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B EXERCISES

3 E22-1B (Change in Principle—Long-term Contracts) Choice Two Manufacturing Company changed

from the completed-contract to the percentage-of-completion method of accounting for long-term con-
struction contracts during 2014. For tax purposes, the company employs the completed-contract method
and will continue this approach in the future. (Hint: Adjust all tax consequences through the Deferred Tax
Liability account.) The appropriate information related to this change is as follows.

Pretax Income from:

Percentage-of-Completion Completed-Contract Difference
2013 $680,000 $500,000 $180,000
2014 600,000 560,000 40,000

Instructions
(a) Assuming that the tax rate is 40%, what is the amount of net income that would be reported in
2014?
(b) What entry(ies) are necessary to adjust the accounting records for the change in accounting prin-
ciple?

3 E22-2B (Change in Principle—Inventory Methods) Royal Inc. began operations on January 1, 2009, and
uses the FIFO method of pricing inventory. Management is contemplating a change in inventory meth-
ods for 2015. The following information is available for the years 2012–2014.

Net Income Computed Using:

Average-Cost Method FIFO Method LIFO Method
2012 $105,000 $120,000 $ 80,000
2013 70,000 80,000 50,000
2014 150,000 165,000 130,000

Instructions
(a) Prepare the journal entry necessary to record a change from the FIFO method to the average cost
method in 2015.
(b) Determine net income to be reported for 2012, 2013, and 2014, after giving effect to the change in
accounting principle.
(c) Assume Royal Inc. used the average cost method instead of the FIFO method during the years
2012–2014. In 2015, Royal changed to the LIFO method. Prepare the journal entry necessary to
record the change in principle.

3 E22-3B (Accounting Change) Kyto Electronics decides to adopt the average cost method of inventory
valuation at the beginning of 2014. Kyto had used the LIFO method for financial reporting since its in-
ception on January 1, 2012, and had maintained records adequate to apply the average-cost method ret-
rospectively. Kyto concluded that average-cost is the preferable inventory method because extreme ef-
fects of FIFO or LIFO on the income statement and balance sheet are averaged. The following table
presents the effects of the change in accounting principles on inventory and cost of goods sold for each
year.

Inventory Determined by Cost of Goods Sold Determined by

LIFO Average-Cost LIFO Average-Cost
2012 $2,000 $3,000 $10,000 $ 9,000
2013 3,000 5,000 10,500 9,500
2014 3,500 6,000 11,000 10,500

Other information:
1. For each year presented, sales are $15,000 and operating expenses are $2,500.
2. Kyto provides 2 years of financial statements, and earnings per share information is not required.
3. Ignore income taxes.

Instructions
(a) Prepare income statements under LIFO and average-cost for 2012, 2013, and 2014.
(b) Prepare income statements reflecting the retrospective application of the accounting change from
the LIFO method to the average-cost method for 2013 and 2014.
(c) Prepare comparative retained earnings statements for 2013 and 2014 under the average-cost
method. Retained earnings reported under LIFO are as follows:
1
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2 • Chapter 22 Accounting Changes and Error Analysis

Retained Earnings Balance

2012 $2,500
2013 4,500
2014 6,000
(d) Prepare the note to the financial statements describing the change in method of inventory valua-
tion. In the note, indicate the income statement line items for 2013 and 2014 that were affected by
the change in accounting principle.

3 E22-4B (Accounting Changes) Fort Texas Company began operations on July 1, 2010, and has used the
average-cost method of inventory valuation since its inception. In 2014, it decides to switch to the FIFO
method. You are provided with the following information.
Net Income Retained Earnings
Under Average Cost Under FIFO Under Average Cost
2010 $ 55,000 $ 60,000 $ 55,000
2011 125,000 135,000 180,000
2012 165,000 190,000 315,000
2013 110,000 115,000 400,000

Instructions
(a) What is the beginning retained earnings balance at January 1, 2011, if Fort Texas prepares
comparative financial statements starting in 2013?
(b) What is the beginning retained earnings balance at January 1, 2013, if Fort Texas prepares
comparative financial statements starting in 2013?
(c) What is the beginning retained earnings balance at January 1, 2014, if Fort Texas prepares compar-
ative financial statements starting in 2014?
(d) What is the net income reported by Fort Texas in the 2013 income statement if it prepares
comparative financial statements starting with 2011?

