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Sam Houston Inc: Change in estimate, inventory, depreciation

Sam Houston Inc. was organized in late 2008 to manufacture and Sanitizing Hand Wipes. This was a response to the increase in the number of cases in America in the Fall of 2008. Most of the company's customers are Colleges and Universities. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes.
2008 $140,000a 2010 $205,000
2009 160,000b 2011 $276,000

a. Includes a $12,000 increase because of change in bad debt experience rates
b. Includes extraordinary gain of $40,000.

The company has decided to expand operations and has applied for a sizable bank loan. The company wants to get into the White Board Cleaning Fluid Business. The bank officer has indicated that the records of Sam Houston Inc. should be audited and presented in comparative statements to facilitate analysis by the bank. Sam Houston Inc. therefore hired the auditing firm of Littlejohn and Littlejohn, CPAs and has provided the following additional information to the CPA firm.

In early 2009, Sam Houston Inc. changed its estimate from 2% to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2008, if a 1% rate had been used, would have been $12,000. The company therefore restated its net income for 2008. The reduction was due to the number of credit checks performed by the company prior to extending credit.

2. In 2011, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. The effect on the income statements for the previous years is as follows.

2008 2009 2010 2011
Net income $140,000 $160,000 $205,000 $ 276,000
unadjustedâ?"LIFO
basis
Net income 155,000 165,000 215,000 260,000
unadjustedâ?"FIFO
basis
$ 15,000 $ 5,000 $ 10,000 ($ 16,000)

3. In 2009, the company changed its method of depreciation from the accelerated method to the straight-line approach. The company used the straight-line method in 2009. They found that the machines were not wearing out as fast as first predicted. The effect on the income statement for the previous year is as follows in 2009.

2008

Net income unadjustedâ?"accelerated $140,000
method
Net income unadjustedâ?"straight-line 147,000
method
$ 7,000

4. In 2011, the auditor discovered that:

a. The company incorrectly overstated the ending inventory by $11,000 in 2010.
b. A dispute developed in 2009 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2008, the company was not permitted these deductions, but a tax settlement was reached in 2011 that allowed these expenses. As a result of the court's finding, tax expenses in 2011 were reduced by $60,000.

Instructions
a. Assume we are in the year 2012.
b. Indicate how each of these changes or corrections should be handled in the accounting records. Ignore income tax considerations. Hint You should have 4 comments.
c. Present comparative income statements for the years 2008 to 2011, starting with income before extraordinary items. Do not prepare pro-forma amounts. Ignore income tax considerations.

Solution Preview

Your tutorial is in excel (attached) with instructional comments guiding you through the four reconciling items.

REQUIREMENT A. What this means is that it is too late to make entries to 2008-2011 and so these are either corrections of an error, requiring restatement, entries needed in 2012, or no entries needed at all.

REQUIREMENT B. How changes should be handled:

1. Bad debt experience. Changes in estimates, such as establishing the allowance for ...

Solution Summary

Short discussion explains each strategy and computation.

$2.19