Question

Whaley Distributors is a wholesale distributor of electronic components. Financial statements for the years ended December 31, 2016 and 2017, reported the following amounts and subtotals (\$ in millions):

In 2018 the following situations occurred or came to light:

a. Internal auditors discovered that ending inventories reported on the financial statements the two previous years were misstated due to faulty internal controls. The errors were in the following amounts:

b. A liability was accrued in 2016 for a probable payment of \(\$ 6.6\) million in connection with a lawsuit ultimately settled in December 2018 for \(\$ 3.8\) million.

C. A patent costing \(\$ 16.8\) million at the beginning of 2016, expected to benefit operations for a total of six years, has not been amortized since acquired.

d. Whaley's conveyer equipment was depreciated by the sum-of-the-years'-digits (SYD) basis since it was acquired at the beginning of 2016 at a cost of \(\$ 27.0\) million. It has an expected useful life of five years and no expected residual value. At the beginning of 2018 , Whaley decided to switch to straight-line depreciation.

Required:

For each situation:

1. Prepare any journal entry necessary as a direct result of the change or error correction as well as any adjusting entry for 2018 related to the situation described. (lgnore tax effects.)

2. Determine the amounts to be reported for each of the five items shown below from the 2016 and 2017 financial statements when those amounts are reported again in the \(2016-2018\) comparative financial statements.

Answer 1

step: 1 of 12

Adjusting Entries

These are the journal entries that are recorded at the end of the accounting period to correct or adjust the income and expense accounts in conformity with the accrual principle of accounting.

 

step: 2 of 12

Change in estimate; useful life and residual value of equipment:

Accounting changes:

Consistency and comparability are the two qualitative characteristics of accounting information. These financial reporting attributes are maintained by every entity to ensure the reliability of the financial statements. However, changes occur and they are as shown below:

(1) Change in accounting principle

(2) Change in accounting estimate

(3) Change in reporting entity

 

step: 3 of 12

1(A)

 

Date	Account title and explanation	Debit	Credit
2018	Inventory	$9,800,000
	Retained Earnings		$9,800,000

• Inventory is an asset and it is understated by $9.8 million in 2017. In order to adjust it, Whaley distributors need to debit the inventory by $9.8million in 2018.

• Due to understatement of $9.8 million of inventory in 2017, the income also understated by the same amount in 2017. In order to correct it, retained earnings account must be credited to increase the earnings by $9.8million.

 

step: 4of 12 

1(B)

Date	Account title and explanation	Debit	Credit
2018	Liability -litigation	$6,600,000
	Gain -litigation		$2,800,000
	cash		$3,800,000
	( To record gain on litigation)

• Liability – litigation is an expense. There is a decrease in liability value. Therefore, it is debited.

• Gain on litigation would increase the equity value; thereby the loss on litigation of $2,800,000 would be compensated. Therefore, Gain on litigation is credited.

• Cash is an asset. There is a decrease in asset value. Therefore, it is credited

 

step:  5 of 12 

1(C)

Date	Account title and explanation	Debit	Credit
2018	Retained Earnings**	$5,600,000
	Patent		$5,600,000
	( To record Change in Inventory Value )

***  = {16.8 Million / 6 years}*2 years  = 5.6 Million

• In order to amortize the patent for 2 years (2016 and 2017), retained earnings must be debited to decrease the equity value.

• Patent is an asset. There is a decrease in asset value. Therefore, it is credited.

 

step:  6 of 12 

Adjustment entry for the year 2018:

Date	Account title and explanation	Debit	Credit
2018	Patent Amortization expense**	$2,800,000
	Patent		$2,800,000
	( To record amortization expense)

 

**Patent Amortization expense = {16.8 Million / 6 years}*1 year = $2.8 Million

 

step:  7 of 12 

1(D)

No journal entry to record the change of estimate.

 

step:  8 of 12 

Sum of the years’ digits depreciation:

First sum the digits in the year of the assets’ useful life. . For the first and second year the depreciable amount is {$27,000,000 x (5+4) ÷15)} = $16,200,000.

Calculate the depreciation value over remaining 3 years:

 

step:  9 of 12 

 

calculate the annual straight-line depreciation:

The calculated depreciation value over the remaining 3 years is $10,800,000 and the remaining years are 3 years.

Now, calculate the annual straight –line depreciation:

 

Annual Straight Line Depreciation = {Depreciable Value over remaining 3 years / Remaining years }

                                                         = { 10,800,000 / 3 years)

                                                         =  $3,600,000

 

step:  10of 12 

Adjustment journal 2018:

Date	Account title and explanation	Debit	Credit
2018	Depreciation  expense	$3,600,000
	Accumulated depreciation		$3,600,000
	( To record Depreciation adjustng entry)

 

 Depreciation expense is an expense. There is a decrease in liability value. Therefore, it is debited.

• Accumulated depreciation is a contra asset. There is a decrease in asset value.

 

step:  11 of 12

 

part 2)

Determine the amount to be reported for each of the given five items of financial statements when those amounts are reported again in 2016- 2018 comparative financial statements.

 

Particulars	Assets	Liability	Shareholder's Eq.	Net income	Expenses
2016	$720	$320	$400	$200	$148
2016 Inventory	($11.80)		($11.80)	($11.80)	$11.80
Loss Contigency	No Adjustment to prior years
Patent	($2.80)		($2.80)	($2.80)	$2.80
Depreciation	No Adjustment to prior years
	$705.40	$320.00	$385.40	$185.40	$162.60

 

step:  12 of 12

Particulars	Assets	Liability	Shareholder's Eq.	Net income	Expenses
2017	$800	$390	$410	$220	$173
2016 Inventory				$11.80	($11.80)
2017 Inventory	$9.80		$9.80	($9.80)	($9.80)
Loss Contigency	No Adjustment to prior years
Patent	($5.60)		($5.60)	($2.80)	$2.80
Depreciation	No Adjustment to prior years
	$804.20	$390.00	$414.20	$219.20	$154.20