3 E22-5B (Accounting Changes) Presented below are income statement prepared on a FIFO and LIFO
basis for Marvel Inc. (Prior to 2013, there were no differences due to LIFO and FIFO.) The company
presently uses the LIFO method of pricing its inventory and has decided to switch to FIFO method in
2014. The LIFO income statement is computed in accordance with GAAP requirements. Income taxes
are ignored.
LIFO Basis FIFO Basis
2013 2014 2013 2014
Sales $10,000 $10,000 $10,000 $10,000
Cost of goods sold 6,000 6,300 5,500 5,600
Operating expenses 1,500 1,500 1,500 1,500
Income before profit sharing 2,500 2,200 3,000 2,900
Profit sharing expenses 500 440 500 680
Net income $ 2,000 $ 1,760 $ 2,500 $ 2,220

Instructions
(a) If comparative income statements are prepared, what net income should Marvel report in 2013 and
2014?
(b) Marvel’s profit-sharing agreement with its top management requires a contribution of 20% of in-
come before profit sharing. Explain why, under the FIFO basis, Marvel reports $500 in 2013 and
$580 in 2014 for its profit-sharing expense.
(c) Assume that Marvel has a beginning balance of retained earnings at January 1, 2014, of $25,000
using the LIFO method. The company declared and paid dividends of $1,000 in 2014. Prepare
the retained earnings statement for 2014, assuming that Marvel has switched to the FIFO
method.

3 E22-6B (Accounting Changes—Depreciation) Hearts Inc. acquired the following assets in January 2012.
Equipment, estimated service life, 5 years; no salvage value $650,000
Building, estimated service life, 40 years; salvage value, $500,000 $5,500,000
The equipment has been depreciated using the double-declining balance method for the first 2 years for
financial reporting purposes. In 2014, the company decided to change the method of computing depre-
ciation to the straight-line method for the equipment, but no change was made in the estimated service
life or salvage value. It was also decided to change the total estimated service life of the building from
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B Exercises • 3

40 years to 35 years, with no change in the estimated salvage value. The building is depreciated on the
straight-line method.

Instructions
(a) Prepare the general journal entry to record depreciation expense for the equipment in 2014.
(b) Prepare the journal entry to record depreciation expense for the building in 2014.

5 7 E22-7B (Change in Estimate and Error; Financial Statements) Presented below are the comparative state-
ments for Titan Company.
2013 2014
Sales $640,000 $890,000
Cost of sales 480,000 565,000
Gross profit 160,000 325,000
Expenses 60,000 106,000
Net income $100,000 $219,000
Retained earnings (Jan. 1) $680,000 $740,000
Net income 100,000 219,000
Dividends (40,000) (85,000)
Retained earnings (Dec. 31) $740,000 $874,000

The following additional information is provided:

1. In 2014, Titan decided to switch its depreciation method from the straight-line method to the
double-declining-balance method. The assets were purchased at the beginning of 2013 for $200,000
with an estimated useful life of 5 years and no salvage value. (The 2014 income statement con-
tains depreciation expense of $40,000.)
2. In 2014, the company discovered that the ending inventory for 2013 was understated by $33,000;
ending inventory for 2014 is correctly stated.

Instructions
Prepare the revised income and retained earnings statement for 2013 and 2014, assuming comparative
statements.

3 5 E22-8B (Accounting for Accounting Changes and Errors) Listed below are various types of accounting
changes and errors.
7
______ 1. Change in the amortization period for a trademark.
______ 2. Change from double-declining-balance method to straight-line method of depreciation.
______ 3. Change from FIFO to average-cost inventory method.
______ 4. Change from percentage-of-completion to completed-contract method on construction
contracts.
______ 5. Change in equipment’s salvage value.
______ 6. Change due to understatement of inventory.
______ 7. Change in the rate used to compute bad debt expense.
______ 8. Change from presenting unconsolidated to consolidated financial statements.
______ 9. Change from direct write-off to allowance method of accounting for bad debts.
______ 10. Change from LIFO to average-cost inventory method.

Instructions
For each change or error, indicate how it would be accounted for using the following code letters:
a. Accounted for prospectively.
b. Accounted for retrospectively.
c. Neither of the above.

