Described below are six independent and unrelated situations involving accountin
ID: 2599810 • Letter: D
Question
Described below are six independent and unrelated situations involving accounting changes. Each change occurs during 2016 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 2015 that carry a one-year warranty against manufacturer’s defects. Based on industry experience, warranty costs were expected to approximate 3% of sales. Sales of the awnings in 2015 were $4,100,000. Accordingly, warranty expense and a warranty liability of $123,000 were recorded in 2015. In late 2016, the company’s claims experience was evaluated and it was determined that claims were far fewer than expected: 2% of sales rather than 3%. Sales of the awnings in 2016 were $4,600,000 and warranty expenditures in 2016 totaled $104,650. b. On December 30, 2012, Rival Industries acquired its office building at a cost of $1,120,000. It was depreciated on a straight-line basis assuming a useful life of 40 years and no salvage value. However, plans were finalized in 2016 to relocate the company headquarters at the end of 2020. The vacated office building will have a salvage value at that time of $760,000. c. Hobbs-Barto Merchandising, Inc., changed inventory cost methods to LIFO from FIFO at the end of 2016 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2016, is $750,000. d. At the beginning of 2013, the Hoffman Group purchased office equipment at a cost of $396,000. 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, 2016, the company changed to the straight-line method. e. In November 2014, 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 2015, Huggins had not reached a settlement with state authorities, but legal counsel advised Huggins that it was probable the company would have to pay $260,000 in penalties. Accordingly, the following entry was recorded: Loss—litigation 260,000 Liability—litigation 260,000 Late in 2016, a settlement was reached with state authorities to pay a total of $416,000 in penalties. f. At the beginning of 2016, 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 $511,000. 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 2016 related to the situation described. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.) ReferenceseBook & Resources General JournalLearning Objective: 20-01 Differentiate among the three types of accounting changes and distinguish between the retrospective and prospective approaches to accounting for and reporting accounting changes.Learning Objective: 20-04 E
Explanation / Answer
Solution:
a. This is a change in estimate.
No entry is needed to record the change 2016
Adjusting entry:
Warranty expense (2% x $4,100,000).....82,000
Estimated warranty liability...........................82,000
If the effect is material, a disclosure note must describe the effect of change in estimate on income before extraordinary items, net income and related per share amounts for the current period.
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 are not sufficient to find the cumulative income effect of the change necessary to retrospective revise accounts. Therefore, a company changing to LIFO generally reports the beginning inventory in the year the LIFO method is adopted $750,000 here as the base year inventory for all the future LIFO calculations. The disclosure required is a footnote to the financial statements describes the nature and justification for change as well as an explanation to why the retrospective applicable was not practicable.
d. This is a change in accounting estimate resulting from a change in accounting principle.
No entry is needed to record the change2016
Adjusting entry:
Depreciation expense New amount
Accumulated depreciation New amount
Change in depreciation method is considered a change in accounting estimate results from a change in accounting principle. Accordingly, the Hoffman groups indicates the change prospectively, previous financial statements are not revised. Instead, the company employs the straight-line method. The undepreciated cost remaining at the time of change is depreciated straight-line over the remaining useful life.
e. This is a change in estimate.
To revise the liability on the basis of the new estimate:
Loss – litigation ………….156,000
Liability – litigation ($416,000 – 260,000)………156,000
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.
f. This is a change in accounting principle accounted for prospectively.
Because the change will be effective only for the assets placed in service after the change in date, the change does not affect assets depreciated in prior period. The nature of and justification for the change should be explained in the disclosure notes. Also, the effect of change on the current period’s financial statements should be disclosed.