Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was

ID: 2483847 • Letter: W

Question

Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was started in 2004 by two talented engineers with little business training. In 2016, the company was acquired by one of its major customers. As part of an internal audit, the following facts were discovered. The audit occurred during 2016 before any adjusting entries or closing entries were prepared.

a. A five-year casualty insurance policy was purchased at the beginning of 2014 for $36,000. The full amount was debited to insurance expense at the time.

b. Effective January 1, 2016, the company changed the salvage value used in calculating depreciation for its office building. The building cost $628,000 on December 29, 2005, and has been depreciated on a straight-line basis assuming a useful life of 40 years and a salvage value of $120,000. Declining real estate values in the area indicate that the salvage value will be no more than $30,000.

c. On December 31, 2015, merchandise inventory was overstated by $26,000 due to a mistake in the physical inventory count using the periodic inventory system.

d. The company changed inventory cost methods to FIFO from LIFO at the end of 2016 for both financial statement and income tax purposes. The change will cause a $970,000 increase in the beginning inventory at January 1, 2017.

e. At the end of 2015, the company failed to accrue $15,700 of sales commissions earned by employees during 2015. The expense was recorded when the commissions were paid in early 2016.

f. At the beginning of 2014, the company purchased a machine at a cost of $740,000. Its useful life was estimated to be 10 years with no salvage value. The machine has been depreciated by the double-declining balance method. Its book value on December 31, 2015, was $473,600. On January 1, 2016, the company changed to the straight-line method.

g. Warranty expense is determined each year as 1% of sales. Actual payment experience of recent years indicates that 0.70% is a better indication of the actual cost. Management effects the change in 2016. Credit sales for 2016 are $4,200,000; in 2015 they were $3,900,000.

Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2016 related to the situation described. (Ignore tax effects.) IF not adjusting entry is needed, please indicate "NO ADJUSTING ENTRY"

Explanation / Answer

a) Prepaid Insurance 14400 Insurance expense 7200 Retained earnings 21600 Insurance expense has been charged at time of payment of insurance premium amount excess charged would have reduced retained earnings as incomes net of expenses is transferred to retained earnings Accordingly we will reverse expense booked and transfer current year cost to current year income statement and future year amount to prepaid insurance b) Depreciation expense 15700 Accumulated depreciation 15700 Depreciation has been charged at straight line method as = ( cost of asset - salvage value) / life of assets = (628000-120000) / 40 = 12700 per year Book Value at end of 2015 = 501000 Cost of asset = 628000 Depreciation till date = 127000 = 12700 x 10 year Now amended depreciation for year 2016 onwards will be = ( book value at beginning of 2016 - revised salvage value) / remaining life of asset = ( 501000-30000)/30 = 15700 per year c) Retained earnings 26000 Merchandise Inventory 26000 Overstated closing inventory have increased profits of last year now by debiting retained earnings we will reduce increased effect of wrong valuation of merchandise inventory d) No adjusting entry As company has changed its accounting method for inventory, it will automatically be adjusted in financial statement This is not an error, it s change in accounting estimates.

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Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was

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Williams-Santana, Inc., is a manufacturer of high-tech industrial parts that was

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