5 7 E22-9B (Error and Change in Estimate—Depreciation) Premium Doors Inc. purchased

equipment on January 1, 2013, for $250,000. At that time it was estimated that the equipment would
have a 5-year life and no salvage value. On December 31, 2014, the firm’s accountant found that the
entry for depreciation expense had been omitted in 2013. In addition, management has informed the
accountant that the company plans to switch to the sum-of-the-years’-digits method for depreciating
equipment, starting with the year 2014. At present, the company uses the straight-line method of
depreciation.
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4 • Chapter 22 Accounting Changes and Error Analysis

Instructions
Prepare the general journal entries the accountant should make at December 31, 2014. (Ignore tax effects.)
5 E22-10B (Depreciation Changes) On January 1, 2010, Apartments Plus Company purchased an apart-
ment building and related equipment that have the following useful lives, salvage values, and costs.
Building, 25-year estimated useful life, $300,000 salvage value, $2,500,000 cost
Equipment, 10-year estimated useful life, no salvage value, $300,000 cost
The building has been depreciated under the straight-line method through 2014. In 2015, the company
decided to switch to the double-declining-balance method of depreciation for the building. Apartments
Plus also decided to change the total useful life of the equipment to 12 years, with a salvage value of
$10,000 at the end of that time. The equipment is depreciated using the straight-line method.

Instructions
Prepare the journal entry(ies) necessary to record the depreciation expense on the building and equip-
ment in 2015.
5 E22-11B (Change in Estimate—Depreciation) Via Rio Co. purchased equipment for $1,000,000 which
was estimated to have a useful life of 15 years with a salvage value of $25,000 at the end of that time.
Depreciation has been entered for 5 years on a straight-line basis. In 2015, it is determined that the total
estimated life should be 10 years with no salvage value at the end of that time.

Instructions
(a) Prepare the entry (if any) to correct the prior years’ depreciation.
(b) Prepare the entry to record depreciation for 2015.
5 E22-12B (Change in Estimate—Depreciation) Zebra Corp. changed from the straight-line method to the
double-declining-balance method in 2015 on all its equipment. There was no change in the salvage val-
ues or useful lives. The equipment was purchased in 2014, and the original cost was $600,000 with no sal-
vage value and a 6-year estimated useful life. Income before depreciation expense was $560,000 in 2014
and $760,000 in 2015. Zebra’s tax rate is 40%.

Instructions
(a) Prepare the journal entry(ies) to record the change in depreciation method in 2015.
(b) Starting with income before depreciation expense, prepare the remaining portion of the income
statement for 2014 and 2015.
3 E22-13B (Change in Principle—Long-term Contracts) Black Hoe Construction changed from the
completed-contract to the percentage-of-completion method of accounting for long-term construction
contracts during 2015. For tax purposes, the company employs the completed-contract method and
will continue this approach in the future. The appropriate information related to this change is as
follows.
Pretax Income from:
Percentage-of-Completion Completed-Contract Difference
2014 $125,000 $ 25,000 $100,000
2015 360,000 200,000 160,000

Instructions
(a) Assuming that the tax rate is 40%, what is the amount of net income that would be reported in 2015?
(b) What entry(ies) are necessary to adjust the accounting records for the change in accounting
principle?
3 E22-14B (Various Changes in Principle—Inventory Methods) Below is the net income of Jonesey Lab-
oratories computed under the three inventory methods.
FIFO Average-Cost LIFO
2012 $75,000 $50,000 $30,000
2013 55,000 50,000 38,000
2014 58,000 50,000 42,000
2015 60,000 50,000 40,000

Instructions
(Ignore tax considerations.)
(a) Assume that in 2015 Jonesey decided to change from the average-cost method to the FIFO method
of pricing inventories. Prepare the journal entry necessary for the change that took place during
2015 and show net income reported for 2013, 2014, and 2015.
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B Exercises • 5

(b) Assume that in 2015 Jonesey, which had been using the LIFO method since incorporation in 2012,
changed to the average-cost method of pricing inventories. Prepare the journal entry necessary for
the change in 2015 and show net income reported for 2013, 2014, and 2015.
7 E22-15B (Error Correction Entries) The first audit of the books of Nuvo Corp. was made for the year
ended December 31, 2014. In examining the books, the auditor found that certain items had been over-
looked or incorrectly handled in the last 3 years. These items are:
1. Nuvo Corp. amortized goodwill of $400,000 recorded from an acquisition in 2013 over 40 years.
2. The company did not record the estimated warranty accrual of $66,000 at the end of 2014.
3. A patent infringement lawsuit filed against the company in 2012 was settled late in 2014. It was
determined that the company owed $100,000. The company recorded a $50,000 liability in 2013
based on its assessment at the time. The payment was charged against the accrual in 2014.
4. In 2013, the company purchased equipment for $220,000 (salvage value of $20,000) that had a use-
ful life of 5 years. The bookkeeper deducted the salvage value from the cost before applying the
double-declining balance method in each year.
5. In 2014, the company wrote off $100,000 of accounts receivable believed to be uncollectible; this
loss was charged directly to Retained Earnings.

