Question

Hiatt Textile Corporation is planning to expand its current plant facilities and is in the process of obtaining a loan at City Bank. The bank has requested audited financial statements. Hiatt has never been audited before. It has prepared the following comparative financial statements for the years ended December 31, 2015 and 2014.

Hiatt Textile Corporation Comparative Balance Sheets December 31, 2015 and 2014
	2015	2014
Assets
Current assets:
Cash	$  602,500	$  400,000
Accounts receivable	980,000	740,000
Allowance for bad debts	(92,500)	(45,000)
Inventory	517,500	505,000
Total current assets	$2,007,500	$1,600,000

	2015	2014
Plant assets:
Property, plant, and equipment	$  417,500	$  423,750
Accumulated depreciation	(304,000)	(266,000)
Total plant assets	$  113,500	$  157,750
Total assets	$2,121,000	$1,757,750
Liabilities and Stockholders’ Equity
Liabilities:
Accounts payable	$  303,500	$  490,250
Stockholders’ equity:
Common stock, par value $25; authorized, 30,000 shares;
issued and outstanding, 26,000 shares	$  650,000	$  650,000
Retained earnings	1,167,500	617,500
Total stockholders’ equity	$1,817,500	$1,267,500
Total liabilities and stockholders’ equity	$2,121,000	$1,757,750

Hiatt Textile Corporation Comparative Income Statements For the Years Ended December 31, 2015 and 2014
	2015	2014
Sales	$2,500,000	$2,250,000
Cost of goods sold	1,075,000	987,500
Gross margin	$1,425,000	$1,262,500
Operating expenses	$  575,000	$  512,500
General and administrative expenses	300,000	262,500
	$  875,000	$  775,000
Net income	$  550,000	$  487,500

The following facts were uncovered during the audit.

• (a) On January 20, 2014, Hiatt had charged a five-year fire insurance premium to expense. The total premium amounted to $15,500.
• (b) Over the last two years, the amount of loss due to bad debts has steadily decreased. Hiatt has decided to reduce the amount of bad debt expense from 2% to 1.5% of sales, beginning with 2015. (A charge of 2% has already been made for 2015.)
• (c) The inventory account (maintained on a periodic basis) has been in error the last two years. The errors were as follows:

  2014:	Ending inventory overstated by $37,750
  2015:	Ending inventory overstated by $49,500

• (d) A machine costing $75,000, purchased on January 4, 2014, was incorrectly charged to operating expense. The machine has a useful life of 10 years and a residual value of $12,500. The straight-line depreciation method is used by Hiatt.

Instructions:

• 1. Prepare the journal entries to correct the books at December 31, 2015. The books for 2015 have not been closed. (Ignore income taxes.)
• 2. Prepare a schedule showing the computation of corrected net income for the years ended December 31, 2014 and 2015, assuming that any adjustments are to be reported on the comparative statements for the two years. Begin your schedule with the net income for each year. (Ignore income taxes.)

Answer 1

	1….Journal entries	Debit	Credit
a.	Fire Insurance premium(15500/5)	3100
	Prepaid Insurance(15500/5*3)	9300
	Prior-year item(15500/5*4)		12400
b.	Allowance for Bad debts	12500
	Bad debt expense		12500
	(2500000*(2%-1.5%))
c.	Retained earnings(2014)	37750
	Inventory		37750
	COGS	11750
	Inventory		11750
	(49500-37750)
d.	Property,plant & Equipment	75000
	Prior year item		75000
	Prior year item-Depn.(75000-12500)/10	6250
	Depn. Expense	6250
	Acc. Depn.PP&E		12500

2.Schedule showing the computation of corrected net income for the years ended December 31, 2014 and 2015
	2015	2014
Net Income	550000	487500
(Expenses)/additions to N/I
Fire Insurance premium(15500/5)	-3100	12400
Bad debt expense	-12500
COGS-understated		-37750
COGS-understated	-11750
M/c purchase incl.as opg. Exp.		75000
Depn. Exp.	-6250	-6250
Corrected net income for the year	516400	530900