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Exam 20: Accounting Changes and Error Corrections

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Question 61

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In December 2013, Kojak Insurance Co. received $500,000 in premiums for a two-year property insurance policy. The company recorded the transaction by debiting cash and crediting insurance premium revenue for the full amount. An internal audit conducted in early 2014 flagged this transaction.

A) Kojak needs to correct an accounting error.
B) Kojak has made a change in accounting principle, requiring retrospective adjustment.
C) Kojak is required to adjust a change in accounting estimate prospectively.
D) Kojak is not required to make any accounting adjustments.

E) B) and D)
F) C) and D)

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Question 62

Multiple Choice

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At the end of the current year, a company overstated prepaid insurance by $80,000 and understated supplies expense by $100,000. Its effective tax rate is 40%. As a result of this error, net income is:

A) Overstated by $108,000.
B) Overstated by $12,000.
C) Understated by $108,000.
D) Understated by $12,000.

E) B) and C)
F) A) and D)

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Question 63

Multiple Choice

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Accounting changes occur for which of the following reasons?

Disclosure notes related to a change in accounting principle under the retrospective approach should include:

We record and report most changes in accounting principle retrospectively, but sometimes report the changes prospectively. Explain when it is appropriate to report the changes prospectively. Provide examples.

The cumulative effect of most changes in accounting principle is reported:

Red Corp. constructed a machine at a total cost of $70 million. Construction was completed at the end of 2009 and the machine was placed in service at the beginning of 2010. The machine was being depreciated over a 10-year life using the straight-line method. The residual value is expected to be $4 million. At the beginning of 2013, Red decided to change to the sum-of-the-years'-digits method. Ignoring income taxes, what will be Red's depreciation expense for 2013?

What is the effect of the error on Berkshire's 2013 income statement?

At the end of the current year, a company failed to accrue interest of $500,000 on its investments in municipal bonds. Its tax rate is 30%. As a result of this error, net income is:

When a change in accounting principle is reported, what is sometimes sacrificed?

Error corrections require restatement of all the affected prior year financial statements reported in comparative financial statements.

Annual depreciation expense on a building purchased a few years ago (using the straight-line method) is $5,000. The cost of the building was $100,000. The current book value of the equipment (January 1, 2013) is $85,000. At the time of purchase, the asset was estimated to have a zero salvage value. On January 1, 2013, the company decided to reduce the original useful life by 25% and to establish a salvage value of $5,000. The firm also decided double-declining-balance depreciation was more appropriate. Ignore tax effects. Required: (1.) Record the journal entry, if any, to report the accounting change. (2.) Record the annual depreciation for 2013.

In the previous year, a firm failed to record premium amortization of $40,000 and $30,000, respectively, on its bonds payable and held to maturity bond investments. These errors affect both income before tax and taxable income. The firm's tax rate is 30%. As a result of this error, net income was:

Gore Inc. recorded a liability in 2013 for probable litigation losses of $2 million. Ultimately, $5 million in legitimate warranty claims were filed by Gore's customers.

After issuing its financial statements, a company discovered that its beginning inventory was overstated by $100,000. Its tax rate is 30%. As a result of this error, net income was:

Cherokee Company's auditor discovered some errors. No errors were corrected during 2012. The errors are described as follows: (1.) Beginning inventory on January 1, 2012, was understated by $5,000. (2.) A two-year insurance policy purchased on April 30, 2012, in the amount of $24,000 was debited to Prepaid Insurance. No adjustment was made on December 31, 2012, or on December 31, 2013. Required: Prepare appropriate journal entries (assume the 2013 books have not been closed). Ignore income taxes.

Cooper Inc. took physical inventory at the end of 2012. Purchases that were acquired FOB destination were in transit, so they were not included in the physical count.

Lindy Company's auditor discovered two errors. No errors were corrected during 2012. The errors are described as follows: (1.) Merchandise costing $4,000 was sold to a customer for $9,000 on December 31, 2012, but it was recorded as a sale on January 2, 2013. The merchandise was properly excluded from the 2012 ending inventory. Assume the periodic inventory system is used. (2.) A machine with a five-year life was purchased on January 1, 2012. The machine cost $20,000 and has no expected salvage value. No depreciation was taken in 2012 or 2013. Assume the straight-line method for depreciation. Required: Prepare appropriate journal entries (assume the 2013 books have not been closed). Ignore income taxes.

Hepburn Company bought a copyright for $90,000 on January 1, 2010, at which time the copyright had an estimated useful life of 15 years. On January 5, 2013, the company determined that the copyright would expire at the end of 2018. How much should Hepburn record as amortization expense for this copyright for 2013?