Instructions
Prepare the journal entries necessary in 2014 to correct the books, assuming that the books have not been
closed. Disregard effects of corrections on income tax.
7 E22-16B (Error Analysis and Correcting Entry) You have been engaged to review the financial state-
ments of Water Sync Inc. In the course of your investigation you find a number of irregularities during
the current year.
1. Insurance for a 6-month period purchased on October 1 of this year was charged to prepaid insur-
ance in the amount of $5,000.
2. Year-end estimate of bonuses totaled $61,000 and was not recorded because the payment would
not be made until next year.
3. Warranty expense averages 5% on current year sales of $5,000,000. Warranty expense is automat-
ically debited for 5% of each sale. During the current year, the company also paid $225,000 in
warranty related claims. The bookkeeper thought that the payments were an expense and debited
warranty expense.
4. Office rent is paid quarterly in advance. The first quarter rent for next year ($25,000) was paid in
December and rent expense was debited.

Instructions
Prepare the necessary correcting entries, assuming that Water Sync Inc. uses a calendar-year basis.
7 E22-17B (Error Analysis and Correcting Entry) The reported net incomes for the first 2 years of US
Books Corp. were as follows: 2013, $268,000; and 2014, $412,000. Early in 2015, the following errors were
discovered.
1. Depreciation of equipment for 2013 was understated $68,500.
2. Depreciation of equipment for 2014 was overstated $39,000.
3. December 31, 2013, inventory was overstated $12,000.
4. December 31, 2014, inventory was understated $73,600.

Instructions
Prepare the correcting entry necessary when these errors are discovered. Assume that the books are closed.
(Ignore income tax considerations.)
7 9 E22-18B (Error Analysis) Six Above Company’s December 31 year-end financial statements contained
the following errors.
December 31, 2013 December 31, 2014
Ending inventory $15,600 overstated $36,000 overstated
Depreciation expense $21,500 understated —

Rent of $165,000 was prepaid in 2014 covering the 12-month period beginning July 1, 2014. The entire
amount was charged to expense in 2014. In addition, on December 31, 2014, vacant land was sold for
$65,000 cash ($5,000 cost), but the entry was not recorded until 2015. There were no other errors dur-
ing 2013 or 2014, and no corrections have been made for any of the errors. (Ignore income tax
considerations.)
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6 • Chapter 22 Accounting Changes and Error Analysis

Instructions
(a) Compute the total effect of the errors on 2015 net income.
(b) Compute the total effect of the errors on the amount of Six Above Company’s working capital at
December 31, 2015.
(c) Compute the total effect of the errors on the balance of Six Above Company’s retained earnings at
December 31, 2015.
7 9 E22-19B (Error Analysis and Correcting Entries) A partial trial balance of Opticar Corp. is as follows on
December 31, 2014.

Dr. Cr.
Supplies expense $ 35,000
Accrued salaries and wages $ 7,500
Interest receivable on investments 650
Insurance expense 156,000
Prepaid rent 36,000
Accrued interest payable 65,000

Additional adjusting data:

1. A physical count of supplies on hand on December 31, 2014, totaled $6,500.
2. Through oversight, the sales salaries of $4,000 were not accrued as of December 31, 2014.
3. The Interest Receivable on Investments account was left unchanged during 2014. Accrued interest
on investments amounts to $2,800 on December 31, 2014.
4. The unexpired portions of the insurance policies totaled $42,000 as of December 31, 2014.
5. $36,000 was paid on January 1, 2014 for the rent of a building through the end of 2015.
6. Depreciation for the year was erroneously recorded as $75,000 rather than the correct figure of $7,000.
7. A further review of depreciation calculations of prior years revealed that depreciation was over-
stated by $45,000. It was decided that this oversight should be corrected by a prior period adjustment.

Instructions
(a) Assuming that the books have not been closed, what are the adjusting entries necessary at Decem-
ber 31, 2014? (Ignore income tax considerations.)
(b) Assuming that the books have been closed, what are the adjusting entries necessary at December
31, 2014? (Ignore income tax considerations.)
(c) Repeat the requirements for transactions 6 and 7, taking into account income tax effects (use a 40%
tax rate) and assuming: (1) books have not been closed, and (2) books have been closed.
7 9 E22-20B (Error Analysis) The before-tax income for DogCat Inc. was $650,000 for 2014 and $521,800 for
2015. However, the accountant noted that the following errors had been made:
1. The bookkeeper in recording interest income for both years on an investment in 4% bonds with a
par value of $100,000 made the following entry for each year.

