Described below are six independent and unrelated situations involving accountin
ID: 2522373 • Letter: D
Question
Described below are six independent and unrelated situations involving accounting changes. Each change occurs during 2018 before any adjusting entries or closing entries were prepared. Assume the tax rate for each company is 40% in all years. Any tax effects should be adjusted through the deferred tax liability account.
a.) Fleming Home Products introduced a new line of commercial awnings in 2017 that carry a one-year warranty against manufacturer’s defects. Based on industry experience, warranty costs were expected to approximate 4% of sales. Sales of the awnings in 2017 were $4,000,000. Accordingly, warranty expense and a warranty liability of $160,000 were recorded in 2017. In late 2018, the company’s claims experience was evaluated and it was determined that claims were far fewer than expected: 3% of sales rather than 4%. Sales of the awnings in 2018 were $4,500,000, and warranty expenditures in 2018 totaled $102,375.
b.) On December 30, 2014, Rival Industries acquired its office building at a cost of $1,100,000. It was depreciated on a straight-line basis assuming a useful life of 40 years and no salvage value. However, plans were finalized in 2018 to relocate the company headquarters at the end of 2022. The vacated office building will have a salvage value at that time of $750,000.
c.) Hobbs-Barto Merchandising, Inc., changed inventory cost methods to LIFO from FIFO at the end of 2018 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2018, is $740,000.
d.) At the beginning of 2015, the Hoffman Group purchased office equipment at a cost of $385,000. Its useful life was estimated to be 10 years with no salvage value. The equipment was depreciated by the sum-of-the-years’-digits method. On January 1, 2018, the company changed to the straight-line method.
e.) In November 2016, the State of Minnesota filed suit against Huggins Manufacturing Company, seeking penalties for violations of clean air laws. When the financial statements were issued in 2017, Huggins had not reached a settlement with state authorities, but legal counsel advised Huggins that it was probable the company would have to pay $250,000 in penalties. Accordingly, the following entry was recorded:
f.) At the beginning of 2018, Jantzen Specialties, which uses the sum-of-the-years’-digits method, changed to the straight-line method for newly acquired buildings and equipment. The change increased current year net earnings by $500,000.
Required:
For each situation:
1. Identify the type of change.
2. Prepare any journal entry necessary as a direct result of the change as well as any adjusting entry for 2018 related to the situation described.
Explanation / Answer
EXPLANATION A -- a. 2018 adjusting entry: Warranty expense (3% × $4,500,000) = $135,000
This is a change in estimate. No entry is needed to record the change. If the effect is material, 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.
EXPLANATION B -- This is a change in estimate. No entry is needed to record the change.
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.
EXPLANATION -- C This is a change in accounting principle that usually is reported prospectively. No entry is needed to record the change.
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 ($740,000 in this case) as the base year inventory for all future LIFO calculations. The disclosure required is a footnote 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.
EXPLANATION D -- This is a change in accounting estimate resulting from a change in accounting principle.
EXPLANATION E -
Warranty expense 135000 Estimated Warranty liability 135000