the journal entries to correct the books at December 31, 2020. The book s for 2020 have not been closed. Ignore income taxes. 2. Prepare a schedule showing the computation of corrected net income for the years ended December 31, 2020 and 2019, assuming that any adjustments are to be reported on comparative statements for the 2 years. The first items on your schedule should be the net income for each year. Ignore income taxes. (Do not prepare financial statements.)arrow_forwardChelsea Bank provided overdraft facilities to Liverpool Ltd and Manchester & Co. were Liverpool’s auditors. The relevant overdraft facility letters between Chelsea Bank and Liverpool Ltd contained a clause requiring Manchester & Co. to send Chelsea Bank, each year, a copy of the annual audited financial statements.In 2018 Liverpool Ltd was put into receivership with approximately $23.5M owing to Chelsea Bank. Chelsea Bank claimed that, due to massive fraud, Liverpool’s financial statements for the previous years had misstated the financial position of Liverpool and Manchester & Co. had been negligent in not detecting the fraud. Chelsea Bank contended that it had continued to provide the overdraft facilities in reliance on Manchester’s unqualified opinions.Manchester & Co. applied to the court for an order striking out the claim on the grounds that, even if all the facts alleged by Chelsea Bank were true, the claim could not succeed in law because Manchester & Co.…arrow_forwardMTy Bhd has two issues identified by auditors relevant to events after the reporting period for the year ended 31 December 2017 as follows: During the audit, the auditor has discovered a material fraud committed by the company’s Accounts Officer. Investigations revealed that a total of RM250,000 of the trade receivables as shown in the statement of financial position at 31 December 2017 was paid and the money has been embezzled by the Accounts Officer. The auditor revealed that RM105,000 was embezzled in the year to 31 December 2016 and the balance in the current year. MTy Bhd has not covered insurance for the loss, thus, the amount of RM250,000 is not recoverable. MTy Bhd is being sued by an employee who lost a hand in an accident while at work on 1 June 2017. The company is contesting the claim as the employee was not following the safety procedures. Accordingly, the financial statements include a note of a contingent liability of RM103,000 for personal injury damages. On 10…arrow_forward
- During the course of the audit, the following additional information was obtained: a. The trading securities were acquired on December 31, 2011. The securities have a fair value of P67,000 at December 31, 2012. b. In discussion with the company officials, it was determined that the doubtful accounts expense rate based on net sales should be reduced to 2% from 3%, effective January 1, 2012. c. As a result of errors in the physical count, inventories were overstated by P12,000 at December 31, 2011 and by P17,500 at December 31, 2012. d. On January 1, 2011, the cost of equipment purchased for P30,000 was debited to repairs and maintenance. PRTC depreciates equipment of this type by the straight-line method over a five-year life with no residual value. e. On July 1, 2012, fully depreciated equipment purchased for P21,000, was sold as scrap for P2,500. The only entry PRTC made was to debit cash and credit property and equipment for the scrap proceeds. The property and equipment (net) had a…arrow_forwardChelsea Bank provided overdraft facilities to Liverpool Ltd and Manchester & Co. were Liverpool’s auditors. The relevant overdraft facility letters between Chelsea Bank and Liverpool Ltd contained a clause requiring Manchester & Co. to send Chelsea Bank, each year, a copy of the annual audited financial statements.In 2018 Liverpool Ltd was put into receivership with approximately $23.5M owing to Chelsea Bank. Chelsea Bank claimed that, due to massive fraud, Liverpool’s financial statements for the previous years had misstated the financial position of Liverpool and Manchester & Co. had been negligent in not detecting the fraud. Chelsea Bank contended that it had continued to provide the overdraft facilities in reliance on Manchester’s unqualified opinions.Manchester & Co. applied to the court for an order striking out the claim on the grounds that, even if all the facts alleged by Chelsea Bank were true, the claim could not succeed in law because Manchester & Co.…arrow_forwardGolden bank recently appointed the accounting firm Sanford,Son and Golrich as the banks auditors. The Bank quickly became one of Sanford,Son and Golrich’s largest clients. Subject to Reserve bank regulations,Golden Bank must provide for any expected losses on Accounts Receivable that the bank might not collect in full. During the course of the audit ,Sanford,Son and Golrich determined that the collectability of three large accounts of Golden bank seemed questionable. The auditors discussed this with Debbie Lee, the Financial controller . She assured the auditors that the loans were good and the debtors will be able to pay them in full once the economy recovers. Due to the effect of the covid 19 pandemic on the economy ,what the controller says is unlikely. Therefore Sanford,Son and Golrich must record a loss for the portion of the Accounts Receivable that might not be collectible.The controller objected and threatened to dismiss the auditors if they keep on insisting that the bank…arrow_forward
- Kim Company, a CPA firm, conducted an audit for the 2020 financial statements of Erin Corporation. The auditors found that the accounting manager changed the journal entry for estimating bad debt expense to a smaller number to hide the poor results from extending credit to high risk customers. This made income materially higher than it otherwise would have been. This is an example of: Embezzlement Employee fraud Larceny Management fraud O None of the abovearrow_forwardFor each situation, identify the appropriate audit report and briefly explain the rationale for selecting the report. During the course of the audit of Sail-Away Company, the auditor noted that the current ratio has dropped to 1.75. the company’s loan covenant requires the maintenance of a current ratio of 2.0, or the company’s det is all immediately due. The auditor and the company have contacted the bank, which is not willing to waive the loan covenant because the company has been experiencing operating losses for the past few years and has an inadequate capital structure. The auditor has substantial doubt that the company can find adequate financing elsewhere and may encounter difficulties staying in operation. Management, however, is confident that it can overcome the problem. The company does not deem it necessary to include any additional disclosure because management members are confident that an alternative source of funds will be found by pledging their personal assets. The…arrow_forwardWhaley Distributors is a wholesale distributor of electronic components. Financial statements for the years ended December 31, 2016 and 2017, reported the following amounts and subtotals ($ in millions): Assets Liabilities Shareholders' Equity Net Income Expenses 2016 $ 770 $ 345 $ 425 $ 225 $ 153 2017 850 415 435 245 178 In 2018 the following situations occurred or came to light: Internal auditors discovered that ending inventories reported on the financial statements the two previous years were misstated due to faulty internal controls. The errors were in the following amounts: 2016 inventory Overstated by $ 12.3 million 2017 inventory Understated by $ 10.3 million A liability was accrued in 2016 for a probable payment of $7.6 million in connection with a lawsuit ultimately settled in December 2018 for $4.3 million. A patent costing $19.8 million at the beginning of 2016, expected to benefit operations for a total of…arrow_forward
- Intermediate Accounting: Reporting And AnalysisAccountingISBN:9781337788281Author:James M. Wahlen, Jefferson P. Jones, Donald PagachPublisher:Cengage Learning