Cash 4,000
Interest Income 4,000

The bonds were purchased at a discount of $7,700 on January 1, 2014, to yield an effective interest
rate of 5%. (Assume that the effective-yield method should be used.)
2. Sales for 2015 included amounts of $61,000 which were delivered in 2014 and paid for in 2015. Ti-
tle passed to the purchaser upon delivery.
3. Interest of $82,500 related to the construction of a manufacturing facility had been erroneously
charged to the expense during 2014 instead of being capitalized as part of the facility’s cost. The
facility was completed and occupied on January 1, 2015. The company applies a rate of 5% to the
balance in the building account at the end of the year in its determination of depreciation charges.
4. The inventory on December 31, 2014, was overstated by $16,800.

Instructions
Prepare a schedule showing the determination of corrected income before taxes for 2014 and 2015.
7 9 E22-21B (Error Analysis) When the records of InterOne Corporation were reviewed at the close of 2015,
the errors listed below were discovered. For each item indicate by a check mark in the appropriate col-
umn whether the error resulted in an overstatement, an understatement, or had no effect on net income
for the years 2014 and 2015.
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B Exercises • 7

2014 2015
Over- Under- No Over- Under- No
Item statement statement Effect statement statement Effect
1. Failure to record accrued
interest on investment in
bonds in 2014; that amount
was recorded when received
in 2015.

2. Failure to record accrued

salaries at the end of 2014.

3. An inventory shipment that

was shipped F.O.B. shipping
point was in transit over the
end of the year and omitted
from the 2014 ending
inventory.

4. Failure to reflect supplies

on hand on balance sheet
at end of 2015.

5. Failure to record the correct

amount of ending 2015
inventory. The amount was
overstated because of
consigned inventory on hand
was included.

10 *E22-22B (Change from Fair Value to Equity) On January 1, 2014, GEO purchased 60,000 shares (a 15%
interest) in Graphic Corp. for $2,700,000. At the time, the book value and the fair value of Graphic Corp.’s
net assets were $16,000,000.
On July 1, 2015, GEO paid $3,000,000 for 60,000 additional shares of Graphic common stock, which
represented a 15% investment in Graphic. The fair value of Graphic’s identifiable assets net of liabilities
was equal to their carrying amount of $17,000,000. As a result of this transaction, GEO owns 30% of
Graphic and can exercise significant influence over Graphic’s operating and financial policies. Any excess
fair value is attributed to goodwill.
Graphic reported the following net income and declared and paid the following dividends.

Net Income Dividend per Share

Year ended 12/31/14 $500,000 None
Six months ended 6/30/15 425,000 $0.50
Six months ended 12/31/15 360,000 $0.60

Instructions
Determine the ending balance that GEO should report as its investment in Graphic Corp. at the end of
2015.
10 *E22-23B (Change from Equity to Fair Value) EchoLab Inc. was a 40% owner of Quiet Inc., holding
800,000 shares of Quiet’s common stock on December 31, 2014. The investment account had the follow-
ing entries.

Investment in Quiet
1/1/13 Cost $8,100,000 9/8/13 Dividend received $325,000
12/31/13 Share of income 650,000 9/2/14 Dividend received 400,000
12/31/14 Share of income 835,000
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8 • Chapter 22 Accounting Changes and Error Analysis

On January 1, 2014, EchoLab sold 500,000 shares of Quiet for $7,500,000, thereby losing its significant in-
fluence. During the year 2015 Quiet experienced the following results of operations and paid the follow-
ing dividends to EchoLab.

Quiet Dividends
Paid
Income (Loss) to EchoLab
$1,600,000 $310,000

At December 31, 2015, the fair value of Quiet’s shares held by EchoLab is $3,525,000. This is the first re-
porting date since the January 1 sale.

Instructions
(a) What effect does the January 1, 2015, transaction have upon EchoLab’s accounting treatment for
its investment in Quiet?
(b) Compute the carrying amount in Quiet as of December 31, 2015.
(c) Prepare the adjusting entry on December 31, 2015, applying the fair value method to EchoLab’s
long-term investment in Quiet securities.